The last few months brought scorching debates around the various proposals introduced in the U.S. Senate infrastructure bill and the crypto industry was caught right in the middle of the blaze. Lawmakers added last-minute third-party tax reporting requirements for crypto transactions to the final version of the bill that passed to the House of Representatives.

While no one was surprised that the 1099 regulations finally emerged, the industry was shocked by the impracticality of who was included in the reporting scope. Specifically, the bill’s language proposed by Senator Robert Portman from Ohio defined a broker obligated to report under internal revenue code section 6045 as, “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.”

Instead of limiting the new tax reporting requirements to exchanges or other custodians that settle cryptocurrency transactions, the law proposes to include actors that do not even have access to the information needed for 1099 reporting. Despite the assurances by Senator Portman and Senator Mark Warner in the subsequent colloquy that the requirements are not intended to be applied to certain actors, the implications of the language as written ensnare software developers who helped create the blockchain, miners who create new cryptocurrency tokens for transacting on a blockchain and node operators who are responsible for running the blockchain network, to name a few.

Hopes were quickly dashed that any amendments might occur in the House of Representatives when the House Rules Committee agreed to a process in late August that effectively blocks any amendments from being considered for the infrastructure bill.

The industry continues to employ damage control tactics, including lobbying House Democrats to include amendments in the annual Budget Resolution bill language, which is now front and center on the U.S. political stage.

The OECD is also contemplating third-party reporting for crypto transactions

The OECD is expected to release a framework for third-party reporting of cryptocurrency assets sometime this year too. According to the October 2020 Report, the requirements will build upon the existing Common Reporting Standard regime.

One of the primary debates amongst the G20 countries has been whether exchanges and custodians should report every cryptocurrency transaction occurring on their platforms. Although aggregated reporting is currently done by brokers dealing in traditional securities, governments insist that transparency is needed into every crypto transaction to ensure that taxpayers are complying with their tax obligations.

The industry argues that reporting every transaction is impractical in part because cryptocurrency is bought and sold in fractional amounts. Dispositions of tiny increments of crypto can occur hundreds or thousands of times during the year for a single taxpayer and transactions can occur on multiple exchanges for the same asset. As a result, requiring transaction level reporting from every exchange is not likely to produce an accurate picture for tax liability purposes.

What is practical for government, the industry and taxpayers?

In the U.S., most exchanges and custodians agree that third-party information reporting is needed – not only to help taxpayers comply with their income tax obligations but also to help bring legitimacy to crypto as an asset for more investors. But there are a lot of issues to consider in order for third-party reporting to be useful and practical – for all stakeholders.

Governments should consider taking a step back to first classify the various types of cryptocurrency assets transacting in the industry and determining whether all asset transactions should really be reported – or if some transactions should be reported differently. For example, the proposed U.S. legislation seems to assume that gain or loss income is derived from all cryptocurrency transactions when the reality is that there are a lot of products that may not produce gains or losses, or that may produce other types of taxable income (which should be taxed at different rates).

Governments should also be careful when identifying who is in scope for third-party information reporting. The mishaps with the U.S. legislation are an example of why lawmakers should consult with industry professionals to ensure that they are identifying who is the best equipped to provide the information they need to enforce tax compliance.

In the centralized market, the actors won’t be as difficult to identify but in the decentralized market, what is practical? In these P2P transactions, there are no third parties, and trades and fiat money is transacted between people directly. While the asset transaction details are available on the public blockchain, there is no way to identify who owns the private keys that are associated with those transactions. Should the developers of decentralized public blockchains become accountable for building in some sort of tax reporting mechanism for transactions occurring on chain?

Finally, governments should consider whether a de minimis reporting threshold for trading transactions is appropriate with some cryptocurrency transactions. For example, does the IRS really want an exchange to report the transaction that occurred when Sally used her Bitcoin to buy some Starbucks? As mentioned, crypto is often disposed of in tiny increments and the government should consider whether the cost to distinguish the tax liability for minimal amounts is worth the effort.

It is crucial for the industry to be at the table with lawmakers – but it’s just as important that lawmakers heed their advice.