The IRS is working on a new tax form to capture your crypto activity

What happened

The Infrastructure Act passed by the US Congress in 2021 brought cryptocurrency exchanges under the controversial “broker” definition and subject to the IRS information reporting regime. As a result, beginning January 1, cryptocurrency exchanges will be required to report their clients’ annual cryptocurrency gains and losses to the Internal Revenue Service, just like stockbrokers.

The Treasury makes regulations related to the Infrastructure Act. Regulations (often referred to as Regs) interpret legislation and give specific instructions on how to comply with the law. As part of the Regs, the IRS is reportedly working to introduce a brand new tax form called Form 1099-DA for exchanges to capture individual annual cryptocurrency activity that is subject to taxation. The draft Regs are expected to come out in the next few months, and for now the details of the form and the information it will capture are unknown. If adopted, exchanges will use the new form to report your cryptocurrency gains and losses to the IRS.

Key concepts

What are 1099s?

A 1099 is a form filled out by financial institutions that summarizes a customer’s annual activity that is subject to tax. There are a few different types, including: 1099-Bs (income from brokerage and barter transactions) issued by stockbrokers to report annual gains and losses arising from stock transactions; 1099-INT (Interest Income) forms, which are used by financial institutions to report annual interest income; and 1099-MISC (Miscellaneous Information) forms that some cryptocurrency exchanges use to report stakes and similar types of income.

There are three copies to each 1099 form – copy A, copy 1, and copy B. The first two are filed with the IRS and the taxpayer’s state, respectively, by the financial institution. Copy B is sent out to clients to be filed with their taxes.

For example, let’s say you bought a unit of $TSLA for $500 and sold it for $1,200 on Robinhood during 2021. In January of this year, Robinhood was required to file a Form 1099-B showing $700 ($1,200 – $500) in capital gains taxable. Copy A and Copy 1 report this amount to the tax authorities and your state, respectively. You will receive copy B to help you file your taxes.

The purpose of 1099s

Thanks to information reported to the IRS by financial institutions through 1099s, the agency knows your annual gains and losses for you register your tax. If you submit a return without including that activity, the IRS may automatically detect the discrepancy and send you a tax notice to correct the error. Thus, 1099s help ensure that taxpayers who engage in income-generating activities with financial institutions are tax compliant.

Form 1099-DA

Currently, there is no dedicated 1099 form to capture one’s annual cryptocurrency gains and losses. In the absence of a cryptocurrency-specific tax form, some exchanges have used Form 1099-K to report cryptocurrency activity in the past. Some have decided not to issue a profit and loss statement. As a result, the information reported to the tax authorities by exchanges has been poor to non-existent for a long time.

This has led to lower tax compliance rates among crypto users. Because clients do not receive a form at the end of the year, they mistakenly believe there is no activity to report and no tax to pay.

For example, 99% of taxpayers report wage income when they receive a Form W-2 (Wage and Tax Statement) from employers. Over 80% of stock account holders report capital gains and pay taxes when they receive a Form 1099-B from brokerages that summarizes their annual capital gain/loss activity. On the other hand, if a third party does not generate a tax form, more than 50% of taxpayers do not comply with taxes. (U.S. Government Accountability Office)

Form 1099-DA aims to change this by capturing cryptocurrency activity and mandating exchanges to report it to the IRS on an annual basis. It is reasonable to expect that this new form will report the information necessary to calculate gains (or losses), such as asset type, purchase date, sale date, gross proceeds and cost basis.

1099-DA potential pitfalls for multi-exchange users

While information reporting has clearly increased tax compliance in many non-crypto-related areas, following the same traditional system in crypto could easily create more loopholes or even fail due to decentralized finance, transfers and self-custody.

Fast-growing DeFi exchanges such as Uniswap and dYdX will not be able to issue any form of 1099s because they do not collect so-called Know-Your-Customer (KYC) information (name, address and social security number) from users. This information is usually required to file any form of 1099 with the IRS and the states.

Additionally, asset transfers between crypto wallets and exchanges are extremely common compared to the traditional securities world. These transfers between centralized exchanges to/from DeFi and non-compliant foreign exchanges will also result in incomplete and inaccurate 1099s due to gaps in cost bases.

Also, self-storage is common in the crypto world to ensure the privacy and security of assets. Self-service assets will also make it more difficult for exchanges to issue complete 1099s because the cost basis is usually not available.

Finally, users of multiple exchanges will likely receive multiple 1099-DAs from different platforms. This can lead to confusion and will require taxpayers to use crypto tax software to reconcile activity across multiple wallets and exchanges.

If you’re an individual exchange user (a shrinking segment of crypto investors), your 1099-DAs will likely show all the information necessary for you to file your taxes accurately. This will make your tax returns faster, easier and cheaper than they are today.

Effective date

Pursuant to the Infrastructure Act, exchanges are required to follow information reporting rules from and including January 1, 2023, and issue 1099-DAs to customers in the first quarter of 2024 for the previous tax year. However, because the rules have not yet been published and made available for public comment, the schedule may be extended by one year.

Next step

Expect to see the draft Form 1099-DA along with proposed Regs in the next few months.

Further reading