U.S. IRS Finalizes Crypto Tax Reporting Rules for DeFi Brokers

The U.S. Internal Revenue Service (IRS) has finalized rules requiring certain brokers in decentralized finance (DeFi) to report gross proceeds from digital asset sales.

Under the updated regulation, "DeFi brokers" are treated similarly to traditional brokers handling securities. They are required to collect user trade information and issue a Form 1099, as stated by the U.S. Department of the Treasury. These forms report payments beyond typical employer income.

Aviva Aron-Dine, acting assistant secretary for tax policy, stated, "These regulations will help ensure that all taxpayers play by the same set of rules and have access to the information they need to file their taxes accurately." The intent is to align digital asset reporting with traditional asset reporting, simplifying the tax process for compliant taxpayers and addressing the tax gap.

The finalized rule requires some DeFi participants to file tax returns that disclose customer names and addresses. The Treasury indicates that this applies to "front-end service providers" that directly interact with customers, suggesting entities running principal websites for DeFi protocols, rather than the protocols themselves.

An often-cited example of a potentially impacted entity is Uniswap Labs, known for facilitating decentralized exchange interactions. However, it remains unclear how the new rule will be implemented.

Critics within the crypto industry argue that expanding tax reporting requirements is problematic since DeFi operates differently than traditional assets. They emphasize the difficulty in identifying responsible entities to collect and share user data, with some indicating that a lack of centralized service providers creates a challenging situation for compliance.

The rule is set to take effect on or after January 1, 2027. The initiative to enhance tax enforcement for digital asset service providers originated in the Infrastructure Investment and Jobs Act passed in 2021, aimed at funding the bill’s provisions.

In August 2023, the IRS introduced proposed regulations on tax reporting for cryptocurrency brokers, later revising them to include exchanges under the new rules, effective from 2025. However, the definition for "digital asset middleman" for DeFi remains unresolved due to industry objections.

Despite a commentator's argument advocating for DeFi treatment distinct from traditional securities brokers because of unique challenges in information collection and reporting, the IRS disagreed. The IRS and Treasury asserted that participants with technological expertise in financial services must adhere to the same regulations as any other financial services entity.

Bill Hughes, senior counsel at Consensys, indicated the likelihood of legal and Congressional challenges against the new rule. His prediction is that a lawsuit will argue the rule exceeds Treasury's authority and breaches the Administrative Procedure Act, and further Congressional review may seek disapproval, similar to actions in the current year regarding SAB 121.

The Blockchain Association, a Washington D.C.-based industry lobbying group, expressed its intent to take aggressive action against the rule change. Under the Congressional Review Act, lawmakers may overturn certain federal agency actions, as documented by the Congressional Research Service.