IRS Finalizes Tax Reporting Rules for DeFi Crypto Digital Assets

The Internal Revenue Service has published final settlement for sales and exchanges of digital assets on the new Form 1099-DA for decentralized financial brokers, as well as transitional relief.

The requirements for decentralized financial companies begin on January 1, 2027, two years later than the rules for centralized exchanges and platforms. The new rules should generate a deluge of information reports on Form 1099-DA to the IRS of cryptocurrency brokers, traders, banks, wallet centers and taxpayers starting January 1, 2025.

The IRS and Treasury have decided to delay the initial requirements for DeFi brokers by two years, until early 2027, in response to comments on the initially proposed regulations.

“Although the proposed rule’s proposed applicability date applies to the reporting of gross proceeds from sales of digital assets made on or after January 1, 2025, the Department of the Treasury and the IRS agree that a deadline is warranted for trading front-end service providers treated as broker-dealers (DeFi brokers) under these final regulations,” states the final rule, published last Friday. “First, many of these DeFi brokers may not have systems in place to collect and store customer identity information or contracts with third-party service providers to do the same. Second, many of these DeFi brokers may also not have systems in place to collect, store and report customer transaction information or contracts with third-party service providers to do the same. Third, many of these DeFi brokers also do not have withholding systems. the backup source that would allow withholding and paying cash backup withholding tax. Based on these considerations, final §1.60451(a)(21) applies to sales of digital assets occurring on or after January 1, 2027. “

Other changes were also made to the proposed regulations, according to Jessalyn Dean, vice president of tax information reporting at Ledgible, a crypto tax and accounting software provider, in a report. LinkedIn Post.

“The broad definition of digital asset intermediary has been significantly narrowed from the proposed regulations to apply only to ‘trading front-end services’ with greater clarity and examples provided,” she wrote. “This removes from the definition of broker blockchain application layers, blockchain protocols, Internet service providers and other possible provider types in decentralized digital asset sales that are not a front-end service of trading (a newly defined term detailed in the blog). The IRS estimates that between 650 and 875 digital asset providers will meet the definition of such a digital asset intermediary.

The IRS said it intends to work closely with stakeholders to ensure proper implementation of the reporting rules, including mitigating penalties in the early stages of implementation for all cases, except particularly egregious ones, involving intentional non-compliance with these rules. To promote industry readiness to comply with the backup withholding requirements that will apply to new returns required by these final regulations, the IRS is issuing Notice 2025-3 in conjunction with the final regulations to provide transitional relief from broker reporting penalties and backup withholding under section 3406 on such sales. The Notice delays the effective date of backup withholding to January 1, 2028 for possible backup withholding obligations imposed under Section 3406 for payments that must be reported by DeFi brokers on the forms 1099-DA, Digital Asset Proceeds from Broker-Dealer Transactions, for sales transactions. .

Additionally, the notice states that the IRS will not impose penalties for a DeFi broker’s failure to deduct, withhold and pay any backup withholding tax for calendar year 2028, caused by a decrease in the value of the digital assets received between the time of the transaction giving rise to the reserve withholding tax and the time the broker liquidates 24% of the digital assets received, provided that the broker agrees to carry out such liquidation immediately thereafter the transaction giving rise to reserve withholding tax. For sales transactions completed in 2028 for customers who opened accounts with the broker before January 1, 2028, the notice further states that backup withholding will not apply to any beneficiary who provides an account number. tax identification to the broker, whether or not on a Form W-9 in the manner required, provided that the broker submits such beneficiary’s TIN to the IRS TIN matching program and receives a response indicating that the TIN provided by the beneficiary is correct.

The IRS issued additional relief Tuesday, the afternoon just before the New Year. It posted Notice 2025-07providing temporary relief allowing eligible taxpayers to rely on alternative methods to make adequate identification, within the meaning of section 1.1012-1(j)(3)(ii), with respect to units of an asset digital assets held under the custody of a broker. According to this notice, the Department of the Treasury and the IRS understand that certain digital asset brokers may not have in place, by January 1, 2025, the technology necessary to accept specific instructions or standing orders communicated by the taxpayers, and that these technological limitations could leave some taxpayers unable to make adequate identification in accordance with this section of the Internal Revenue Code. Thus, by default, all units held by these brokers that are sold, assigned or transferred would be determined according to the FIFO rule, or first in, first out rule.

Significant moment

There are no exemptions to reporting basic cost information specifically reserved for DeFi providers, Dean noted, but in most cases these trading front-end services will not provide custody services, so that the sales they must report are not covered assets. . Only declaration of raw products will be required in such cases, she added.

Nonetheless, she considers this a “historic moment for the DeFi industry,” although lawsuits have already been filed to stop the rules.

“The collection of personal customer data, tax withholding and tax reporting to the IRS is a historic moment for the DeFi industry that will have enormous implications across its fabric of existence,” he said. -she writes. “It is unclear what impact the lawsuits against the U.S. Treasury and IRS will have on these regulations, including possible flaws in the technical understanding of the DeFi ecosystem that the final regulations may have relied on. have already been filed by the Blockchain Association. Additional lawsuits may be filed in the coming weeks.

The U.S. Supreme Court’s overturning of the Chevron doctrine in Loper Bright Enterprises v. Raimondo in June, and the change in the presidential administration, will also likely impact these regulations, she noted, as well as others in the works. Guidance and Adoption of the Crypto Asset Reporting Framework by the United States

Exclusions in the regulations

There are also exclusions in the final rule regarding the definition of who must report.

“The rules focus on defining the term digital asset intermediary, focusing on individuals who provide effective service,” wrote Miles Fuller, senior director of government solutions at TaxBit, a tax compliance technology provider and crypto accountant, in an article. LinkedIn Post. “An execution service is any service that is a trading front-end service for which the type of arrangement means that the provider would know or is able to know whether the nature of the transaction involved results in reportable gross proceeds from of the sale of digital content. A trading service front end means a user interface that allows a user to enter order details and transmit those details to an automated protocol that is part of a distributed ledger network. This seems to focus on people who operate websites that allow users to do this. connect to digital asset trading protocols.

He noted that it depends on whether the person has sufficient control or influence — the standard set by the Organization for Economic Cooperation and Development in 2019 — over the trading front end. This includes the ability to modify, update or otherwise affect the terms on which the Services are provided; the ability to collect fees on transaction flow, whether or not such fees are collected; and the ability to track or receive confirmation from the distributed ledger that the order has been executed and recorded in the ledger. Contractual restrictions not required by law will not be taken into account during the analysis.

He noted that the rules expressly exclude two specific groups from the covered definition: validation services and wallet software providers.

“This is consistent with Treasury’s statement to Congress in early 2022 that validators and wallet software providers would not be subject to reporting,” Fuller said. “However, with respect to wallet software providers, Treasury notes that if a wallet software provider also provides execution services, it would be subject to reporting, but only with respect to trading services Finally, Treasury excludes from the statement any operator of a digital asset trading protocol that does not include the performance of services as defined in the rules. This last element appears to correspond to the Fifth Circuit’s opinion. regarding the holding of Tornado Cash, according to which immutable smart contracts constituting blockchain protocols are generally not elements owned or controlled by anyone.