Recent action from Washington D.C. will soon change the way you report digital assets with a proposed new IRS form, 1099-DA.
If you buy and trade digital assets, you’ll want to take note.
Previously, the IRS required digital assets to be reported as third-party payments with Form 1099-K. Within the last year, federal laws were passed that will soon change the way the purchase, sale, and trade of cryptocurrency and NFTs are reported to ensure accurate reporting and compliance. With these changes comes a proposed new form, 1099-DA.
Below, you’ll read about the new IRS Form 1099-DA, what prompted its creation, how reporting will change, and how businesses can stay ahead in their preparation for tax season.
What Is Form 1099-DA?
Form 1099-DA is expected to roll out in the 2023 tax year and will be specialized on the basis of accurately reporting capital gains and losses from digital asset investments. We don’t know yet what the form will look like, but it will likely resemble Form 1099-B, which some had previously used for digital asset reporting. This form is generated during the sale or exchange of stocks, cash, or other properties.
The specific type of reporting on 1099-DA should be similar to the 1099-B in that taxes are based on the type of assets, cost-basis, fair market value, and holding period. To many, these additions to crypto tax reporting will help solidify the emerging industry as well as lower the barrier to entry for people who are interested to begin investing in crypto. The reporting change also ensures accurate capital gains reporting, which under the previous 1099-K digital asset reporting increased an investor’s tax liability.
Many investing in crypto already use 1099-B to report their digital earnings and purchases, although many also utilize form 1099-K, which was designed for third-party payments and tends to overtax and inaccurately report cryptocurrency gains and earnings.
When the 1099-DA is released, problems that are prominent in Form 1099-K reporting, such as the overtaxing of crypto traders, will be avoided while making the language in the form more specific to digital assets unlike 1099-B.
What Prompted The Changes To Cryptocurrency Reporting?
There are many reasons why digital asset reporting has captured the attention of the IRS. The IRS wants to be certain that cryptocurrency and other digital assets are properly accounted for and that those in the exchange are verified and legitimate. Similar to buying, trading, and selling any asset, the staking and mining of cryptocurrency is now equally subjected to taxing. It also ensures that digital asset exchanges are now subjected to the same regulations as financial institutions.
Senator Rob Portman championed changes to the digital asset space to ensure accurate reporting in the emerging industry. He was a key author of the Infrastructure Bill Act signed by President Biden which includes the reporting changes that lead to the form’s creation.
“Cryptocurrency is a digital asset that more and more people are investing in, and we should want that to continue in a healthy and sustainable way,” Portman said in a joint statement with other lawmakers regarding these components of the bill. “Standardizing this basic information reporting by crypto brokers for tax purposes is going to help provide more certainty for everyday Americans looking to invest in these digital assets.”
While these changes seem like a way to target and tax digital assets, the reporting changes will be designed to fix flaws and ensure the accuracy of IRS reporting.
What Are The Changes In The Reporting? How Is Form 1099-DA Different From 1099-B And 1099-K?
Previously, tax reporting for crypto/digital assets was done using Form 1099-B and 1099-K, where the former is used to report broker and barter exchanges to report a gain on capital assets and the latter is used for third-party payments. 1099-B reporting differs from 1099-K in that it reports individual transactions that detail many things, including a description of the item, the date it was acquired/sold, the amount of the acquisition/sale, and any federal tax withholdings.
Form 1099-B is used by some due to cryptocurrency’s similarities to stock trading. But it often presents challenges for crypto exchanges since the decentralized, easily-transferable nature of crypto can make it difficult to calculate an asset’s cost basis information.
Here’s an example: when shares are traded on the NYSE or other traditional exchanges, there is a means to track the buyer’s number of shares, cost-basis, fair market value, and holding period. The same doesn’t really exist for crypto trades.
For example, a trader might transfer cryptocurrency between wallets on two different exchanges and then sell the asset on the second exchange. The second exchange would know the amount the crypto sold for and the date it was sold, but it wouldn’t know the same information about the crypto’s acquisition.
1099-K is also used by credit card companies and third-party payment processors. This is significant because initially, the minimum amount to report on 1099-K was $20,000 with a minimum threshold of at least 200 transactions. However, there were many flaws to this reporting, one being the proliferation of gig economy employment as well as crypto trading platforms.
