The Senate is about to vote on an infrastructure bill that includes provisions on tax reporting on “revenue” that could have a devastating impact on the business model of cryptocurrency products and services. The crypto community is rightly outraged by blanket language that could harm not only cryptocurrency exchanges like Coinbase (COIN), but also software developers and other small business owners who keep the cryptocurrency “infrastructure” – or the ecosystem – going.
The bill’s provisions – titled the Infrastructure Investment and Jobs Act – go well beyond simply requiring cryptocurrency brokers to follow similar tax reporting rules for brokers of other financial assets such as stocks, as proponents claim.
Since 2011, traditional brokerage firms have been required to report capital gains and losses to the government and send 1099 tax forms to individual clients. However, a comparison of the tax reporting requirements for traditional brokers and the broad language that crypto would regulate in this draft law shows that the latter provisions are far more extensive and intrusive, both in the definition of “broker” and in the information to be reported.
First, there is a much broader definition of “brokers” in the Infrastructure Act. In the 2008 legislation on the taxation of traditional financial assets as part of the Trouble Asset Relief Program (TARP), “broker” is defined relatively narrowly as a company that does business directly with a customer. In this legislation and other provisions of tax law known as the “Tax Code”, a “broker” is defined as a “trader, swap exchange” [which is defined elsewhere in the tax code as “any organization of members providing property or services who jointly contract to trade or barter such property or services”] and any other person who regularly acts as an intermediary (for a fee) in relation to property or services. “
In contrast, the Draft Infrastructure Bill’s provisions on tax reporting include in the definition of a broker (on page 2434 of the bill’s embedded PDF file) “any person responsible (for a fee) for the regular provision of services to perform digital asset transfers” is on behalf of someone else. “Unlike the provisions of the Tax Code that regulate traditional financial investments, these rules could – depending on the interpretation of those responsible at the Treasury and the Internal Revenue Service (IRS) – as” brokers “of cryptocurrencies or” digital Assets “- a large number of people who provide services but do not interact directly with cryptocurrency customers.
“The broad, confusing language opens the door for almost every entity within the cryptocurrency ecosystem to be viewed as a ‘broker’ – including software developers and cryptocurrency startups who do not hold or control assets on behalf of their users,” observes the Liberal -Leaning civil rights group of the Electronic Frontier Foundation.
Software developers and other technicians in the crypto world – as well as in traditional financial services – have no way of preparing tax reports because they often do not know the identity of the individual customers they are transacting for. This is by design so that privacy and data security are protected, and sensitive data is primarily kept in the hands of the financial firms that customers have given their information to. But under these provisions, many secondary crypto companies would be forced to set up new monitoring procedures “know your customer”. As the EFF noted, these provisions would mean that “any company even tangentially related to cryptocurrency could suddenly be forced to monitor its users”.
Other digital privacy advocates and cryptocurrency investors and entrepreneurs, as well as senators from both parties, have voiced similar criticism. Both Conservative Senate Member Pat Toomey (R-PA) on the Banking Committee and Liberal Senator Ron Wyden (D-OR) said the regulations needed to be tightened.
In the current language, the regulations could also reach the individual entrepreneurs at the heart of the cryptocurrency industry: the miners. As Paul H. Jossey – Principal Attorney at Jossey PLLC and Adjunct Fellow for Cryptocurrencies and Crowdfunding at my organization, the Competitive Enterprise Institute, explains in an interview: “As the name suggests, miners conduct an online version of gold prospecting using cryptography and computing power. “With Bitcoin and many other types of cryptocurrency, miners maintain the distributed ledger system – called blockchain – which ensures data integrity and prevents fraudulent transactions, and they are in turn rewarded with native cryptocurrency.
Although miners would likely conform to the current Infrastructure Act definition of “effecting the transfer of digital assets on behalf of another person”, they do not know the identity of the other person. This is an embedded feature of blockchain development that protects privacy and data security for cryptocurrency holders.
Also, many miners are the furthest removed from a traditional finance brokerage firm. Jerry Brito, executive director of a think tank on crypto-politics, notes that a miner “can be a kid in his dorm room.” Jossey says he is concerned that these “worrying provisions” of the Infrastructure Act “could undermine the main benefits of the apolitical and decentralized governance of crypto.” If this happened it would detract from the many other benefits of crypto, such as:
One of the fixes being discussed on the hill, according to those familiar with the legislative process, is stating that a “broker” is limited to someone who interacts directly with a “client” and that he or she is only is responsible for providing to the government information about the customer that he or she already has. The latter change would reduce the likelihood that crypto entrepreneurs would have to conduct privacy-threatening surveillance of cryptocurrency holders.
While the tax and regulatory frameworks for cryptocurrencies need updating, and I and others have suggested many constructive ideas about it, in this case the solution is to not make the tax reporting rules for crypto broader than they have been for traditional ones in more than a decade Finance broker.
One thing should be clear. Any bill aimed at improving infrastructure should not contain provisions that could destroy rather than help build an important piece of America’s digital infrastructure.
John Berlau is a Senior Fellow at the Competitive Enterprise Institute and author of the 2020 book George Washington, Entrepreneur: How Our Founding Father’s Private Business Pursuits Changed America and the World