Love them or (probably) hate them, taxes are a certainty every year. But in 2023, tax regulations in the crypto world are expanding. And like it or not, crypto exchanges and wallets will need to comply.
1099-Bs will be required by law to be issued to customers who transact cryptocurrency through an exchange or wallet. This means that crypto exchanges and wallets need to start preparing now for gathering and tracking that scope of information on customers — upwards of 27 million Americans who own cryptocurrency.
While non-compliance is not an option, there are a few different ways that exchanges and wallets can prepare for this new regulation, and avoid penalties from the IRS.
The category of 1099 documents simply reports any non-W2 income an individual makes over $600. The 1099 form actually predates the W2 form with its origins in modern income tax laws of 1917, and is considered an information reporting document in that a company or entity provides information to an individual about their wages, tips, salary, or other income. The 1099 category has expand over the past century to include the 1099-DIV, which reports dividends and distributions, the 1099-INT, which reports interest income, the 1099-MISC, which reports miscellaneous income, and the 1099-B, which reports the proceeds from brokerage or barter exchange transactions.
Brokerage firms or barter exchanges issue 1099-Bs to customers with a list of their transactions, gains and losses, and other information, and also send a copy to the IRS. As such, brokerage firms and barter exchanges need to collect information on their customers, track their transactions, and generate reports of those transactions for tax time.
But crypto exchanges and wallets aren't brokerage firms or barter exchanges — so why all this talk of 1099-Bs? Because with the passage of the Infrastructure Investment and Jobs Act, the IRS now considers crypto exchanges and wallets to function like brokerage firms and barter exchanges. And beginning in 2023, the IRS will require by law crypto exchanges and wallets to generate 1099-B form — or something like it — for each of their customers, with copies sent to the Federal government and each state that requires reporting as well.
In a world where crypto exchanges and wallets have not typically had to gather information on their customers, nor track their transactions, much less report out on them, will you be prepared to pivot quickly?
There’s a lot of information that appears on a 1099-B that a broker would issue today. It includes customer information basics like their name, address, and social security number. Then, it includes an itemized list of their exchanges and activity, including a description of the asset, the date it was sold, any gains or losses on the asset, and other information.
What might this look like for a crypto exchange or wallet? This new form might include the crypto holder’s name and personal information, and an itemized list of every transaction they made on your exchange: a list of which currency they used, what date they made the transaction, how much they bought or sold the currency for, and what types of gains or losses they incurred. Additionally, crypto exchanges will have to have processes in place to gather and certify social security numbers before accounts can be set up, like collection through W-9s, or a way to validate existing SSNs. Beyond these new tax forms, crypto exchanges may have to report on existing tax obligations like backup withholdings as well.
So, the challenge is going to be in the tracking, as crypto exchanges and wallets will need to collect customer information, track each transaction, and generate a report with all that information come tax time. And you’ll need to create a system for managing this on the backend. But should you build it in-house, or take another route?
Building capabilities in-house for your new tax form collection and generation is an option. But is it one you should take?
Consider that building in-house is going to take time, resources, and cost. First, how do you start building this process? If you’ve already been collecting customer and transaction information, you still need to find a way to extract all that information and create a compliant tax document. But if you haven’t been tracking that information, then you need to build that capability, too.
Additionally, do you have in-house resources available who can build this capability, and get it stood up in the next few months? Do you have the budget to research, design, source, develop, and test this capability, and further funds and personnel to maintain it?
One of the biggest challenges to this will be compliance. Are you building your capabilities correctly in order to fulfill your obligations to the IRS, with penalties if you don’t?
You could look to a third-party vendor to build your data collection and form generation system, but you’ll run into the same issues: time, cost, and compliance expertise. So what’s the best option?
Why devote time and resources building it yourself when you can use an API designed for just this type of thing? Using APIs to generate the tax documents that you need will not only lessen the scope of setting up your 1099-B systems. You won’t have to devote engineering resources to building out an in-house system from scratch and maintaining it into the future. APIs can help crypto exchanges and wallets deploy this new capability quickly — in a day or two — and can get you prepared well in advance of 2023. And using an API designed by someone who knows the tax requirements won’t leave you worrying about compliance — especially when expanded reporting to include things like staking is likely on the horizon.
Love it or hate it, tax change is on the horizon, and crypto exchanges and wallets have to be prepared. However, there’s still time to take action on ramping up capabilities for collecting and reporting — and the quickest and easiest way to implement the system you need will be through using custom APIs for your purposes. There’s still time before 2023 — but not much — so act today.