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On 15 November 2021, President Biden signed into law the
Infrastructure Investment and Jobs Act ("IIJA"). This bipartisan
infrastructure package dedicates over $1.2 Trillion to upgrading
America's infrastructure over the next decade. Included in the
package are new authorities for the US Internal Revenue Service and
Treasury Department, giving them the power to establish tax
reporting rules for cryptocurrency transactions starting in
2023.
The provision entitled "Information Reporting for Brokers and
Digital Assets" in the IIJA is designed to bolster tax-enforcement
efforts and help pay for the spending authorized by the bill. The
bill mandates that a broker will have to report any digital-asset
transfer moved to the account of an unknown person or address. The
new rules stand to put tremendous emphasis on a broker's Know Your
Customer (KYC) and tax information reporting systems. To lower
reporting obligations, a firm will need to have a robust means of
identifying customers and accounts that receive transfers.
Passage of the IIJA followed the Report on Stablecoins that was
issued by the Presidential Working Group Report on Capital Markets
(PWG) which called for stablecoin issuers to be regulated as a
depository institution. This report called on Congress to pass
legislation subjecting these firms to prudential supervision and in
the intervening period, it outlined existing enforcement authority
possessed by the Securities and Exchange Commission (SEC),
Commodity Futures Trading Commission (CFTC) and the Financial
Stability Oversight Council (FSOC).
These two events taken together present a sea change in the
regulatory expectations for crypto brokers and firms dealing in
digital assets. Going forward, these firms will need to have
extensive KYC, AML and tax reporting infrastructure. Additionally,
if they are issuing stablecoins, they should be prepared to meet
the regulatory burdens that are expected of depository institutions
including capital requirements and strict disclosure rules.
Overview of the cryptocurrency tax rules included in the
IIJA
The IRS has historically treated cryptocurrency and other
digital assets as property, applying general
property-tax-transaction principles. Many studies have indicated
that over the years appropriate taxes have not been paid by holders
of digital assets in a substantial number of cryptocurrency
transactions.
Stemming from this, the information-reporting provision of the
Senate infrastructure bill aims to bring transparency to the market
while also giving taxpayers greater certainty as to their taxable
gains and losses related to the transaction of digital assets.
Each time a unit of cryptocurrency is traded it creates a
taxable event. This occurs whether the cryptocurrency is converted
into a fiat currency like the US dollar or another cryptocurrency
(which is treated as the sale of one digital asset and
corresponding purchase of another). This is important if the holder
of the digital asset had a substantially lower basis in the asset
when they purchased it than when they sold it. The appreciation is
taxable, depending on how long the owner holds the asset, either at
the short-term or long-term capital gains rate. Conversely, losses
on digital assets can be used to offset other taxable gains accrued
in a year[CL1] .[1]
To bring transparency to the market and increase the visibility
of taxable receipts due to the Treasury Department, the rules in
the infrastructure bill mandate that brokers must report all
digital-asset transactions "from an account maintained by such
broker to an account which is not maintained by, or an address not
associated with, a person that such broker knows or has reason to
know is also a broker." This is meant to be accomplished through an
annual tax report, such as one in the Form 1099 series or another
form the IRS may design to meet the new reporting objective. The
reporting requirements become effective January 1, 2023 and will be
required for all tax returns filed for the taxable year.
While some within in the industry fear that this provision could
lead to further regulation of digital assets outside the scope of
the bill, there is a rule of construction embedded within the
section designed to limit its impact. The rule of construction
states that:
"Nothing in this section or the amendments made by this section
shall be construed to create any inference, for any period prior to
the effective date of such amendments, with respect to —
(1) whether any person is a broker under section 6045(c)(1) of
the Internal Revenue Code of 1986, or
(2) whether any digital asset is property which is a specified
security under section 6045(g)(3)(B) of such Code."
