By: Jessalyn Dean, VP of Tax Information Reporting at Ledgible

On June 28, 2024, the crypto and digital assets industry received the long awaited final regulations seeking regulatory clarity and improving taxpayer compliance with regards to sales, exchanges, transfers, and payment processing involving digital assets. Additionally, supplemental transitional relief and guidance was issued in the form of Notice 2024-56, Notice-2024-57, and Revenue Procedure 2024-28. At Ledgible, we summarized the proposed regulations in August 2023, submitted our public comment letter to the IRS addressing our feedback, and provided our expert testimony at the IRS public hearing in November 2023. The IRS and Treasury reviewed over 44,000 public comments that were received, highlights of whichare addressed in the extensive “Summary of Comments and Explanation of Revisions” which takes a plain-language approach to explaining the contents of the final and pending guidance.

Further guidance and clarity is still needed in many areas of the final regulations. The IRS and Treasury have attempted to strike a balance between overall compliance needs and implementation challenges for brokers. At Ledgible, we will continue our work through further comment letter submissions to the IRS and Treasury, industry collaborations, and working groups. We suggest reading our original summary of the proposed regulations to form the basis of the rest of this deep-dive analysis into the final regulations.

Highlights

• Broker and Digital Asset Definitions & Transitional Relief: broadly speaking, there is no change to the definitions between the proposed and final regulations. Rather, further clarity and examples are provided. For now, most decentralized exchanges and unhosted wallet providers are out of scope until the IRS releases further guidance. Registered Investment Advisors (RIAs) can be in scope as digital asset brokers. A definition was added for Tokenized Securities in order to apply special cost basis and reporting requirements for those Tokenized Securities. A definition for a qualifying stablecoin was added in order to apply de minimis thresholds and exemptions from reporting. Central Bank Digital Currencies remain out of scope of the definition of digital assets. Clarification is given that the IRS uses the terms wallet and account synonymously. The final regulations introduce the abbreviation PDAP to refer to digital asset payment processors.
• Timeline & Transitional Relief: most of the original timeline dates remain the same as in the proposed regulations, but the IRS offers penalty relief to brokers that cannot meet their obligations on time but can demonstrate that they acted in a good-faith manner with their best efforts to comply. Tracking and reporting of cost basis information was proposed to begin January 1, 2023 but has been postponed to January 1, 2026. Reporting of transfer-in information remains indefinitely retroactive in the final regulations but the information to be reported has been limited. The revised timeline is presented later in this analysis.
• Tax Withholding & Transitional Relief: phased in backup withholding requirements in the final regulations bring welcome relief to brokers who need to properly document their customers on a certified Form W-9, Form W-8, or appropriate substitutes. Due to the nature of non-fractionalized digital assets, tax withholding on certain NFTs, certain PDAP payments, and certain real estate transactions is suspended until the IRS releases further guidance.
• Covered Security Definition Change: the final regulations modify the definition of a Covered Security from “hosted wallet services” to “custodial services” in order to remain neutral on the method that the custodian uses to provide its services. This means that if a digital asset platform offers to open a hosted wallet for its customers through partner providers, like white-label wallet services of a third-party, then such digital asset platform will be treated as offering custodial services through an agent and the digital asset platform will be a broker and remain in scope of cost basis reporting requirements. This will be a significant implementation and data coordination challenge for digital asset platforms that do not host wallets for their customers but do offer to open accounts at hosted wallet partner providers on behalf of their customers.
• Wash Sale Rules: the final regulations remain silent on any future application of wash sale rules to crypto, NFTs, and other digital assets. The final regulations do clarify that traditional financial instruments that are already subject to wash sale rules will remain subject to them even if they are tokenized.
• Reporting Changes: the final regulations remove the requirement for brokers to report the time of sales / exchanges / transfers, the transaction ID or hash, and the wallet address on Form 1099. However, brokers will still have the burden of collecting and retaining transaction ID or hash and wallet address information for seven years for most transactions. De minimis thresholds and single aggregate reporting (rather than transaction-by-transaction reporting) have only been introduced for certain PDAP, Specified NFT, and certain Qualifying Stablecoin transactions into fiat currency. A complete exemption from reporting was introduced where certain Qualifying Stablecoins are exchanged to other non-stablecoin digital assets (e.g. USDC to ETH).
• No VWAP Pricing: the final regulations clarify that the USD value at the time of the transaction is required to be reported and that brokers are not permitted to use volume weighted average pricing (e.g. daily). This will be especially burdensome to brokers that do not currently record in their customer transaction records the USD pricing exchange rate or value for digital asset exchanges (e.g. BTC to ETH).

Revised Timeline

* This date is unchanged from the proposed regulations, and instead provides penalty relief where the digital asset broker can demonstrate that they have made best faith efforts to comply with the deadlines.

** Until further guidance is issued, tax withholding is postponed on certain sales / exchanges of Specified NFTs, certain real estate transactions, and PDAP transactions.

