The IRS’s new crypto tax grab is a bridge too far

As President Reagan knew years ago, every time an innovation is born, the government is eager to tax it. This time, the IRS has a new target in its sights — cryptocurrencies. 

Last month, the IRS closed the comment period on a proposed rule for certain digital asset brokers, including digital asset trading platforms, wallet providers and payment processors. The rule, if finalized, would require these entities that fall under the rule’s definition of a broker to submit information to the IRS on their customers’ digital asset transactions. 

Up to a point, requiring brokers to report transaction information to the IRS is in line with convention. But the IRS’s rule goes beyond congressional intent.

For example, the IRS offers an expansive definition of digital asset, which includes stablecoins and nonfungible tokens, or NFTs, many of which never realize a capital gain or loss. What is most concerning is that if an individual uses a stablecoin to purchase coffee, groceries or any everyday good or service, the IRS is mandating that transaction be reported, for he IRS’s rule also fails to offer a de minimis exemption for small transactions.

Last Congress, a bipartisan cadre of lawmakers introduced a bill to ensure that small digital asset transactions need not be reported to the IRS. After all, overreporting will lead to more government surveillance and paves the way for the IRS to harass individuals and small businesses.

This is not the first time the IRS has attempted to grossly expand its authority. The IRS tried to lower the reporting threshold to $600 for bank account transactions, which would have significantly burdened small businesses and individuals with onerous and invasive reporting requirements. Additionally, Congress wrongly directed the IRS to lower the threshold for third-party network transactions from $20,000 to $600.

The IRS was unsuccessful with bank accounts, so now they are going after taxpayers’ digital asset transactions.

The proposed rule also targets decentralized protocols run by decentralized autonomous organizations. These peer-to-peer operations are different from centralized exchanges because they do not have the knowledge or information required to report transactional information to the IRS.

The IRS rule also requires duplicative reporting. Traditionally, the IRS has not required brokers conducting sales for other brokers to report to the IRS. This rule acknowledges that this could be repetitive, but it would still prefer to have those transactions reported anyway. The IRS is so fixated on retrieving customers’ personally identifiable information and ensuring taxes are properly reported that it is ignoring the costs of overreporting. This goes beyond what is required of traditional brokers and what Congress intended.

Taxpayers should also be concerned about overreporting because the IRS has an embarrassing history of data breaches. The less information reported to the IRS, the better. Data stored at the IRS was hacked or compromised in 2015, 2016, 2017, 2019 and 2020. The IRS has also released sensitive information on its own.

Lawmakers recently raised concerns about the IRS’s data security deficiencies.

The IRS admits that it did not thoroughly study the economic effects of this rule on small businesses. According to Michigan v. EPA, “No regulation is ‘appropriate’ if it does significantly more harm than good.” In this case, the IRS is fixated on terminating “the overall tax gap” to the detriment of small businesses with no perceived benefits.

The Keep Innovation in America Act should be enacted to fix the statutory definition of a digital asset broker. The bill would codify a better definition of broker for digital asset transactions, tailor the definition of digital asset and narrow the information reported to the IRS. 

Although the Treasury Department indicated that “ancillary parties” are not intended to report transaction information to the IRS, leadership within the executive branch has the power to unilaterally shift course without any consideration from Congress. The only foolproof solution is to explicitly codify protections for decentralized autonomous organizations, miners and other parties that would not know transaction information.

Lawmakers should understand the negative implications of allowing the IRS to collect innumerable amounts of transactional information on digital assets. Congress needs to take the reins and pass legislation that would codify the proper definition of a broker and protect consumers by statutorily exempting small transactions from IRS reporting.

In the meantime, the IRS should withdraw the unworkable rule since it fails to capture Congress’s intent and could be found to be arbitrary and capricious.

Providing the proper legislative framework for a burgeoning industry will ensure the U.S. can continue to promote technological innovations and be the lodestar for distributed ledger technology across the globe.

Bryan Bashur is the director of Financial Policy at Americans for Tax Reform.