People creating, buying and selling non-fungible tokens (NFTs) in the United States might soon be forced to disclose information about their business partners. This is due to an existing tax law that requires them to file their transactions with the Internal Revenue Service (IRS).
Traditionally, the tax law code named 6050I requires people who receive $10,000 in a single cash or equivalent transaction, such as via a money order, to file records of the transaction with the IRS. However, recent modifications to the law — proposed in the now-passed Infrastructure Investment and Jobs Act — address digital assets, such as those earned from selling NFTs and cryptocurrencies, and may classify them as taxable. Here’s how this development could impact future tax filings.
What Are the New Requirements?
Starting January 1, 2023, brokers must declare “digital assets” transactions on Form 1099-B or any comparable tax form to the IRS. This means that digital assets are now treated as “specified securities,” which is to identify their customers and the cost base of their digital assets gains and losses.
In addition, brokers are expected to record transfers of digital assets to non-brokers. The inclusive interpretation of the law could cover all cryptocurrencies and potentially other types of digital assets, such as non-fungible tokens (NFTs). And, like any other 1099-B reporting, you’ll face penalties if you don’t file or don’t include information about certain transactions involving these assets on your tax return. The bill also loosely defines a broker as anybody who frequently provides any service that facilitates transfers of digital assets on behalf of other people.
However, crypto enthusiasts have raised concerns about this definition, which many feel is overly far-reaching. Developers, crypto miners and other investors without the capabilities to monitor transactional activities could now be treated as brokers and subjected to the same taxation requirements.
For example, miners play a crucial role in verifying Bitcoin transactions through the blockchain by solving mathematical puzzles in exchange for a stipulated amount of Bitcoin. However, miners often verify thousands of transactions per day and may not necessarily have access to each asset during the process. Therefore, they cannot provide the information expected under the bill, despite the fact that they seemingly meet the definition of brokers as people who frequently facilitate the transfer of digital assets.
When Will the Proposed Bill Take Effect?
Because the Infrastructure Investment and Jobs Act was signed into law in November of 2021, new reporting requirements for cryptocurrency transactions will be required beginning January 1, 2023. Brokers must provide 1099-B forms recording cryptocurrency and NFT transactions, and cryptocurrency trading platforms will also be required to report these types of transactions to investors and to the IRS at the end of each calendar year. NFTs could receive a similar tax treatment as that of cryptocurrencies, with a long-term capital gains rate that generally varies from 0 to 20%, based on income.
If you transfer assets from one wallet to another, which is a recorded transaction but not necessarily one that results in earned income, the original wallet platform needs to provide certain asset information to the wallet platform that receives the transfer. The IRS also maintains the ability to redefine certain terms as needed for the sake of clarity, which could result in some changes to these recently developed rules.
Things are still a little less clear where NFTs are concerned. NFTs sold after a holding period of less than a year could be subjected to short-term capital gains rates that equal ordinary income tax rates. Creators who produce NFTs and later offer them for sale on digital marketplaces get taxed the moment they sell their NFTs. For example, if James created an NFT and later sold it for Ethereum (ETH) valued at $6,000, he would have to declare the $6,000 as part of his ordinary income. He’d then need to pay self-employment taxes on this amount. If he creates NFTs, he can write off his ordinary and fundamental business expenses to balance his income.
Some common taxable NFT-related activities include:
- Selling NFTs for cryptocurrency
- Purchasing NFTs with a fungible crypto asset
- Trading some NFTs for others
What Are Potential Consequences of Enforcing the Bill?
The bill’s new condition for businesses to solicit and report personal information about parties involved in some trades of cryptocurrency transactions over $10,000 could have unforeseen repercussions. But, these will depend on the ways the new law’s obligation is implemented.
Section 6050I’s reporting obligations have traditionally applied to a single individual or to untraceable cash payments on goods and services. However, these new requirements, and the explanations regulating them, don’t map onto digital assets that are transacted online in a traceable manner because of blockchain technology. Say that lawmakers later clarify the section so it only covers digital asset transactions that are cash-like, such as using Bitcoin to pay for goods or services in person. If that’s the case, the bill may have a diminished impact on the cryptocurrency industry.
Efficiency, privacy and decentralization are the core technologies driving blockchain. Transparency regarding blockchain transactions — via a publicly administered ledger built on technology that facilitates secure peer-to-peer transactions at no extra costs or with centralization — is important to crypto users and investors.
The bill also presents a challenge for the new category of digital asset “brokers.” Brokers that have customers outside the U.S could face complex withholding, reporting and other compliance requirements that could encourage people to move their cryptocurrency activities to other competing countries.