Crypto Tax Proposal Open for Revision, IRS Officials' Questions Suggest

While crypto representatives and lawyers cautioned the U.S. Internal Revenue Service (IRS) that its crypto tax proposal is a dangerous and improper overreach, questions posed by a panel of IRS and Department of the Treasury officials at a Monday hearing may reveal some flexibility in the rule as it's still being written.

The panel of federal officials, who weren't identified as they asked questions during the audio hearing, showed interest in potential burdens on decentralized platforms under their proposed rule, whether stablecoin transactions should be reported and how non-financial assets could be identified as such. The crypto tax rule was proposed in August, and a public comment period ended Monday, but a final version is probably months away and would likely respond to at least some of the industry's condemnation.

The government officials asked more than once how digital assets that may not be financial in nature, such as most non-fungible tokens (NFTs), could be separated out, and whether brokers could be in a position to identify them. Marisa Coppel, a lawyer with the Blockchain Association, said she thought that would be possible, especially if the IRS narrows what it considers a "broker" to only include the centralized exchanges.

The officials asked Coppel to clarify that central point of industry criticism, which came up repeatedly at the hearing: the proposal's wide definition of brokers required to report data, which currently includes some decentralized finance (DeFi) projects and wallet software. They wanted to know what the decentralized platforms' main burdens would be.

"There's obviously a ton of information that needs to be collected in order to do this reporting," she explained. "And if there's no specific person that either owns or controls the software that users are using in DeFi, there's no way to collect that information."

William Entriken, who was involved with the ERC-721 standard that paved the way for NFTs on Ethereum, also argued that there are some kinds of transactions for which the law doesn't or shouldn't let the IRS gather information about – mentioning spending on guns or abortions.

"There are a lot of special classes of purchases," said Entriken, and this regulation's demand for reporting individual transactions would contrast with those, legally. "That's going to be a problem."

The government panel asked Entriken if they were to change their proposal's insistence on reporting transactions of assets that are never meant to show a loss or gain – such as stablecoins – whether that would also address the problem of specialized classes of purchases the government shouldn't be tracking. Mostly, he suggested.

The stablecoin reporting requirement in the proposal was a frequent point of contention, with people from the crypto sector saying it doesn't make sense to include those transactions as taxable exchanges of assets. Stablecoins are tokens whose value is tied to a steady asset, such as the dollar, and are used as the common currency in the digital assets industry.

"Do you propose that there should not be reporting with respect to stablecoins?" one of the panelists asked a representative of Coinbase (COIN). "Do you have a suggestion for how the term stablecoin would be defined?"

Lawrence Zlatkin, Coinbase's vice president for tax, said in the hearing that "tax reporting when there is no gain or loss, including stablecoins, will result in expansive but low value reporting."

The IRS has itself noted that its proposal could bring on several billion additional tax filings each year, potentially flooding the already overburdened agency.

"The IRS should not police every digital asset transaction," Zlatkin argued.

Getting into another of the core concerns – crypto users' privacy – the IRS officials asked a lawyer who specializes in U.S. financial know-your-customer laws about the inner workings of digital identification systems that could maintain people's anonymity. They discussed the technology of privacy tokens and how they're already being adopted in the industry.

And the government team asked a representative of a transaction aggregator – businesses that let clients connect their wallets and exchange accounts to a central hub for figuring out their tax burdens – how such services figure out the cost basis for assets and how those businesses can improve their consistency after reports that different firms have been known to come up with different data on a customer's tax liabilities.

Shehan Chandrasekera, the head of tax strategy at CoinTracker, suggested the IRS "could consider introducing standards" for the aggregation industry.

If the IRS finishes this rule before the Securities and Exchange Commission completes a couple of its own crypto-targeted efforts, it would mark the first significant crypto regulation in the U.S. Most of the 13 people invited to speak at Monday's hearing were critical of the proposal (as were the vast majority of more than 124,000 submitted comments), with some of them suggesting it could have dire consequences that snuff out crypto innovation in the U.S. One of them was just confused as to how a regular person navigates what's going on.

Tavarus Blackmon, an NFT artist, lamented that it's difficult for a small business like his to "successfully reconcile our tax liability." As for the IRS proposal, he posed a question before the 10-minute speaker timer cut him off:

"If a broker does not know they are a broker, are they still a broker?"

Read More: IRS 'Raided' by Crypto Investors as Industry Puts Up Fight Against U.S. Tax Proposal