Cryptocurrency Exchanges Serious about 1099 Reporting Despite Incomplete IRS Guidance

Ron Quaranta is founder and chairman of Wall Street Blockchain Alliance, the world’s leading non-profit trade association promoting the comprehensive adoption of blockchain technology and crypto assets across global financial markets. He will speak at the GCS Intelligent Reporting conference in San Antonio later this month. Ron spoke with Sovos recently about cryptocurrency tax regulations in light of recently released IRS clarification of crypto tax policy. 

Sovos: What was your initial impression of guidance the IRS released on crypto taxation?

Ron Quaranta: Keeping in mind that I am not an accountant by training, my perspective is that the IRS may still be struggling with some of the complicated aspects of blockchain and cryptoassets. For example, it seems to me that the agency is conflating airdrops and hard forks. I think they don’t fully understand the delineation between a hard fork and an airdrop. The way they represented it seems to be a sequential process in their minds. The knowledgeable technology and accounting folks realize that’s not necessarily correct, and that there are other iterations that need to be considered. For instance, are all taxpayers expected to be aware of the moment they actually “receive” an airdropped token, and what is the tax burden at that point? There are still many questions to be answered.

A hard fork is a new fork away from the blockchain. Bitcoin Cash and Bitcoin Gold were forks away from the blockchain. This is acceded to by the majority of users within a blockchain. The fork becomes the new blockchain going forward. An airdrop is the giving away of free tokens, as a very basic example. You don’t necessarily need one to accomplish the other.

Sovos: What do you think the impact of the IRS guidance will be for individuals and institutions?

Ron Quaranta: If the burden is on individual taxpayers to recognize those two events, they might not be able to do it. Mom and Pop who open an account with an exchange the way we open a bank account will have very little understanding of this. It points to the need for tools that exchanges and vendors can and are beginning to develop to help investors to understand and act on their tax responsibilities.

From an institutional perspective, my personal opinion is that a lot of people were hoping was that the IRS would back off of calling crypto assets property as it did with the initial guidance in 2014. Many hedge fund colleagues have noted that from their vantage point, this did not make much sense. A lot of people were hoping for guidance that moved away from that. Everyone had hoped and wished that IRS would come down with a different viewpoint, and that’s not what it did.

Sovos: The guidance largely avoided any mention of 1099 reporting or tax reporting of any kind. What does that mean for exchanges that might not know how to handle reporting due to a lack of specific guidance?

Ron Quaranta: As these exchanges professionalize, as they begin to seep more deeply into the US ecosystem, they’ll have to amend some of these tools for 1099 reporting. My understanding is that they’re going down that road already. When we talk about these larger exchanges, they have chief compliance officers and accounting professionals, and regular interaction with the US Department of Treasury, the IRS, the SEC and other regulators. They are not unprepared to address reporting challenges.

I don’t fall into the camp that says they don’t know what they’re doing. There are reasons they’re registered money service businesses and trust companies. All of our members are institutional in one shape or form. They have the tools and resources to do that archaeology and research.

Sovos: How about individual investors? The IRS has been sending a message that it will crack down on investors who don’t report crypto transactions. Are they getting the message? Would clarification of reporting regulations help?

Ron Quaranta: Individuals who are investing at exchanges are a different story. People expect reporting on their retirement accounts, for instance, but they may not necessarily be getting that with crypto. It’s an uneven evolution depending on the type of venue or exchange. If you’re talking about the five largest exchanges, they’ve got as much reporting that they can put together in light of the guidance that does exist. That has to evolve based on new guidance.

How that evolves over time will be a reflection of how much is reported to the IRS as virtual currency transactions. Of the several million investors in 2018, according to some estimates something like less than a few thousand reported crypto transactions. That’s either out of malfeasance or ignorance, but the proof will be in the pudding. The top line of new Form 1040, while confusing and in need of clarification, cites virtual currency, so the IRS is certainly paying more attention to crypto tax enforcement. 

Sovos: With no regulation by a central bank, crypto used to have a reputation for being a bit lawless and a haven for avoiding taxes. How well do those ideas hold up today?

Ron Quaranta: Our trade association is focused on global corporates and institutional investors. I honestly don’t get the sense it’s a crypto-anarchist conversation anymore. We don’t have a member who says we don’t believe crypto should be taxed. What they want to know is how they can become compliant so they can be more deeply involved. No institution wants to pick a fight with the IRS, Treasury or the SEC. The notion that crypto assets exist solely to help people avoid taxes seems to me to be patently false. That does not mean we’ll be in a utopia of people always paying their taxes, but it’s misleading to say that crypto assets exist just for tax avoidance.

We live in a global ecosystem that says crypto is not about avoiding taxes. Crypto has a lot of appeal for other reasons. There will be some funds interested in trading into the volatility in the market. Corporates understand that some levels of commerce will happen with crypto assets. They will need to understand how to value, report and pay taxes on those. They will be looking for tools and processes to do that. In many instances, some individuals may be caught up in the get-rich-quick hype by purchasing crypto like Bitcoin. But that perspective also is evolving as individuals learn more about crypto and virtual assets.

Sovos: We don’t know where the IRS will go from here on guidance, what the agency will issue next or when it might provide another clarification. Where do you see crypto regulations and enforcement heading from here?

Ron Quaranta: I won’t say that we’re done. This space is evolving so rapidly that we don’t know what we don’t know. One of the things that comes out of our legal conversations is that many of these guidelines are based on facts and circumstances. There’s value in what the IRS came up with. But it will need to keep evolving.

My personal opinion on that is no one wants to run a business that sits in fear of enforcement every year. They want to be compliant and they want to offer the opportunity for US citizens to trade an instruments like virtual assets that many believe are a new asset class. The important aspect is the education curve. I think institutions are beginning to understand the importance of having crypto assets in portfolios. Three or four years ago, they said they didn’t want to hear about bitcoin. They had this false belief that it was illegal. That’s not the case anymore. There’s an opportunity for alpha. These are new asset classes they need to understand.