IRS Unveils New DeFi Rules: Navigating Potential Risks
The Internal Revenue Service (IRS), the leading financial regulator in the U.S., is rolling out new crypto tax rules, which will impact the DeFi market. What are the major worries for the American crypto community?
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In recent years, DeFi has noticeably edged out traditional banking services. These decentralized platforms offer financial services that often exceed the boundaries set by traditional systems.
However, as this alternative ecosystem grows, regulators are adapting, and reshaping their criteria to ensure compliance with tax laws.
On August 29, the IRS released a document highlighting a comprehensive set of new rules crafted for the crypto market, with a significant emphasis on decentralized finance.
We’ll outline several new regulations that are expected to be introduced soon.
Gross Proceeds and Mandatory Reporting
The IRS has introduced new regulations regarding the reporting of gross revenue for DeFi platforms. With these changes, decentralized brokers are required to report proceeds from the sale of cryptocurrencies and other digital assets. This includes all crypto trading platforms, digital payment processors, and wallets with trading/exchange features, with the sole exception being hardware wallets.
They've unveiled a new Form 1099, which details profits and losses for each category of asset for the tax year.
Calculation of Proceeds and Taxable Basis
The IRS also intends to refine the approach to calculating the amount realized by incorporating the asset's base cost. While it's still unclear what will be considered the base cost, it's evident that this shift will affect how gains and losses are tallied when selling cryptocurrencies and NFTs.
Taxpayers (platform users) are encouraged to keep independent records to ensure the platform's report is accurate.
Reporting Requirements for DeFi Platforms
Platforms trading in digital assets and offering cryptocurrency-backed loans are set to encounter stringent reporting standards. These platforms will be required to disclose transactions that exceed an as-yet-undetermined IRS threshold, bolstering transparency in the activities of DeFi users.
These steps are taken with the overarching aim to decisively eliminate tax evasion.
Tax Implications for Staking Rewards
Earnings from staking and the subsequent profits will now come with associated tax repercussions. Initially, the IRS intends to roll out an informative initiative to ensure those involved in such operations are fully cognizant of their tax duties.
All DeFi participants who earn rewards from staking their assets will be subject to tax. The exact rate remains unspecified.
It's evident, though, that both tokens allocated to liquidity pools and those utilized for enhancing blockchain security will be taxed. To the IRS, the motive behind the staking isn't of primary concern.
Defining Taxable Events
The IRS has outlined a specific set of actions that will have tax implications:
- Sale of any cryptocurrency or NFT;
- Receipt of an asset through a fork;
- Obtaining an asset via any type of airdrop;
- Beneficially trading one asset for another;
- Utilizing cryptocurrency for purchasing goods/services;
- Converting cryptocurrency into fiat money;
- Engaging in mining activities;
- Participating in staking;
- Earning copyright royalties;
- Borrowing cryptocurrency when it's directed towards investing or operating a personal business that yields income;
- Profits from lending cryptocurrency.
Conversely, fewer activities fall outside the tax scope:
- Purchasing digital assets with fiat currency;
- Transferring cryptocurrency from one personal wallet to another;
- Making a collateral deposit on a loan.
Enhanced KYC/AML Requirements
Regulators stress that practices within the DeFi sector must align with the conventional financial guidelines that banks and commodity exchanges follow. In this context, there will be no exceptions. Therefore, transactions that involve anonymous cryptocurrencies or use mixers will be considered unlawful.
Foreign Account Reporting
DeFi users with accounts on foreign platforms might face additional regulatory requirements. The IRS has voiced concerns about tax evasions associated with offshore activities and insists that American traders operating internationally must uphold their tax obligations.
However, how these obligations will be enforced is yet to be clarified.
Conclusion
The present document is more an indication of intentions than a conclusive mandate. It has been officially announced that public consultations are set to run until October 30, 2023. Congress will hold public hearings on November 7-8. After these events, the definitive version of the new regulations, effective from 2025, will be presented to the public.
This timeline provides DeFi platforms a window to strategize their business direction under the upcoming regulations.
For example, dYdX founder Antonio Juliano opines that decentralized platforms should consider not catering to American clients for the next ten years. It would be prudent to focus on business growth in nations with a more accommodating legal framework.
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