Definition of "digital-asset broker" continues to
generate controversy
A particularly contentious part of the provision relates to the
definition of a "digital-asset broker." The provision states that a
digital-asset broker will constitute, "any person who (for
consideration) is responsible for regularly providing any service
effectuating transfers of digital assets on behalf of another
person."
Many prominent proponents of cryptocurrency and digital assets
fear this definition is too broad and may potentially capture
cryptocurrency miners and software developers—harming
innovation in the sector and possibly causing software developers
to move overseas.
An intense cryptocurrency lobbying effort sought to amend the
provision to explicitly exempt miners, validators, and software
developers. While this effort did produce compromise language
(endorsed by Treasury Secretary Janet Yellen), the amendment did
not make it into the bill prior to passage in the Senate and
House.
Despite the compromise language failing to make it into the IIJA
prior to it becoming law, broad application of the provision may
still be avoided. As with all federal rules, after the Treasury
Department issues regulations to implement the law, there will be a
period during which interested parties can comment and give their
view. Broad application would only happen if the Treasury
Department takes a very wide view when writing the implementing
regulations. This would be inconsistent with their public support
of the compromise language that was specifically designed to exempt
software developers, validators, and miners.
PWG issues Report on Stablecoins which calls for
stablecoin issuers to be regulated as depository
institutions
The PWG is a working group that is chaired by the Treasury
Secretary and has representatives of all the major financial
regulators that report to the Secretary including the Chairmen of
the SEC, the Chair of CFTC, the head of the Federal Deposit
Insurance Corporation (FDIC), the Comptroller of Currency (OCC) and
representatives from the Federal Reserve. Earlier this year
Secretary Yellen chaired a public meeting to discuss the systemic
risks posed by stablecoins and committed to releasing a public
report that would outline the administrations approach to
regulating this class of digital assets.
This report was eagerly anticipated for the signals it would
give to stablecoin issuers as to what they can expect from the
Biden administration. The findings of the report represent close to
worst case scenario for these companies. In the report the PWG
outlined the immense risks posed by stablecoins and how a potential
run on an individual stablecoin could pose systemic risk to the
financial system.
The report also highlighted the current regulatory gaps that
exist, posing challenges for regulators to address the risks
identified in the report. Its main recommendation is for Congress
to pass legislation designating these companies as depository
institutions subjecting them to prudential regulations by the OCC
and FDIC. In the intervening period prior to legislation being
signed into law, the report highlights the existing enforcement
authorities of the SEC and CFTC and how they can be used to address
the risks posed by stablecoins.
Most importantly the report highlighted the role the FSOC could
play in addressing the systemic risks posed by these assets. The
FSOC was created by the Dodd-Frank Act and is a council led by the
Treasury Secretary that is empowered to identify and regulate firms
that pose a systemic risk to the financial system. The report
stated clearly that the FSOC was in position to designate
stablecoin issuers as systemically important financial institutions
if Congress and the regulatory agencies fail to act. Such a
designation would subject those firms to prudential supervision,
even in lieu of an act of Congress.
What do digital-asset brokers need to know?
US-based financial firms, such as cryptocurrency exchanges and
banks, planning to offer digital assets to their clients should be
prepared to comply with the new reporting rules. Foreign exchanges
and financial firms that allow US clients to transact digital
assets are also expected to be subject to the regulations. These
firms will have to send outreach communications to all of their US
clients informing them of the new tax-reporting requirements.
Stablecoin issuers in particular should be prepared to be regulated
as depository institutions and will need to have on hand the
expertise, compliance and technological infrastructure to meet the
rigorous standards expected of banking institutions.
Firms will also have to upgrade their onboarding processes and
systems to ensure that they can properly identify their clients,
their accounts and addresses, the beneficial owners of these
accounts, and the accounts and addresses to which their clients
will be transferring digital assets. This will be of paramount
importance since reporting obligations would kick in at the point
when a broker is unaware of the account or address to which the
digital asset is being transferred. New Procedures will be required
to flag and manage transactions when a client, beneficial owner, or
asset transfer involves an individual or entity that may be a
sanctioned or represent political or anti-money laundering
risk.