Please note that not all relevant dates are mentioned in this timeline overview, including those applicable to documentation of exempt foreign payees, and those applicable to issues pending further guidance such as application of reporting to decentralized exchanges, etc.

Key Findings Generally, Compared to Proposed Regulations

Transitional Relief For Brokers - Notice 2024-56 - Deferral of Tax Withholding & Reporting for Certain Transactions

At the end of a transition period, all brokers will be required to have a certified Form W-9, W-8, or appropriate substitute forms on file for their customers in order to avoid having to withhold certain US taxes. In recognition of the time that is needed to implement systems to collect and validate these forms, the IRS has offered brokers the implementation relief discussed below. 

This notice provides a phased-in approach for applying backup withholding of 24% to US Persons which is portrayed in the bottom half of the revised timeline presented earlier in this analysis. Critical to this approach is the implementation and use of the IRS TIN Matching Program by brokers and demonstrating good faith efforts to document their payees on a Form W-9. During the phase-in and in lieu of a certified Form W-8 on file, a broker can treat an account as an exempt foreign person for accounts established prior to January 1, 2026, for sales / exchange transactions effected prior to January 1, 2027, so long as the account has not been previously identified as a US Person and there is no US residence address on file.

The notice also postpones tax withholding until further guidance is issued related to certain non-fractionalized digital assets such as certain NFTs, certain PDAP payments, and certain real estate transactions. It is important to note that this does not apply to tokenized real estate, which is typically a fractional interest in a trust, partnership, or corporation (who then holds title to the real estate). The phase-in of documentation and withholding requirements is portrayed in the bottom half of the revised timeline presented earlier in this analysis. 

This notice also provides relief from certain failure to deposit penalties for tax withholding that was required to be collected and deposited to the IRS, in which the full amount could not be deposited due to a decrease in the value of the digital asset withheld in the transaction. This relief only applies to sales / exchange transactions before January 1, 2027 where the broker immediately liquidates the withheld digital assets for fiat cash.

The IRS will publish a revised Form W-9 and instructions to account for the new exempt recipient of certain US digital asset brokers. The addition of this new exempt recipient category will facilitate the reduction of duplicate reporting on omnibus accounts and situations where multiple brokers all meet the definition of a broker for the same transaction. Until the revised form has been published, brokers can accept a written statement from the other brokers which remains valid until 1 year beyond the revision date of the new Form W-9 (once it is published).

As the first date of reporting of gross proceeds has not changed, the notice provides penalty relief for brokers that cannot timely file but demonstrate good faith efforts to have done so. The first reporting of gross proceeds over 2025 transactions is due in Q1 2026. If the broker cannot file on time (Q1 2026) then they have until Q1 2027 to file these returns. In such a case, the broker would be reporting two years of returns at once: both 2025 transactions and 2026 transactions. However, in the case that the IRS approaches a broker for an audit exam before the filing of such late returns, then penalty relief may not be available.

Transitional Relief For Brokers - Notice 2024-57 - Deferral of Tax Withholding & Reporting for Certain Transactions

Until IRS and Treasury have studied the following transactions more deeply and issued final guidance, there is no tax withholding, cost basis, or gross proceeds reporting on the following six transaction types in the context of sales / exchanges / transfers:

1. Wrapping and unwrapping transactions;
2. Liquidity provider transactions;
3. Staking transactions;
4. Transactions described by digital asset market participants as lending of digital assets;
5. Transactions described by digital asset market participants as short sales of digital assets; and
6. Notional principal contract transactions.

Reporting Exemptions & De Minimis Thresholds

The IRS has adopted the following de minimis thresholds and exemptions from reporting in order to reduce the burden of annual reporting for small transactions or those transactions that result in no gain or loss. It is important to note that a de minimis threshold is different from an exemption. A transaction that is exempt from reporting is never subject to tax withholding. But in the case of a payee that is subject to backup withholding, the de minimis thresholds no longer apply and the payment is therefore withholdable and reportable at any value. As you can see from the below table, applying the de minimis thresholds and exemptions will not be straightforward in practice.

Other than the default rule, all of the above are optional for the broker if they find that applying the exemptions, the de minimis thresholds, or aggregations to be burdensome. Brokers are allowed to change their approach to this year by year.

Qualifying stablecoins are those that meet the following three conditions for the entire calendar year:

1. Designed to track one-to-one a single fiat currency;
2. Uses one of two stabilization mechanisms, either a) a results-focused test using a 10 day testing window for a 3% variance or b) a regulatory obligation requires issuer redemption to customers one-to-one back to the single fiat currency; and
3. It is accepted as payment by persons other than the issuer.