The main flaw, however, is the lack of cost basis (initial investment amount) and other portfolio information. Due to a lack of information, crypto traders were being taxed for capital gains based on the entirety of their portfolios’ worth, instead of the actual gain/profit realized.
The reporting for 1099-K has changed since, with credit card companies and third-party processors being assessed for a minimum of $600 regardless of the number of transactions.
Many thought that crypto payments would fall under this new rule, but it appears that the new regulation from lawmakers to track these payments more accurately is on the way.
No matter the forms you’ve been using, tracking digital asset portfolios is tricky due to the frenetic pace of the cryptocurrency ecosystem. Due to crypto’s transferability between digital wallets as well as its liquidity when used as a currency, it is hard to track a digital asset holder’s information. Therefore, it would be unable to determine the gains or losses a trader made on the transaction.
The missing pieces of information from 1099-B and 1099-K are what 1099-DA is aiming to provide for digital assets. The proposed form and new reporting aim to keep your tax liability lower and enable investors to remain more compliant with tax laws and guidelines from financial institutions and government agencies.
Preparing For Tax Season And Staying Ahead
Washington has made it clear that crypto platforms should adhere to the same standards as traditional financial institutions. This includes KYC document collection as well as W8/W9 collection to remain FATCA/CRS compliant. In addition to this, the definition of a “broker” in the eyes of the IRS has expanded to fit the digital environment. This has been the topic of much debate.
Many believe that the supporting businesses like miners, digital wallet providers, and other tailored custodial services need not be subject to the same regulations as legitimate crypto brokers. However, financial regulatory agencies continue to disagree. SEC Chairperson Gary Gensler believes intermediaries in the crypto market provide a mixture of functions that are regulated by the SEC, including exchange functions, broker-dealer functions, custodial and clearing functions, and lending functions. He believes these functions serve the role of a broker. To ensure that crypto operates as valid securities, these platforms should be registered according to those laws.
“Many crypto intermediaries provide lending functions for a return,” Gensler said earlier this month at Practising Law Institute’s SEC Speaks 2022.
“If a lending platform is offering and selling securities, it too comes under SEC jurisdiction.”
He adds “Crypto investors should benefit from exchange rulebooks that protect against fraud, manipulation, front-running, wash sales, and other misconduct. Crypto intermediaries also engage in the business of effecting transactions in crypto security tokens for the account of others, which makes them brokers, or engage in the business of buying and selling crypto security tokens for their own account, which makes them dealers.”
The SEC’s message is clear: to remain legitimate, cryptocurrency exchanges, miners, and wallets will all have to adhere to the new tax compliance reporting. This means crypto exchanges will report accurate trading information and go deeper into KYB/KYC as changes take place while assets are shuffled around and well beyond. The diligent actions necessary to ensure compliance include verifying users on your platform with checks that include TIN Verification, OFAC checks, FATCA (including Foreign Account Tax Compliance Act List) validation, Politically Exposed People diligence, and the Death Master File verification checks. They not only level the playing field between exchanges and traditional institutions, but also place requirements on other facets of the industry that are standard in broker exchanges.
For those who want to mitigate risk or business owners struggling to keep up with the moving target of compliance, you can use a real-time verification platform like Compliancely powered by Zenwork to validate the vendors you onboard. Compliancely provides Real-Time TIN & Name Matching with results that are returned within seconds. Additional checks include:
- Specially Designated Nationals
- FATCA List
- European Sanctions List
- Denied Persons List
- Politically Exposed People
- Death Master File
Compliancely’s results guarantee accuracy because the information is derived from the originating source.
Also, using informational tax software like Tax1099 (also powered by Zenwork) can also navigate you through these changes. Ahead of the filing season, onboard your users by verifying their identity with our W8/W9 Collection and their tax identification number with Real-Time TIN matching. Once the IRS shifts to form 1099-DA, we will have that form available for eFile along with many others that can be useful to your organization, including W-2 Filings, 1099-NEC, 1099-MISC, and many others. These features are available not only through our UI, but can also be customized through our powerful API.
The Gold Rush excitement that comes with cryptocurrency exchanges doesn’t have to end with IRS regulation. With accurate tracking of payments and onboarding users and vendors, crypto traders can still enjoy buying, trading, and reaping the benefits of this ecosystem and remain compliant with IRS/SEC guidelines.