On October 30th, Americans for Tax Reform submitted a comment letter to the Internal Revenue Service (IRS) urging the withdrawal of a proposed rulemaking expanding reporting requirements for digital asset transactions. This proposal would affect millions of Americans utilizing decentralized protocols, stablecoins, digital assets exchanges, and nonfungible tokens (NFTs). The rule applies onerous regulatory reporting requirements on digital asset transactions and exposes taxpayers’ privacy information. Overreporting to the IRS poses significant privacy concerns and opens the door for the IRS to continue to harass Americans if the agency is under the impression that a taxpayer is noncompliant.
In 2021, Congress expanded the definition of “broker” 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 letter notes a few issues that arise as a consequence of this broad and vague definition. An entity effectuating transfers of digital assets encompasses miners, validators, software developers, and “other entities that would not have the knowledge to report transaction information.”
The proposal would directly compel wallet software providers and digital asset brokers to report customer transactions since they would be positioned to know the gross proceeds from digital asset sales as digital asset middlemen. The letter also highlights the IRS’s targeting of decentralized finance platforms, detailing the proposal’s efforts to categorize Decentralized Autonomous Organizations (DAOs) and DeFi entities as brokers in order to collect data on customer identities. However, this provision is unreasonable given the structure of how DAOs and DeFi entities operate and the limitations on their ability to gather information on transactions. The letter points out that:
It remains unclear how a DeFi protocol or DAO would be able to comply with reporting requirements in the Proposal if they do not know the identity of the party that makes a sale.
IRS overreach is also exemplified in the proposal’s refusal to allow for the extension of the multiple broker rule exemption to digital asset brokers. The IRS typically allows brokers to forego reporting when conducting sales on behalf of other brokers in an effort to avoid duplicative reporting. This is not the case, as the letter notes, with digital asset brokers, strengthening the argument that this proposal opens another avenue for the IRS to justify collecting personally identifiable information (PII). The fact that the requirements go beyond what is typically demanded of traditional brokers is arbitrary and capricious—further reinforcing the argument that the proposal is unnecessarily burdensome.
The letter then goes on to raise concerns regarding reporting requirements on NFT and stablecoin transactions based on the potential for these transactions to incur capital gains. Among these concerns are data breaches and privacy infringements on taxpayer data as well as costly compliance fees on brokers now responsible for facilitating and settling digital asset payments. The letter explains that:
The Proposal requires broker reporting for the sales of all digital assets, including stablecoins and nonfungible tokens (NFTs). However, the most egregious provision of the Proposal is that it requires brokers to report digital asset transactions that ‘solely facilitate order processing, clearing, or settlement.’ Stablecoins are integral in facilitating transactions without selling the digital asset. As such, every stablecoin used for a transaction is implicated in the reporting requirements. This burdensome reporting is costly to stablecoin issuers and the brokers that would have to report the information. Reporting these transactions would not be beneficial to the IRS because it does not report any actual realization of a transaction. No gain or loss was reported. Additionally, reporting this information could lead to leaks of PII. Data breaches at the IRS have occurred in the past and are likely to occur again. More information stored with the IRS is at risk of landing in the hands of bad actors.
To counter this, the IRS should at the very least consider a de minimis exemption for merchant transactions, setting a threshold under which transactions would not be liable for reporting to the IRS:
The Proposal fails to include a de minimis exemption for certain merchant transactions. According to the Proposal, ‘this treatment of a [third party settlement organization] as a digital asset payment processor applies without regard to whether the payment to the merchant is below the de minimis threshold described in section 6050W(e) and, thus, not reportable under section 6050W.’ A de minimis threshold exists for TPSOs to settle third party network transactions—albeit at a threshold that is too low. There should also be a de minimis threshold for digital asset payment transactions.
The IRS itself concedes the proposal will have costly effects on the digital asset market. The letter cites IRS self-estimated figures on the monetary impact of the proposed rule and subsequently calls for government regulators to respect consumer choice and allow the free market to function without interference:
The Proposal itself estimates the impact of the proposed requirements to affect 13-16 million taxpayers who hold digital assets as well as approximately 5,000 brokers dealing in digital assets. The average broker is expected to incur 425 hours of time burden and $27,000 for ongoing annual costs to comply with the proposal if enacted. The start- up aggregate time and monetary burden is expected to range between 1,275-3,400 hours and $81,000 to $216,000 per firm.The costs of these regulations will be passed onto users of digital asset platforms, raising the potential for platforms to roll back available services or raise fees on users. The IRS should be cognizant of the impact the rulemaking proposal will have on an emerging asset market. Regulatory bodies should not impose rules that select winners and losers in markets. Businesses and consumers should be left to their own discretion when deciding on how to settle payments.
The IRS also admitted that it published the proposed rule without a solid understanding of how the rule would impact small businesses. The Proposal clearly ignores the potential economic effects on small businesses in the name of tax compliance:
The IRS admitted that it does not have a solid grasp on the economic effects the Proposal will impose on small businesses. According to the Proposal, the ‘Treasury Department and the IRS have not yet determined whether the proposed rule, when finalized, will likely have a significant economic impact on a substantial number of small entities. The determination of whether reporting by small brokers and real estate reporting persons on certain digital asset transactions will have a significant economic impact on a substantial number of these entities requires further study.’ The Proposal should not have been released without a thorough study of the impact on small entities. The IRS should withdraw this rule and start over in order to better understand the impact on small entities and how the Proposal could create barriers to entry due to excessive compliance costs.
The letter concludes by urging deference to the major questions doctrine established in West Virginia v. EPA which bars federal agencies from pursuing rules lending themselves to significant economic or political consequences unless directly authorized by Congress.