Payee Documentation, Exempt Recipients, & Tax Withholding

• Final regulations removed the US indicia that was specific to digital assets and reverted to existing securities indicia. This means that until further guidance is issued, brokers do not need to monitor IP addresses or digital asset wallet addresses to monitor for a US status of a person claiming foreign status.
• IRS will later issue a revision to the Form W-9 to account for certain US digital asset brokers that are exempt recipients for which no Form 1099 reporting is required. A written statement is allowed during the transitional relief period. This addition of an exempt recipient for certain digital asset brokers will relieve duplicate reporting caused by omnibus account holdings and multiple brokers for the same transaction. Brokers that are RIAs are specifically excluded from being an exempt recipient in this context.
• Final regulations clarify that backup withholding, where required, applies to de minimis transactions and aggregated transactions, but does not apply to fully exempted transactions (e.g. sales of a Qualifying Stablecoin for a non-stablecoin unit of crypto).
• After the phase-in period, brokers are required to have all payees documented properly on a certified Form W-9, W-8, or appropriate substitutes. In the interim, brokers can avail of relief from failure to backup withhold on undocumented payees by verifying non-certified TINs (SSNs or EINs) in the IRS TIN Matching Program. In order to use this program, brokers must collect and store full TINs directly from the taxpayer. Brokers cannot rely on collecting the last four digits of a TIN and retrieving the remaining digits from a third-party source like LexisNexis.
• Detailed guidance and examples are given in how brokers should apply backup withholding during exchanges of digital assets in order to prevent cascading tax withholding obligations. The outcome depends on whether the disposed of asset or the acquired asset is used to satisfy the backup withholding tax liability.

Cost Basis

• Tracking and reporting of cost basis information was originally proposed to begin January 1, 2023 but has been postponed to January 1, 2026 in the final regulations. Reporting of transfer-in information remains indefinitely retroactive in the final regulations but the information to be reported has been limited to the transfer-in date and quantity of units. Transaction ID or hash and wallet address still need to be collected and retained by the broker, but not reported.
• Final regulations modify the definition of a Covered Security from “hosted wallet services” to “custodial services” in order to remain neutral on the method that the custodian uses to provide its services. This means that if a digital asset platform offers to open a hosted wallet for its customers through partner providers, like white-label wallet services of a third-party, then such digital asset platform will be treated as offering custodial services through an agent and the digital asset platform will be a broker and remain in scope of cost basis reporting requirements. This will be a large and complex implementation and data coordination issue for digital asset platforms that do not host wallets for their customers but do offer to open accounts at hosted wallet partner providers on behalf of their customers.
• Though NFTs and PDAP Sales are not exempt from cost basis reporting, the final regulations acknowledge situations where cost basis may not be reported for sales or exchanges of such digital assets due to the broker not being in a position to know the cost basis.
• Final regulations clarify that certain Tokenized Securities are exempt from cost basis tracking and reporting as they do not fall under the definition of a Covered Security. This includes most trusts and partnerships. This means that in most cases of tokenized real estate, which are typically tokens representing a partnership interest which in turns holds title to the real estate, there will be no cost basis tracking and reporting obligation. However, such tokenized real estate (via a trust or partnership) is still reported as a sale or exchange subject to gross proceeds reporting on Form 1099-DA.
• Final regulations confirm that wash sale rules apply to Tokenized Securities as they did in pre-existing regulations.
• Final regulations also confirm that taxpayers electing to identify asset disposals using specific identification (also called spec ID) must make the identification no later than the time of the sale / exchange. This is different from the rule that applies to traditional non-tokenized financial products due to differences in settlement timeframes. Where a taxpayer does not make a specific identification of asset disposals, First-in-First-out (FIFO) is the default method for brokers to apply.
• Brokers are allowed to rely on limited taxpayer provided information for purposes of identifying which units are sold / exchanged under the final regulations. This information must be provided no later than the time of sale / exchange and the broker must indicate on the Form 1099-DA that it obtained and relied on such customer provided information.

Allocation of Transaction Costs

• Proposed regulations provided for an allocation of transaction costs in an exchange of 50% to the disposal and 50% to the acquisition. In the final regulations, this reverts to the traditional practice of 100% allocation to the disposal.
• The final regulations also introduce lot relief requirements for an exchange of one digital asset for another, where the acquired asset is disposed of to pay transaction fees or backup withholding tax. In such a case, the acquired asset will be treated as the disposed of asset regardless of any instructions by the taxpayer to use FIFO or spec ID. This is shown in the following example:

PDAPs (Payment Processors)

• Generally speaking, the introduction of the PDAP term was intended to make it easier to refer to digital asset payment processors. These payment processors are different from TPSOs under Form 1099-K reporting rules which target gross transactions paid to merchants (sellers). PDAP Sales target reporting on sales of digital assets by the buyer, which is not addressed under TPSO Form 1099-K reporting.
• Under the proposed regulations, there was a broad application to buyers which would require documentation and reporting on parties to a transaction that may not be a customer of the PDAP. The final regulations address this and limit the application of PDAP Sales to a more narrow scope of buyers that the PDAP is already required to document as part of an AML program.
• Because a broker may have transactions that qualify as both PDAP Sales and the more general digital asset sales / exchanges (that are not payment processing transactions), the final regulations provide for tie breaker rules on how to report the transactions and how to apply de minimis reporting thresholds and exemptions.
• In the proposed regulations, there was an example of payment processing that implied that NFTs themselves could be a “good or service” in their own right under the definition of a TPSO. The final regulations adopted clarification of a kind of look-through approach so that the revised example refers to an NFT that represents a good or service. Note that the IRS has never clearly defined what a “good or service” is and in the commentary to the final regulations refused to do so in this case as well. 