Cryptocurrency, by its nature, is opaque and subject to
heightened money laundering risks because most transactions and
digital wallets are anonymized. This creates tremendous burdens on
firms and law enforcement agencies seeking to enforce Anti-Money
Laundering (AML) and Counter-Terrorism Finance (CFT) laws.
Cryptocurrency, given its use to facilitate illegal activity and
tax evasion (as per the IRS), currently has a critical detection
challenge. Despite constituting a relatively small portion of
today's business income, cryptocurrency transactions are likely to
rise in importance in the next decade. Exchanges and other
financial firms offering digital assets are broadly subjected to
the US Bank Secrecy Act and AML rules. So, they will not only need
to ensure they are properly identifying account owners and
beneficial owners but also able to handle the potential influx of
volumes and remediation stemming from new measures. Broader changes
in AML/CFT regulations are likely to come in H2 2021, with
cryptocurrency transactions valued over $10,000 subject to
heightened reporting.
Additionally, firms must upgrade their tax-preparation
capabilities including the possibility of cost basis calculations,
since they will have to produce increased volumes of Forms 1099
issued to all their US account holders on annual basis after 2023.
There is also a risk the IRS could expand the information reporting
to transfers by non-US clients in the final regulations. In
addition, certified TINs are currently generally required for
brokerage accounts (established after 1983), and it is reasonable
to expect that this would be applicable to reporting for digital
assets as well. Reg. 31.3406(d)-1(c)(2) which delineates the
requirement for certified TINs is not entirely clear as it
references a "brokerage account." Due to the expanded definition of
a broker it seems reasonable to conclude an account opened with
someone that falls into the definition of broker for purposes of
section 6045 will require a certified TIN. The collection of
certified TINs will likely require a significant remediation
effort. Brokers cannot simply make prospective changes to their
onboarding process.
Are NFTs being treated differently?
NFTs would also be included in the definition of digital assets
and presumably they will be subject to cost basis reporting as
well. One area to clarify are NFT marketplaces. The NFT marketplace
may be organized in different ways, where an intermediary may step
in to process payments and others where payments are peer-to-peer.
The structure may matter as to whether and what information
reporting rules apply. Potentially for these marketplaces, you
could see third party payment processor (Form 1099-K) filing
obligations, or broker reporting or possibly application of barter
exchange rules. So it will be interesting to see the direction the
IRS takes when issuing final regulations.
For stablecoin issuers, they are faced with the prosect of
having to comply with the requirements embedded in the IIJA as well
as the additional requirements expected of depository institutions.
This prospect has the potential to have a chilling effect on new
stablecoin issuers, discouraging new entrants in the market. It is
far less likely existing firms will consider issuing a stablecoin
if they believed that doing so would subject the firm to prudential
regulation.
Wash sales and cost-basis
Another area of great concern has to do with wash sales. The
current thinking from practitioners is that wash sales rules do not
currently apply to common cryptocurrencies as they are not stock or
securities. And while not necessarily covered under IIJA, there is
a proposal in the Build Back Better Act under consideration in
Congress currently that would expand wash sales rules to cover
digital assets among other items. The provision also expands the
application of wash sales to actions by related persons. The
proposed amendments are to be effective for dispositions occurring
after December 31, 2021. Wash sales would certainly increase the
difficulty for conducting cost basis reporting for crypto assets.
However, for Form 1099-B reporting purposes, broker wash sale
reporting is currently limited to wash sales within the same
account. Note that this effective date differs from the effective
date for when digital assets are treated as covered securities for
cost basis reporting (digital assets acquired on or after January
1, 2023). It will be useful to monitor developments on the Build
Back Better Act to see whether and when the expanded wash sales
provision may be enacted.
What do digital-asset owners need to know?
