IRS Proposed Rule Could Kill Crypto in America

IRS Proposed Rule Could Kill Crypto in America

The End of DeFi in the United States: How the IRS Proposal Could Kill Crypto

Nearly two years ago, the Infrastructure and Jobs Act (IIJA) passed, marking a significant milestone in the regulation of digital asset transactions. The bill expanded broker information reporting to include digital assets and mandated Internal Revenue Service (IRS) rulemaking to implement the statute. However, the recently proposed rule by the IRS has the potential to cripple the crypto industry in America.

The proposed rule requires newly designated brokers to report sales and exchanges of digital assets, extending the reporting obligations to a wider range of individuals and projects. While stakers and miners are exempt from the reporting requirements, the breadth of the proposal poses a threat to all participants in the ecosystem.

Expanding the definitions of “digital assets” and “broker” would lead to the inclusion of individuals and projects that would not have fallen under the scope of tax reporting obligations. These newly designated brokers would need to collect personal information from users, such as their name, address, and tax identification number. They would then be required to furnish users with a form 1099 to assist in calculating gains and losses on digital asset sales facilitated by the brokers.

Privacy, security, and accessibility to decentralized protocols are major concerns raised by the proposed rule. The requirement to collect personal information raises privacy concerns for users. Additionally, the proposed reporting obligations could create unworkable conditions for various participants in the digital asset ecosystem, leading to the shutdown of operations or relocation of projects offshore. This would ultimately hinder U.S. innovation in blockchain technology.

Moreover, compliance with the proposed reporting requirements would be impossible for decentralized systems lacking a central point of control. This could result in catastrophic consequences for the decentralized use of digital assets, as it would force centralization, introduce unnecessary intermediaries, and make it virtually impossible to access or develop decentralized technology in the United States.

In summary, if the proposed rule remains unchanged, it would effectively spell the end of Decentralized Finance (DeFi) in the United States. This highlights the far-reaching and negative effects that can arise from rulemaking.

One crucial aspect that the IRS needs to consider is the unique characteristics of digital assets when applying tax codes. While the IRS has released the proposed rulemaking, it has done so nearly two years after the passage of the IIJA. For the digital asset ecosystem to have clarity in tax matters, it requires timely and well-informed guidance from the IRS, which has unfortunately been lacking thus far.

To illustrate, the IRS’s staking guidance released in July simplified the description of staking, failing to recognize its complexities. It does not differentiate whether staking rewards consist of transfers of existing digital assets from other holders or newly minted assets. The tax treatment can differ significantly depending on the scenario. The guidance also overlooks liquid staking and delegated staking.

Staking rewards should be treated as property created by the taxpayer and taxed upon sale rather than receipt. Just like a farmer who grows corn pays tax only when selling the corn, staking rewards should be subject to taxation at the point of sale rather than when received.

Clarity in the taxation of digital assets is not only necessary for staking but also for other areas within the industry. However, this clarity must not hinder the development, innovation, and utility of digital assets. Given that digital assets have unique characteristics, they deserve individual consideration when applying the tax codes to this emerging space.

For any hope of improving the proposed rule and the tax treatment of digital assets, the industry must clearly communicate to Washington that the IRS’s digital asset tax agenda is unworkable and needs revision. Industry participants should consider submitting comments for the proposed rule, as the Department of the Treasury and IRS are accepting responses until October 30th.

This proposed broker rule serves as a stark warning, illustrating how the broad application of tax policy to digital assets can have deadly consequences for a new and emerging industry.

Table of Contents

1. The Impact of the Proposed Rule on the Crypto Industry
2. Privacy, Security, and Decentralized Protocols
3. Unworkable Reporting Requirements and Inhibition of Innovation
4. The Threat to Decentralized Finance (DeFi)
5. The Need for Individual Consideration in Taxation
6. Clarity and Innovation in Digital Assets Taxation
7. Call for Industry Action and Submitting Comments
8. Lessons from the Proposed Broker Rule

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