Form 1099 Reporting

Here is the list of information that will be reported on IRS Form 1099-DA as originally proposed overlaid with notations from the final regulations:

• Customer’s name, address, and TIN;
• Name or type of the digital asset sold and the number of units sold; [Final regulations: later Form 1099-DA instructions will address naming conventions]
• Sale date and time in UTC; [Final regulations: removed requirement for reporting the time]
• Gross proceeds of the sale;
• Transaction ID or hash associated with the sale, if any; [Final regulations: no reporting - only collection and retention by broker for 7 years]
• Whether the consideration received was cash, different digital assets, other property, or services;
  • Brokers may be requested to report that specific digital asset received in return where consideration received was in different digital assets [Final regulations: added new requirement, this item was entirely absent from proposed guidance]
• An indicator that cost basis information relied on customer supplied information; [Final regulations: added new requirement, this item was entirely absent from proposed guidance]
• For Specified NFTs, to the extent ordinarily known, the portion of the total gross proceeds reported that is attributable to primary sales. [Final regulations: added new requirement]
• Tax withheld, if any; [Transitional relief: if tax is withheld at 24% but upon immediate liquidation the USD fiat value has dropped, the broker has relief from penalties to the IRS for depositing less than 24% taxes. In such case, the broker should only report on Form 1099 the actual USD fiat tax deposited which may no longer come out to 24% of the transaction value]
• Other items not listed that may apply where a digital asset sale is also a sale of securities;
• Sometimes - where cost basis reporting is required:
  • Acquisition date and time of the asset in UTC; [Final regulations: removed requirement for reporting the time]
  • Adjusted cost basis of the asset sold;
  • Long term or short term character of the sale;
• Sometimes - where cost basis reporting is not required for transferred-in assets prior to 6045A guidance:
  • Date and time of transfer-in transaction; [Final regulations: removed requirement for reporting the time]
  • Transaction ID or hash of transfer-in transaction; [Final regulations: no reporting - only collection and retention by broker for 7 years]
  • Digital asset address(es) from which the transferred-in digital asset was transferred; [Final regulations: no reporting - only collection and retention by broker for 7 years]
  • Number of units transferred in by the customer as part of that transfer-in transaction.

Penalties

• Typical information reporting penalties are assessed on a per-form basis. However, in the case where a broker does not do any reporting at all but was required to have done so then the penalties will be assessed on a per transaction basis and not per form basis. By way of example, where there were 15,000 separate transactions for sales of Qualifying Stablecoins to USD fiat totaling gross proceeds of $15,000, this would be reportable in a single aggregate Form 1099-DA under the optional aggregate reporting rules. Where a broker fails to issue this single aggregate Form 1099-DA then the failure to file penalties would not be assessed for one failure, but for 15,000 failures instead.
• If a Qualifying Stablecoin loses its fiat currency peg during the year then the broker has relief for backup withholding taxes for those transactions that occurred up to the de-qualifying date, plus 30 days (in UTC) after that de-qualifying event. After 30 days have passed, the broker is liable for taxes that they failed to withhold on stablecoins that were no longer Qualifying Stablecoins.