Owners of cryptocurrency and digital assets should familiarize
themselves with the tax rules, specifically regarding the basis
used to establish their assets for any taxable gain or loss. They
should be prepared to receive a Form 1099 (or other applicable form
drafted by the IRS) from all brokers making transactions with their
digital assets and should be prepared to incorporate gains or
losses into annual tax returns.
Most important for the owners of digital assets, is having a
clear understanding the evolving tax rules around emerging assets.
Since 2019, the IRS has made clear that it considers "hard forks"
to be taxable events (notable given Ethereum's London hard fork
that took place on 5 August 2021). Further, the IRS has published
FAQs reminding taxpayers that crypto transactions remain reportable
by the taxpayer, regardless of receipt of a Form 1099, W-2, etc.
This is in addition to the IRS specifically asking on Form 1040
whether a taxpayer has at any time during a tax year received,
sold, sent, exchanged, or otherwise acquired any financial interest
in any virtual currency.
Cryptocurrency owners should also be prepared to undergo more
KYC reviews by the firms with which they transact. This will
include being involved in periodic refresh processes firms will
utilize to ensure they have accurate, up-to-date customer data.
Owners should be prepared to provide current information on their
location, tax status, citizenship, and other information needed to
comply with AML and CFT regulations.
The days of anonymously transacting digital assets through
American financial firms and digital-currency brokers
would seem to be over.
How IHS Markit Can Help
The wide definition of "broker" under Infrastructure Investment
and Jobs Act has the potential to create reporting obligations for
almost every financial firm transacting in digital assets. Firms
should be prepared for these reporting rules by addressing the
systems they utilize for client outreach, KYC,
and tax-compliance
obligations. IHS Markit offers a comprehensive suite of products in
all three of these areas, designed to help firms comply with
regulatory obligations.
Counterparty Manager and Outreach360
IHS Markit offers an industry-leading platform enabling
financial firms to track required regulatory information for their
clients and engage in outreach as necessary. This platform includes
the capabilities of Outreach 360, allowing a firm to conduct a
unified outreach campaign to contact all of its affected clients.
Outreach 360 can be purchased by a client to utilize in-house or as
a managed-service offering where IHS Markit personnel will work to
conduct in outreach combination with and on behalf of the client.
Such outreach will be necessary to inform clients of the upcoming
tax reporting rules, as well as activity to retrieve any
outstanding information needed to comply with the KYC and tax
requirements of the reporting regime.
For firms that offer Stablecoins or expect to offer products
that derive their value from another asset, IHS Markit offers a
comprehensive managed-service offering that can help firms perform
outreach to their clients and receive the required regulatory
information to comply with the SEC SBS regulatory regime. In
addition to the managed services team, IHS Markit has a partnership
with the International Swaps and Derivatives Association (ISDA) on
the ISDA Amend platform. ISDA Amend is an industry-leading platform
that allows swap dealers, security-based swap dealers, and their
counterparties to exchange the required regulatory information
required to comply with the CFTC swaps and SEC SBS regulatory
regime including specific modules related to the ISDA SBS Protocol
and ISDA SBS Top-Up Protocol. Find out more
KYC
Having accurate information to identify your customers is of
paramount importance and these needs will only be heightened by the
requirements of the cryptocurrency reporting regime. The more
information a firm possesses on their clients and the accounts to
which they are transferring their digital assets, the lower their
reporting requirements will be under the regime established in the
Infrastructure Investment and Jobs Act.
