Taxes are one of the few certainties in life and major tax changes are coming very soon for crypto exchanges and wallets. Will you be ready for them?
While cryptocurrency owners have been required to report their crypto gains and losses on their income taxes for a few years now, crypto exchanges and wallets have not had to provide information to the IRS about their customers and their transactions. But all this is about to change as new federal regulations will require crypto exchanges and wallets to provide tax documentation in the form of a 1099-B to their clients. And it won’t be an easy process.
To be prepared for this change, you need to know exactly what will soon happen to crypto exchanges and wallets, what type of report you will be asked for, and why it might not be a good idea to develop these options. . internally.
On the horizon of the tax return
Despite the cryptocurrency’s intent to be decentralized, federal tax rules have caught up with crypto owners, who must report their crypto holdings as property and pay capital gains taxes associated with them. However, unlike brokerages or exchanges, crypto exchanges and wallets did not have to report customer information, transactions and gains or losses to the IRS and issue a form to customers for their own tax purposes.
However, this changed with the Infrastructure Investment and Employment Act, also known as the Infrastructure Bill, on November 15, 2021. The bill expands the tax reporting required for transactions, and beginning in 2023, crypto exchanges and wallets will be required by law to generate and issue 1099- B forms – or something like that – for their clients, the federal government and any state that requires reporting. And with nearly 600 crypto exchanges, the largest of which handles $15.9 billion in volume, they have a lot of work ahead of them.
A 1099-B – like other 1099 forms – is used to report non-W2 income earned over $600 and is records of self-employment or gig work, interest received, dividend payments, etc. Even certain purchases using cryptocurrencies can trigger a taxable event that applies to the $600 threshold. A Form 1099-B is specifically issued by brokerage firms and exchanges and contains a record of all transactions made, the instrument used, gains or losses, etc. The message here is clear: the IRS considers your exchange to be a brokerage or exchange. And as such, you must track and provide a record of all crypto transactions per client made on your platform. You may also need to report existing tax liabilities, such as withholding tax.
Because it is required by law, you have no option to do nothing – or you can and face the penalty. You need to develop your ability to handle this huge amount of data collection and tracking for it to arrive next year. But how will you do this?
Crypto exchanges and wallets must prepare end-to-end for these new tax rules, from collecting customer information to tracking and assigning transactions to generating a form that complies with the law. What type of information does a typical 1099-B contain? You can find a customer’s name, address and social security number – and SSNs require their own collection and verification process before 1099-B issuance can begin. It also contains a list of all transactions made, including what was sold, date sold, amount, profit or loss, and other important information.
There is a lot of data to track and many reports to fix. Your first idea may be to develop these capabilities in-house, but you will face a number of obstacles in doing so, such as:
- Compliance: There are a number of internal challenges. The first is compliance and ensuring that the way you collect and report information complies with this new tax law. And you can be sure that the IRS will be watching crypto exchanges and wallets to make sure they are doing things right.
- The speed: Another challenge will be the speed at which you can design, develop and implement these new features, especially when they need to be ready by the end of the year. Do you have the resources and budget to immediately focus on solving this problem?
- Cost: Costs are another challenge if you build in-house. Consider the research, design, procurement, development, testing and maintenance costs of building, operating and maintaining the backend infrastructure for this capability. Does your exchange have the technical resources to also prioritize this?
- Maintenance: Finally, are you ready to commit to the ongoing work of running this tax process year after year and maintaining the underlying infrastructure? Who will perform software updates to keep pace with changing tax laws? Which team will own it?
Use custom APIs
You don’t have to build your solution yourself. The best approach to get started quickly and easily is to use APIs to track and generate your 1099-Bs. Instead of building all this functionality in-house, APIs will integrate with your system and easily extract all this data to generate the forms you need. Additionally, custom APIs from a knowledgeable vendor not only ensure you stay compliant with tax laws, but keep up with changes and ongoing API maintenance. Ultimately, API integration will save you time, money and resources and prepare you for when new laws come into effect.
Tax changes for crypto exchanges
There is an old saying that there are only two certain things in life and one of them is treasures. Crypto exchanges and wallets face an inevitable future of compliance when it comes to transaction reporting to the IRS — and perhaps even more extensive reporting, including stake taxation. However, another old adage says that one time saves nine, so if crypto exchanges and wallets start building capacity today, they won’t fall out when the IRS calls.