Key Findings for Tokenized Securities, Real Estate, and Other Financial Products

• The final regulations introduce a definition of Tokenized Securities which generally includes 1940 Act funds, certain non-1940 Act equities, anything registered with the SEC (including native tokenized bonds that don’t exist in any form off-chain), and more. Qualifying Stablecoins are explicitly not Tokenized Securities. The purpose for adding this definition is to ensure that these financial products still maintain their previous requirements such as the application of wash sale rules, CUSIP reporting, average basis methodology, etc.
• Under the proposed regulations, money market funds that are exempt from Form 1099-B and cost basis reporting would have lost this exemption by becoming reportable on Form 1099-DA. IRS corrected this oversight in the final regulations such that tokenized versions of money market funds can avail of the same exemptions from reporting as their non-tokenized counterparts. Additionally, tokenized funds more generally will avail of their pre-existing basis adjustment methodologies and reporting such as the use of average cost and 6045B organizational actions reporting via issuer websites.
• Tokenized Securities will generally be reportable on Form 1099-DA, a transition away from their historic reporting on Form 1099-B. However, three types of dual classification tokenized securities will remain reportable on Form 1099-B:
  1. those cleared or settled on a limited access regulated network
  2. certain 1256 contracts
  3. shares in money market funds (where optionally reported)
• Though the launch of a number of spot bitcoin and spot ETH exchange traded funds (ETFs) in 2024 caught the attention of the blockchain and digital assets industry, these are not actually digital assets for purposes of the Form 1099-DA broker regulations. However, such ETFs are primarily structured as grantor trusts which have a look through treatment for the taxpayer to step into the shoes of the ETF in some cases. The final regulations clarify that such ETFs holding digital assets will be subject to the existing WHFIT reporting rules under 1.671-5 which means that there is no Form 1099-DA reporting by the issuer or the custodian holding shares of the ETF for the underlying sales / exchange activity inside of the fund (specifically, where the de minimis 5% exception applies which is outside the scope of the remainder of this analysis). Taxpayers will continue receiving a Form 1099-B from their broker when they effect sales / exchanges of the ETF shares.
• Though traditional securities are already subject to transfer statement reporting under 6045A, their tokenized counterparts will not be required to do transfer reporting until those regulations are finalized. However, brokers can optionally do 6045A transfer reporting in the interim if they have the capability to do so. Reporting of organizational actions affecting cost basis under 6045B will still be required for Tokenized Securities to the extent it already applies. This is because these reports are simply posted on issuer websites which does not pose any undue additional burden to brokers.
• Tokenized real estate, which is typically structured as a token representing an interest in a partnership which in turn holds the legal title to the real estate, will be subject to double reporting both on a Schedule K-1 and on a Form 1099-DA. However, the final regulations clarify that cost basis is generally not required to be reported in this case as most trusts and partnerships do not fit under the definition of Covered Securities. As such, only gross proceeds reporting will be required for such tokenized real estate.

Key Findings for Taxpayers

Though the primary focus of this analysis is on the broker perspective, we highlight here a few key points on the impact for the customers of the brokers:

• Rev Proc 2024-28 offers cost basis transition guidance for taxpayers who have been using a universal or multi-wallet basis allocation approach to change to wallet-by-wallet or account-by-account. Taxpayers must establish their new method by January 1, 2025 to apply to their allocation of unused cost basis from that point forward. In short, and by way of example, taxpayers in the past may have been selling a unit of BTC out of their Coinbase wallet but treating a unit of BTC as having been disposed of out of their self-custodied wallet. This is no longer allowed under the final regulations and a transition is needed for taxpayers to limit ongoing discrepancies between the taxpayer cost basis records and the cost basis reported to the taxpayer by brokers on Form 1099-DA.

• Same as the proposed regulations, the final regulations adopt UTC as the time zone to use for Form 1099-DA reporting purposes. However, the final regulations refused to provide any clarity about how a taxpayer would reconcile incorrect Forms 1099. By way of example, if Taxpayer A sells Asset B at 10pm Eastern on December 31 Year 1 which is 3am UTC on January 1 Year 2, then the broker must report the sale on a Year 2 Form 1099-DA. Taxpayers will have to figure out on their own, with the help of a tax advisor, how to reconcile reporting and pay taxes on the sale in Year 1 in their Form 8949 while they receive a Form 1099-DA in the following Year 2 for that sale.
• Taxpayers should be aware that even where a transaction has not been reported due to delayed implementation, de minimis thresholds, or reporting exemptions applicable to the broker, it may still be a reportable and taxable event to them. This could occur, for example with certain sales of de minimis reporting on Specified NFTs, de minimis reporting on PDAP Sales, de minimis reporting on Qualifying Stablecoins, exempted reporting on Qualifying Stablecoins, decentralized and unhosted transactions, asset wrapping and unwrapping, lending, short sales. liquidity provider transactions, staking, mining, airdrops, closed loop gaming transactions, and more. This is specifically called out in the final regulations: “although the final regulations provide de minimis thresholds for reporting payment transaction sales and designated sales of Qualifying Stablecoins and Specified NFTs, the transactions that fall below the applicable gross proceeds thresholds are nonetheless potentially taxable transactions that taxpayers must report on their Federal income tax returns.” Though this text does not mention exempted reporting on Designated Sales of Qualifying Stablecoins as an example, the outcome could still apply and taxpayers will need to seek further guidance from their tax advisor for any reporting and taxable events that may apply to them for which they don’t receive a Form 1099 from a broker.
• Due to transitional relief provided to brokers in Notice 2024-56, taxpayers may receive some Forms 1099-DA late. Specifically, brokers have some relief for reporting 2025 transactions in Q1 2026 if they demonstrate best faith efforts to comply. In such a case, they can report 2025 transactions as late as Q1 2027. As all impacted taxpayers would have filed their 2025 taxes by then, they may need to file an amended return to account for variances. 

The Devil is in the Detail - Reactions from Ledgible Experts

At Ledgible, we believe that the IRS and Treasury have addressed a number of critical implementation issues regarding custodial and hosted broker reporting in a positive way. We are pleased that they adopted a number of our comment letter and testimony recommendations, including exempting tokenized money market funds from Form 1099 reporting similar to their non-tokenized counterparts, amongst others. However, as mentioned earlier in this analysis, the final regulations may not appropriately balance the challenges for brokers against the needs of the taxpayer, such as where the taxpayer may still be required to report transactions in their personal tax return for which they received no Form 1099 due to an exemption or de minimis reporting threshold applied by the broker.

