How to Invest in Cryptocurrency for Beginners in 2022

Reporting your cryptocurrency trades to the IRS will no longer be done on the honor system. Beginning in tax year 2023, any potentially taxable digital asset transactions will be reported to the agency by a third party.

If you've ever worked or invested in stocks, you're aware that your earnings are reported to the federal government. This is due to the fact that you and the IRS receive a W-2 form from your employer, which reports your annual earnings, and a Form 1099 from your broker, which reports your stock transactions.

However, there have been no comparable third-party reporting requirements for cryptocurrency trades and transfers – or for any other digital assets, such as NFTs – until now.

However, the recently passed infrastructure law includes provisions requiring crypto industry participants who broker digital asset transactions to issue 1099-Bs for their customers' accounts, which you will receive for the first time in early 2024 to reflect your 2023 transactions.

 

In order to make it more difficult to launder money, the new law requires businesses to report to the IRS whenever they receive more than $10,000 in cryptocurrency in a single transaction (or in two or more related transactions), just as they must when they receive cash above that threshold. A federal felony charge can result from willfully failing to do so.

These new reporting requirements will have an impact on investors who trade digital assets in a variety of ways.

investing in cryptocurrency

The new reporting requirements could benefit crypto investors in two ways. First, they show that crypto is here to stay. And, given the difficulty of keeping track of all your transactions, obtaining a 1099 may be beneficial.

However, those who want to keep their transactions private on principle, or who have not met their tax obligations, will lose their anonymity.

When you open a bank or brokerage account, you must provide a large amount of personal information, which is then cross-checked to ensure you are who you say you are. Among other things, you must provide your legal name, address, phone number, and a Social Security number or other taxpayer identification number.

When you open a crypto-related account, however, the information you're asked to provide varies by platform.

 

Until this year, it was fairly common to open [an account or digital wallet] with a name and email, Erin Fennimore, head of information reporting at TaxBit, a cryptocurrency tax software provider, said.

In many cases, this will change by 2023. "You will be asked for personal information that you have most likely never been asked for before," Fennimore said.

And the platforms that must report on your transactions must verify that you are who you say you are.

Furthermore, when a digital asset is transferred from one broker to another, the transferring broker must provide the receiving broker with a statement that includes basis and holding period information on the transferred asset so that the receiving broker can meet its 1099 reporting requirements.

 

Cryptocurrency Reporting Requirements:

Because not every crypto transaction is a taxable event, not every crypto transaction will necessitate third-party reporting.

"Simply purchasing cryptocurrency is not taxable or reportable under the law. You must do something with it, such as sell or trade it, "according to Fennimore.

However, because a reporting entity may not have all of the information related to a transaction, "it will be a practical challenge to always have the tax basis for each trade or transfer," said Christopher Murrer, an associate in Baker McKenzie Zurich's Fintech group.

For example, you could send bitcoin from one of your non-custodial digital wallets to a reputable cryptocurrency exchange and then sell it from that account. The cost basis on the sale may be reported as zero or as the price at the time you transferred the currency, rather than the price at which you purchased it.

As a result, you'll have to explain to the IRS why the information on your 1099 is incorrect. Ultimately, it is the taxpayer's responsibility to report the correct tax basis on their personal tax filings, Murrer said.

Who is required to report?

Some in the cryptocurrency industry have suggested that the law is written so broadly that various players, such as miners and software providers, could be classified as "brokers," even if they have nothing to do with the brokering of a taxable transaction.

If this is the case, those who are incorrectly classified may face "massive reporting obligations," as Coinbase CEO Brian Armstrong stated on Twitter.

Similarly, there is uncertainty about what will be considered a business for the purposes of reporting large single transactions. Because this is a new industry, it's difficult to predict what regulators will consider a business, Murrer said, noting that it's unclear how decentralized finance (DeFi) activities, staking pools, and NFTs might be classified.

However, greater clarity is expected when the Treasury Department issues regulations on how to interpret and implement the reporting requirements of the law.

A senior Treasury official stated that the department has been in discussions with industry players to better define which types of entities should be defined as brokers, trades, and businesses for reporting purposes, noting that miners are highly unlikely to be considered brokers.

The department's top priority is to write those regulations, which will be released in the coming months, according to the official.

When they are, a public notice and comment period will be held before the rules are finalized.