Failure to report is a felony! American investors are furious. What impact will the infrastructure bill have?

The U.S. House of Representatives passed the Infrastructure Investment and Jobs Act on November 5, 2021, with a vote of 228-206. President Biden is expected to sign the bill into law soon.

The approximately $1 trillion infrastructure plan includes $550 billion in new spending and will fund improvements to roads/highways, bridges, public transportation, clean water, the electric grid, broadband internet development, and cybersecurity. Section H of the bill discusses how to fund the new spending, including a section related to digital assets (cryptocurrencies).

Immediately, the bill sparked discussion in the crypto community on Twitter, with most members dissatisfied with the crypto clauses in the bill.

Even the online petition to "remove encryption regulations from the infrastructure bill" three months ago has returned to the attention of the encryption community.

So what are the unfavorable measures for the crypto industry hidden in the infrastructure bill? Let’s take a look.

"Brokerage" and Information Reports

1. All cryptocurrency exchanges (Coinbase, Robinhood, etc.) are now considered “brokers” just like traditional brokers (Fidelity, etc.).

Specifically, the bill states that a “broker” is “any person who is responsible for regularly providing services to transfer digital assets on behalf of others,” but without a clear scope, app developers, wallet providers, and miners may still be classified as “brokers.”

2. Definition of “Digital Assets”.

A “digital asset” is defined as “any digital representation recorded on a cryptographically protected distributed ledger or any similar technology.”

3. Digital assets are considered securities, similar to stocks, bonds, and certain types of commodities.

This has been the most debated issue in the crypto community, and the bill finally provides some clarity: digital assets will be treated like capital gains/losses on securities . In the past, digital assets were classified as property and therefore taxed based on gains or losses. So now the tax treatment of digital assets is essentially the same as before: capital gains must be taxed.

However, securities also face regulation from the U.S. Securities and Exchange Commission (SEC), which is not mentioned in the legislation. The SEC requires traditional securities companies such as stocks to file quarterly reports and provide prospectuses detailing risks. Will cryptocurrencies be required to submit similar documents to the SEC? No specific details are available yet.

4. Information reporting.

Crypto exchanges are required to provide the IRS with information about their customers. Currently, crypto exchanges have not done this, although some exchanges have sent tax forms to customers (for example, Coinbase sends 1099-MISC, which only covers rewards received from Coinbase, not capital gains).

The following information is now required to be reported to the IRS: (1) the name, address, and telephone number of each customer; (2) the gross proceeds from any sale of digital assets; and (3) capital gains or losses and whether the capital gains or losses were short-term (held for one year or less) or long-term (held for more than one year).

5. Heavy penalties for not reporting.

Crypto exchanges that fail to report this information will be subject to fines of $250 per customer, up to $3 million (under 26 U.S.C. § 6722, “Failure to Provide Correct Payee Statements”).

Over $10,000, everyone reports

The infrastructure bill changes Section 6050I of Title 26 of the U.S. tax code, classifying digital assets valued at more than $10,000 as “cash,” and anyone engaged in a trade or business that receives more than $10,000 must file a report.

The IRS explains that this type of information “helps law enforcement combat money laundering, tax evasion, narcotics trafficking, terrorist financing, and other criminal activity.”

This point is also controversial, and we will explain it in detail below.

Effective time

The infrastructure bill requirements start on January 1, 2023, so they will affect tax returns filed in 2024. However, crypto transactions in 2021 and 2022 are not subject to the requirement. This means that crypto exchanges do not need to send you a tax return (for 2023 taxes) until 2024, but it is expected that individual exchanges will begin complying earlier.

The controversial 6050I clause

6050I is different from the "broker" clause mentioned earlier. This is a separate provision, an amendment to Section 6050I of the U.S. tax code, which requires certain cash "receivers" with a value of more than $10,000 to report the name, address and social security number of the "sender" to the government. In the infrastructure bill, digital assets are also classified as "cash", which means that both parties in a crypto transaction need to provide each other with information.