Other Types of Form 1099 Reporting May Still Apply (e.g. Form 1099-MISC, INT, etc)

Some readers may have seen a deferral of tax withholding and reporting for “staking transactions” in Notice 2024-56 and interpreted this to mean that there is no Form 1099 reporting of staking transactions until the IRS issues further guidance. This is not correct. In this notice, the IRS and Treasury were only referring to tax withholding and reporting of sale / exchange transactions. They specifically note that readers should not interpret the guidance to imply what the tax withholding or reporting obligations may be under other code sections such as IRC 6041 and Form 1099-MISC income reporting. This means that staking rewards income that has been reported by digital asset payers on Form 1099-MISC will continue to be reported as such. It is also important to note that the deferral of reporting of these six transaction types in Notice 2024-56 does not imply that they are non-taxable events. Taxpayers will still need to evaluate whether a taxable event has occurred with regards to their activity with lending, liquidity providers, decentralized finance, staking, and more. 

Certain Digital Asset Platforms Not Hosting Wallets May Have Cost Basis Tracking, Calculation, & Reporting Obligations

The news headlines about non-custodial and unhosted wallet services being out of scope, for now, has certainly gained momentum. However, it is not so straightforward. There may be cases where a digital asset platform is providing “custodial services” (which is not defined) with regards to digital assets by way of an agent that provides hosted wallets through white-labeling or wallet-as-a-service. The change came through the final regulations by modifying the definition of a Covered Security from “hosted wallet services” to “custodial services” in order to remain neutral on the method that the custodian uses to provide its services. The intention of this change was to avoid situations where a digital asset platform simply outsources the hosted wallet services to an agent in order to avoid being required to track, calculate, and report cost basis. Such agent relationships will be treated as the digital asset platform providing custodial services which in turn means that the digital asset is a Covered Security subject to cost basis requirements.

We have provided a simple diagram to show how this can appear in practice. Brokers and their hosted wallet partner providers will need to design intricate reconciliation systems of their records to ensure that cost basis is properly tracked, calculated, reported, and eventually transferred. This is because in some cases, the digital asset platform may control the types of outgoing transactions that leave the wallet (since the partner provider holds the private keys) but they do not always control the types of incoming transactions that enter the wallet. There may be nothing to prevent an incoming transfer to such wallets which would mean that the cost basis records of the partner provider could differ from the cost basis records of the digital asset platform. The digital asset platform would not have visibility into such incoming transactions while the partner provider would.

Tokenized Real-World Assets

In our comment letter to the IRS and Treasury we recommended that tokenized securities that are already subject to Form 1099-B cost basis and proceeds reporting should remain reportable on such Form rather than moving to a Form 1099-DA. The final regulations did not adopt this recommendation which means that traditional financial institutions who tokenize traditional financial products will have to adapt their tax withholding, cost basis, and reporting systems to accommodate the new data collection needs and reporting infrastructure applicable to the Form 1099-DA and related rules. This can include, amongst other adjustments, having to calculate, track, and report on cost basis for assets that they do not host but which are held in hosted wallets by partner providers (often referred to as white-labeled wallets or wallet-as-a-service). This can be a typical structure in the case that a traditional financial institution is not allowed to hold crypto assets like stablecoins but wants to facilitate the purchase of their tokenized funds by their customers using stablecoin onramps. A reconciliation system will need to be developed between the transfer agent maintaining cost basis records and the sub-custodian hosted wallet partner provider cost basis records.

In our comment letter to the IRS and Treasury we recommended that tokenized real estate, which is typically structured as a partnership that holds title to the real estate, be exempt from Form 1099-DA cost basis and gross proceeds reporting to the extent it is already reportable on a Schedule K-1. This prevents duplicate and useless reporting since a Form 1099-DA would never present the correct cost basis of an interest in a partnership and also because Forms 1099 are issued on a cash basis whereas the Schedule K-1 is more properly aligned to the accrual or cash basis method of the partnership itself. The final regulations did not adopt this recommendation which means that sales / exchanges of tokenized real estate that is structured as a partnership (or a default partnership) will be subject to duplicate reporting on both a Schedule K-1 and a Form 1099-DA. On the positive side, the IRS clarified that such tokenized interests in a partnership are likely not Covered Securities which would mean that in most cases the tracking, calculation, and reporting of cost basis will not apply to tokenized real estate.

Challenges of Specific Identification Lot Relief and Backup Methods for Refresh Rate Lag

In assessing whether to make spec ID available to customers, brokers will need to consider the real time availability of up-to-date data and the refresh rate that they are willing to pay for in data processing power. This is an important cost vs benefit analysis for brokers to make and could limit some brokers from making spec ID available as an option to their customers. For those brokers that do build a user interface for spec ID and have a reasonably useful data refresh rate for displaying open and available lots to their customers, they must still have a default backup method in place, like FIFO, and communicate that clearly to their customers. Such default backup method would be used by the broker in place of spec ID in the scenario where the taxpayer is doing heavy trading and selects to dispose of an asset that was already disposed of earlier in the day, but still displayed as available to sell due to a lag in the data refresh rate. 

