The industry will have two years to learn the new requirements and develop systems to ensure compliance.

On November 15, 2021, President Biden signed the US$1.2 trillion Infrastructure Investment and Jobs Act into law (the Law). Two provisions of the Law could have a wide-ranging impact on the digital asset industry: (i) the Law includes a broad definition of “digital asset,” and (ii) the Law redefines “broker” to include certain persons providing services to transfer digital assets.

For months, the digital asset industry and its allies had rallied against these provisions on the grounds that they were impracticable and would impose onerous reporting burdens, hinder innovation (particularly against the backdrop of international competition), and threaten privacy rights. As these provisions are now law, their effects are worth noting.

Digital Asset Defined

For purposes of the Law, “digital asset” is defined as “any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the Secretary [of the Treasury].” The definition is broad and appears to capture a variety of digital assets.

Definition of Broker Expanded

The Law amends the definition of “broker” in the Internal Revenue Code to include “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.” The ramification of the expanded definition is that any party deemed a “broker” will be required to report to the IRS on Form 1099-B the gross proceeds (in US dollar) of sales or transfers of digital assets by their customers, along with the customers’ names and addresses.

Such exchanges will be required to record and, in certain cases, report to the IRS the cost basis of customers’ digital assets. But because “any service effectuating transfers” can be construed broadly, there is widespread concern that the tax information collection and reporting burdens could also apply to digital participants that do not have actual customers, do not broker transactions, and cannot even collect the information needed for reporting, such as validators, miners, and hardware/software developers.

How this requirement will apply to decentralized applications such as decentralized exchanges or lending protocols is an open question. Might launching a protocol that performs these services without another intermediary be sufficient to be considered a broker? It remains to be seen.

Reporting on “Cash” Transactions Over US$10,000 Expanded to Digital

Another provision of the Law expands section 6050I of the Internal Revenue Code to include digital assets. Section 6050I requires that taxpayers who, in the course of their trade or business, receive more than US$10,000 in cash and equivalents — in a single transaction or in a string of related transactions — collect, verify, and report a payor’s personally identifiable information (such as name and SSN) to the IRS within 15 days. The penalty for noncompliance includes fines and criminal felony charges punishable by up to five years of imprisonment.

Under the Law, the transfer of digital assets above US$10,000 will be treated like cash. The Law will apply to all taxpayers other than financial institutions — individuals, businesses, custodians, and exchanges — who receive any kind of digital asset above the US$10,000 threshold in the course of a trade or business. This reporting requirement ostensibly includes sales, loans, and barters (whether on centralized or decentralized exchanges, or peer-to-peer) of digital assets such as cryptocurrencies, digital tokens, and NFTs.

Reporting to Start After December 31, 2023

The digital asset provisions of the Law are not effective immediately. Instead, they will apply to tax returns required to be filed, and statements required to be furnished, after December 31, 2023. The digital asset industry will need to spend the next two years learning the new requirements and developing systems to ensure compliance.

According to the Joint Committee on Taxation, the digital asset provisions of the Law are projected to generate close to US$28 billion over the next 10 years. There have been few public attempts to estimate the projected cost of compliance that these provisions will impose on the digital market participants, including Main Street, which has become increasingly involved in the digital asset space.

In the interim, there have already been efforts to amend or repeal some aspects of the Law. One proposal would exempt blockchain validators (i.e., miners), non-custodial hardware or software vendors, and protocol developers from the definition of “broker” (and therefore from the broker information reporting requirements). Another proposal would clarify the definition of “broker” to include “any person who (for consideration) stands ready in the ordinary course of a trade or business to effect sales of digital assets at the direction of their customers.” Whether any significant effort will be made to scale back the application of the cash reporting requirement to digital assets remains to be seen.

In the absence of any amendments to the Law, the Treasury Department will need to clarify who is subject to the digital asset provisions and provide prompt guidance to stakeholders to allow them sufficient time for implementing the Law over the next two years.