All Bitcoin transactions can be traced in the permanent ledger
of Blockchain. But account ownership and wallet information is not
public. With the right tools and analytics, investigators and
law-enforcement can analyze cryptocurrency transactions and
linkages to IP addresses, cryptocurrency wallets, and
integrated-entity data to help find tax evasion, money laundering,
and other illegal activity. IHS Markit has extensive tools that can
help these larger KYC volumes including dedicated support from our
managed-services team. Find out
more
IHS Markit Know Your 3rd Party (KY3P) for VASPs &
Crypto Brokers
Participants in the cryptomarket and cryptocustody are required
to manage the risk of third parties, and with the implementation of
the FATF Travel Rule, they must also conduct due diligence on the
network of virtual-asset service providers or VASPs. As part of the
onboarding process and on an ongoing basis (e.g., annually),
participants must conduct compliance due diligence reviews of all
VASPs participating in the network. This assessment must validate
the adequacy of each VASP's respective BSA/AML and OFAC compliance
programs, which would include vendor due diligence, AML
requirements, and screening for sanctions and OFAC compliance. In
addition, at the point of onboarding and on an ongoing basis,
participants must screen for cyberrisk, data privacy, and data
security controls. The rules and guidelines are extensive, and
we've built the largest financial network in our KY3P and KYC
programs to address the requirements of the travel rule for
cryptomarket participants including the tracking of SLAs, audit
mechanisms, and the ability to ensure complex onsite and remote due
diligence is being conducted to meet requirements. Our
shared-assessment services make a huge efficiency and
cost-reduction impact on the financial services industry, crypto,
and corporate customers. KY3P standardizes supplier-risk
assessments including those of policies, procedures and document,
and supplier interviews, providing measurable observations. KY3P
teams execute this service as a shared-data utility model with rich
third-party and proprietary datasets to reduce costs. Find out
more
IHS Markit Tax Solutions
IHS Markit offers a three-pronged approach to help brokers meet
their tax-compliance obligations. This includes industry-leading
technology to solicit and maintain tax documentation and produce
complete and accurate information reporting that meets the IRS
regulatory requirements. The technology is available for use
in-house or via our managed-service team. We provide advisory
services relating to tax compliance regimes, US tax withholding and
information-return reporting, periodic reviews, and compliance
health checks. Our key people have over 100 years of combined
experience in the field and are also members of the various
cryptocurrency working groups with the OECD, IRS, and within the
industry.
We use the unique combination of expertise, software, and
managed services to offer clients a flexible solution that meets
their needs and helps them meet their tax-compliance obligations.
We can help identify obligations, assist with rapid onboarding of
new account and required re-documentation of existing accounts,
document and maintain required information, identify any required
withholding and reporting, and streamline the process from
beginning to reporting. Because of this integrated and robust
solution, we are able to provide everything in a strong control
environment at a much lower cost than maintaining the
infrastructure and expertise internally. Cryptocurrency cost-basis
information can also be captured and maintained as part of the
offering, together with existing positions or as a separate
standalone process.
Our offerings include, collecting and validating account holder
tax forms, ensuring TINs are certified, and assisting with their
B-Notice process. We can assist with cost basis calculations for
cryptoproducts in addition to traditional securities. We also
provide information reporting including Forms 1099-B, 1042-S, and
expanded FATCA and CRS reporting as they are introduced. All of the
offerings can work together in a strong control environment,
allowing for a streamlined and cost-efficient solution, tailored
the specific requirements of each client. Find out
more
Read similar articles:
What the US infrastructure bill means for cryptocurrency
brokers and owners
[1]
Please note the ability to recognize taxable losses on digital
assets held for less than a month has the potential to be effected
by the prohibition on wash sales included in President Biden's
Build Back Better Act, which is progressing through the
reconciliation process in the US Senate.
[CL1] A sentence on the wash sales
provisions of the Build Back Better bill would be appropriate here.
If even to direct the reader to the paragraph Bill added.
IHS Markit provides industry-leading data, software and technology platforms and managed services to tackle some of the most difficult challenges in financial markets. We help our customers better understand complicated markets, reduce risk, operate more efficiently and comply with financial regulation.
This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.
S&P Global KY3P® is proud to co-sponsor Vendor & Third Party Risk USA with our own Peter Pernebo speaking on 1 June… https://t.co/x9Sj4WxoBJ
May 12
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