Fiat USD Pricing and VWAP Disallowance

The issues of USD pricing are most relevant around exchanges of digital assets for other digital assets as the USD value at the time of the exchange is not typically relevant for the customer trading decision. A number of crypto exchanges do not record USD value or USD price in their record keeping at the time of the exchange but instead use a daily volume weighted average pricing (VWAP) for instances where they need to display or report the USD value of these transactions or ending balances. 

As an example, prior to BlockFi shutting down, they did not record the USD pricing or USD value of transactions in customer records. When BlockFi taxpayers downloaded .csv reports to use for filing their taxes, they would find that they needed to use publicly available pricing information or go lookup their own transaction receipts to get the USD price that they paid. Publicly available pricing information was not correct data in this case because BlockFi commonly marked up the price of the purchases by a margin to make a profit rather than charging a transaction fee. 

Due to the final regulations refusing to allow daily VWAP pricing for Form 1099 purposes, these exchanges and other brokers will need to begin recording the actual USD pricing or USD value at the time of each transaction so that they can accurately report on a Form 1099-DA at the end of the year. Otherwise they will be sifting through large volumes of data at the end of the year and re-creating the USD value, which is likely to be unworkable. Additionally, there will be reconciliation work to ensure that any monthly or annual statements that are provided to customers in fiat USD currency also match the annual Form 1099 reporting values, otherwise customers will contact the broker to complain and ask for a manual reconciliation to explain differences.

RIAs as Brokers

Registered Investment Advisors (RIAs) are shown in the final regulations examples as being brokers but they have explicitly not been added to the exempt recipients list. Where RIA accounts at custodians are titled and held in the name of the taxpayer, then this should not present any Form 1099 reporting by the RIA themselves. In the unusual case that an RIA account at a custodian is titled and held in the name of the RIA, then the custodian will issue a Form 1099-DA to the RIA (as they are not an exempt recipient) and the RIA themselves will be responsible for Form 1099-DA reporting to the taxpayer. This was also the old rule for traditional securities reporting on Form 1099-B but rarely arose as an issue for RIAs due to account titling largely being in the name of the taxpayer.

Importance of Customer Communications & Agreements

Customer communications should be front and center but tend to fall out as an afterthought. Brokers need to consider early upfront communication about something that is going to happen, before it happens. Best practices are to minimize customer complaints and question touch points while also not risking broker customers falling prey to phishing or scam attempts. Here are a few examples:

• If a broker has been reporting transactions in prior years on Form 1099-K or 1099-B and this year it will be reported on a Form 1099-DA, they should warn their customers in Q4 before reporting in a “Preparing for Tax Season” blog or newsletter supplemented by an FAQ. They should explain why this change will happen, which products or customers are or are not affected, and how customers can navigate their way through the new form.
• Brokers will be soliciting sensitive taxpayer information from their customers and delivering sensitive tax forms to them each year. Brokers should email their customers to let them know that they will be asking them to provide sensitive information, before they actually ask for it. For example, a sample email might include statements such as:
  • “In a few weeks, you will be receiving an email from us asking you to provide your certified TIN.”
  • “This is not a phishing exercise and we need you to respond [for X purposes].”
  • “In the meantime, never click on any links requesting your taxpayer identification number and read up here in our blog post for information about why we need to ask you for this.”
• Later, when brokers send the email asking their customers to provide their certified TIN, they should make sure to include specific instructions in the email about how the customer can login to their account and what steps they will follow. Brokers should not ask customers to follow a link to begin the process. Brokers should follow these same suggestions in Q1 - when the customers’ tax Form 1099 is ready to download in their account, customers should not be given a link to “click here” to download the form. 
• Notice 2024-56 sets out that while a broker is required to file Forms 1099-DA for the 2025 calendar year gross proceeds, they have until Q1 2027 to file it so long as they demonstrate their best efforts to have filed on time in Q1 2026. In the case that brokers cannot file timely in Q1 2026 then they need to have a robust communication plan for their customers about why there will be a delay, when they can expect to receive their Form 1099-DA, and what steps they might need to take to amend their tax returns in this case. If not all customers are impacted by this delay, brokers should consider only contacting the customers that will be affected in order to reduce the number of complaints and questions. What brokers are trying to avoid is angry customers receiving a Form 1099-DA late, almost a year after they filed their tax return, who want the broker to reimburse them for having to file an amended tax return.

Lastly, brokers should consider revisiting and revising their customer Terms of Service (TOS) and other agreements. These may need to be reviewed by the legal department of the broker to ensure that it is clear in what cases the broker can withhold certain digital assets for purposes of paying backup withholding taxes, or whether a broker requires a cash margin account to be maintained for certain non-fractionalizing assets (e.g. NFTs).