This is an unusual law in that while it is part of the tax code, it is not really a tax provision. First, unlike other IRS information reporting requirements, transaction reports must be submitted within 15 days, and violating this provision is a felony. Second, it is not limited to "brokers" or crypto exchanges, it applies to all businesses, including individuals. The only ones not subject to Section 6050I are banks and financial institutions.

This is also what scares the American crypto community the most. Some lawyers point out that NFT and DeFi are almost impossible to comply with this law.

Main Objectives

The main goal of this provision is to collect information on crypto asset users. In short, Section 6050I is an anti-crime law where the government uses the reports received to investigate suspicious activities.

Anyone receiving money must report the personal information of the “payer” or “sender” to the government when the following five factors are present:

1. You receive: your “receipt” for the money you received – a record of the transfer.

2. Digital assets: defined as “any digital representation of value” that uses distributed ledger technology.

3. Value exceeds $10,000

4. In the course of a “trade or business”: A “trade” is also a business, even if it is a personal participation.

5. Unless a federally regulated “financial institution” has already reported the same transactions and personal information.

Controversy over DeFi

Section 6050I poses particular problems for DeFi because, if reporting is required, the report would include the name, address, and tax ID number of the person sending the digital asset.

Consider a simple example of an automated market maker on a decentralized exchange. (Centralized exchanges are considered “financial institutions”)

Example 1:

Andy withdraws assets in the liquidity pool by destroying LPs. It is difficult to argue that the withdrawn assets are not Andy’s “receipts.” Moreover, based on the interpretation of “transactions” in the bill, the income will accumulate over time to meet the $10,000 threshold.

Example 2:

Bob uses a decentralized exchange to exchange token A for token B. The token B Bob receives may also be a “receipt”.

Under current regulations, when cash is received, the report requires listing everyone involved in the transaction. Now that the regulations have been revised, digital assets are also equivalent to cash. Then Andy and Bob need to report all the information of the token sender.

But this is also controversial. Generally speaking, tokens obtained from withdrawals from a liquidity pool cannot be traced back to one or more specific accounts, let alone a specific person. Perhaps the tokens are not "received" from one or more people, but from a smart contract. If it is a centralized exchange, then the person who sent B tokens may not be the trader on the other end, but the exchange itself. After all, the person who put these tokens into the liquidity pool did not intend for Bob to receive them.

It can be said, then, that the “person” to be reported in the example is the DEX, which is a collection of smart contracts.

This creates two situations: if the “sender” reported to the IRS is a DEX, the report may be considered compliant by the IRS even without an address and tax ID. Or the recipient may argue that the non-existence of the “person” receiving the digital asset puts the transaction beyond the scope of the regulations.

“This effort to apply 6050I to digital assets, and DeFi in particular, is really absurd.”

Example 3:

Charlie sees a very nice NFT and sends his cryptocurrency to the smart contract in exchange. When the dust settles, Charlie owns the NFT (because NFTs are digital assets under the Act, there may also be reporting requirements for Chaelie).

David is an artist who created an NFT and received Charlie’s cryptocurrency as payment for the NFT. (Fees received when NFTs are traded may also impose reporting obligations.)

In reality, David received cryptocurrency from a smart contract. However, it is implausible that the regulation exempts David from reporting Charlie’s personal information simply because a smart contract was involved.

In summary, the effort to apply Section 6050I to digital assets, especially DeFi transactions, is indeed somewhat absurd. The old law is simply not suitable for this new technology. It is difficult to imagine how 6050I will be applied to digital assets, which is another reason why the proposal has been criticized by the crypto community.

According to Jake Chervinsky, a crypto legal expert in Washington, D.C., the new bill may not bode well for the crypto industry, but noted that there are still important details that have yet to be finalized.

"Yes, the encryption bill is just as bad as it was a few months ago. Yes, the impact of Section 6050I has not been fully explored. And no, you don't need to call your representative because it's out of our hands now."

Importantly, this won’t happen right away, and the law won’t go into effect until 2024 (for FY 2023 reporting). For crypto supporters, the time between now and when the law goes into effect could be a make-or-break moment for the industry.

Source of opinion:

Abraham Sutherland, Lecturer at the University of Virginia School of Law.

Asset Management, Volt.