Here’s how Tax1099 can help crypto exchanges with customer due diligence and 1099 reporting.
Businesses depend on due diligence in some form or another.
While identity verification can be conducted through Know Your Client processes, due diligence requires a special set of checks and criteria to validate and verify the identities of the customer.
For most businesses, identity verification is a mere step of validation used to verify the identities with the source records.
For example, most businesses obtain TINs and legal names from their independent contractors to verify the information against the IRS records. This is just one simple element of the KYC ecosystem.
But due diligence is beyond validation.
And crypto exchanges need that extra layer of verification to prevent financial crime and identity fraud.
The IRS has recently made some changes to the 1099-K reporting regime, which not only impacts the 1099-K reporting, but also the way crypto exchanges deal with their customers.
The threshold for minimum reportable gross total has been reduced from $20,000 to $600, which drastically impacts 1099-K reporting and monitoring the transaction data.
Due diligence, in this narrative, enables the crypto exchange to not only identify the customer and their data, but also enables risk assessment, risk mitigation, and prevention of regulatory noncompliance.
This is because due diligence is a part of the KYC framework with multiple layers of verifications attached to it.
Let’s look at the following discussion to understand the concepts in detail and view how Tax1099 can enable due diligence, regulatory reporting, and compliance for crypto exchanges.
So, let’s get to it.
Customer Due Diligence: For Crypto Exchanges
The amendment to the 4th AML Directive gave rise to the 5th AML Directive, which conveys that crypto exchanges will have to take the same AML and ATF measures as financial institutions to prevent the misuse of financial technology.
Anti-Money Laundering directives issued by the federal government must be followed in order to ensure that the identities are verified thoroughly, and no stone is left unturned. This is where the customer’s history with money laundering, embezzlement, and other financial crime aspects are checked.
Similarly, Anti-Terror Financing (ATF) checks enable crypto exchanges to verify if the incoming profile has any association with designated foreign terrorist organizations and regimes.
In short, KYC, AML checks, and ATF verifications collectively form the due diligence framework. The scope of verification is not limited. Businesses are advised by the EU and the federal government to conduct due diligence procedures within reason and feasibility.
Due diligence procedure has many levels to it, and you can assess and analyze various angles of risk through a variety of checks.
It’s essential to note that due diligence’s scope is not limited to risk assessment. It also has a regulatory incentive. The information obtained through the KYC processes is used for regulatory reporting, which, in turn, helps your business comply and maintain a good standing relationship with the federal agencies.
For example, when you obtain the TIN and legal name of a customer, you’re initially using the information to identify and verify the identities of the contractor through IRS TIN Matching.
However, once the customer transacts with your crypto exchange, the very TIN and legal name information is also used in 1099 reporting.
Let’s look at this in more detail.
1099 Reporting Requirements: For Crypto Exchanges
Crypto exchanges are required to report with Form 1099-K, Form 1099-B, 1042-S, 1099-R, Form 5498, and other forms to report the transaction data and issue the copies to their payees and/or customers.
Each of these forms reports a unique aspect of the crypto transaction, which enables the federal agencies to identify and assess profiles.
Form 1099-K reports the gross total paid to merchants or participating payees in settlement of third-party network and payment card transactions that occurred in a calendar year.
Form 1099-B lists out proceeds from broker and barter exchange transactions that have occurred in a year, with comprehensive details. This form requires monitoring the transaction data to ensure that the customer’s financial activity is in check.
Form 1099-R deals with distributions made as a part of the profit-sharing plans, retirement, annuities, pension, and more. So, if the crypto exchange has paid more than $10 to a participating payee in a tax year, then the same must be reported on this form.
Form 1042-S deals with foreign persons whose source income originates from the U.S. This income must be subject to withholding per section 5000C. So, if a foreign person is earning income through the crypto trade, such an income must be subject to withholding.
Tax information reported on these forms is used for due diligence purposes. It can help provide leads to validate if a certain profile is a high-risk one.
Similarly, it can be used as an additional source of information (because it’s self-evident in nature) to prevent high-risk profiles from accessing your financial technologies.
How Tax1099 Helps
Crypto exchanges have a lot to deal with.
Newer regulations, changes to 1099 reporting, and newer rules are being imposed by the federal agencies more frequently.
The IRS is focused on regulating the crypto exchanges, and you can safely bet that the tax compliance regulations will continue to become stricter.
So, it’s time to catch up with the rapidly changing regulatory ecosystem and adapt to the changes with smart technology to keep up.
Tax1099, an IRS-authorized digital tax compliance enabler, helps crypto exchanges like yours to prepare, validate, and eFile 1099 and other crypto-related forms conveniently.
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