Tax Withholding & Treasury Management

Brokers will need to discuss with their treasury management departments how they will automate the disposing of assets that have been withheld for backup withholding tax purposes. The final regulations provide for certain penalty relief from tax depositing rules where currency fluctuations occur so long as the broker disposes of the asset “immediately”, though “immediately” is not explicitly defined. Additionally, the final regulations have an exemption from reporting such disposals so long as the disposal was executed “immediately”. Aggregate / batching disposals in corporate treasury accounts that are not deemed to be “immediate” may be allowed but would result in no penalty relief and may require Form 1099-DA reporting for the disposal that would otherwise have been exempted from reporting.

Other Notes of Interest

• It will be interesting to see how the overturning of the Chevron case by the US Supreme Court will impact these regulations, other final guidance, and the adoption of CARF by the US. 
• While most non-US digital asset providers are out of scope of broker reporting until further final guidance is issued, certain non-US digital asset providers may still need to assess their obligation to document payees, withhold tax, and annually report certain payments under other code sections of the US information reporting rules. This is especially important for controlled foreign corporations (CFCs, which are owned and controlled by US entities) which are considered to be US payors under other Form 1099 reporting requirements.

Missing Regulations, Guidance, and Clarity

There is still far more guidance to come and brokers will need to have project plans in place to adapt to emerging guidance as it is published, for example:

• Final Form 1099-DA, broker instructions, and composite form reporting
• Revised Form W-9 with exempt recipient for certain digital asset brokers
• Revised Form W-8s for foreign payees
• Revised Form 8949, Schedule D, and associated instructions
• 6045A transfer reporting and 6045B reporting of actions affecting cost basis, including what types of actions on blockchain affect the basis of an asset
• Crypto-Asset Reporting Framework (CARF) guidance and clarity for non-US brokers obligations for Form 1099-DA reporting
• 6050I reporting for anti-money laundering purposes
• Clarity on tax depositing rules (e.g. when does a day end for purposes of tax withholding, to ensure timely deposits with the IRS)
• Source, character, and tax withholding rates of blockchain transactions (e.g. staking) for purposes of tax withholding on foreign persons and accessing tax treaty benefits
• Source and character of NFT transactions such as secondary sales and revenue sharing agreements (typically called royalties in the industry)
• Wash sale rules for crypto and other digital assets
• State Form 1099 reporting requirements that will very likely diverge from federal requirements

How Brokers Should Be Preparing

Planning & Analysis

• Perform deep product analysis with payment and process flows, including identifying which products are Qualifying Stablecoins, which products are Tokenized Securities, what products are Specified NFTs, which products are entirely out of scope of any reporting, ongoing monitoring, and more.
• Form an internal steering committee and join industry working groups.
• Determine which organizational department owns the tax reporting function, KPIs, and budget.
• Consider voluntary reporting in advance of mandatory reporting timelines where customer demands require it or as proof of concept.

People, Skills, & Training

• Recruit and hire the right people (employees vs consultants), consider using an outsourced managed services model or building the knowledge in-house.
• Develop and coordinate training in your organization, with a focus on customer service agents addressing tax questions for geographically diverse customers.

Technology Stack

• Analyze and decide build vs buy.
• Setup accounts with IRS TIN Matching Program; these are employee specific and take time to get verified.
• Begin collecting certified TINs or certifications of foreign status from all new customers, other brokers in your payment flows, and make a plan for documenting existing customers.  
• Track and store customer lot level transaction data.
• Decide what lot relief methodology you will offer to your customers (e.g. FIFO, Spec ID, etc). Build a user interface for customers to select which lots they want to sell for Spec ID.
• Collect and record asset transfer-in data.
• Build tax withholding calculation, conversion, and remittance systems to ensure timely deposits to the IRS.
• Analyze, filter, generate, file, and distribute Forms 1099 to the IRS, payees, and State Revenue agencies.
• Develop an IRS and State Revenue agency governance model to address IRS and State notices.

Who is Ledgible, How Can We Help

The Ledgible platform is built from the ground up to streamline digital asset tax information reporting and compliance. Ledgible ensures compliance for digital assets for some of the largest financial institutions in the world, including top 5 US banks, investment firms with $1B+ AUM, and top 10 crypto exchanges. As a SOC 1 & 2 Type 2 Certified platform, Ledgible is the trusted provider of choice for compliance and Form 1099 generation. We are ready to assist you in developing your customized fit-for-purpose tax reporting operating model. We customize our cost-basis tracking and reporting solution to fit your unique needs. Integration with our partners ensures your compliance needs are covered in customer onboarding, tax withholding calculations, and annual reporting.

Disclaimer

This blog post does not constitute tax or legal advice nor does it constitute a tax or legal opinion. Independent tax and legal advice must be sought by our readers to assess their own circumstances against these final and future regulations and guidance. This blog is Ledgible’s first assessment at summarizing the impact of the final regulations as of June 28, 2024. This means that our assessment should, and will, change as differing interpretations are debated amongst industry working groups.