Exchange regulation: Coinbase warns about risks of new IRS tax monitoring proposal in crypto sector



In August, the Biden administration released a tax monitoring proposal in an attempt to regulate the crypto sector and provide clear guidance to exchanges, brokers and the various providers.

Coinbase did not take the attempt to reform the industry very well and warned “the Internal Revenue Service” (IRS) of the excessive scrutiny and senseless monitoring to which the new rule would subject a large number of U.S. citizens.

This is a very important clash between those who argue that the lack of honesty on the part of crypto market players is increasing the U.S. “tax gap” and those who think such an ironclad proposal will hurt the entire industry.

Let’s look at all the details together. 

Crypto exchange regulation: Coinbase and its disappointment with the IRS’s new tax reform proposal

On Thursday Lawrence Zlatkin, tax vice president of cryptocurrency exchange Coinbase, released a 14-page letter to the Internal Revenue Service (IRS) showing his concerns about a tax proposal to regulate the crypto industry that could be approved in the coming weeks.

The proposal, first made public in August of this year under the Biden administration, could severely damage the entire crypto exchange industry and urge investors and companies to flee the United States, according to the Coinbase exponent.

This is because the new reporting guidance would require exchanges, brokers and payment processors, to put in place tight controls against their customers, without any privacy.

The IRS argues that tax evaders in the crypto world are increasing the U.S. “tax gap” by causing the country to collect less in contributions than expected, and hence it is critical to solve the problem from the top down, without relying on the honesty of individual citizens.

The Nasdaq-listed U.S. exchange, while realizing that clearer regulation on the industry in which it operates is necessary and necessary, argues that the IRS proposal and attached regulations would impose unprecedented, uncontrolled and unlimited monitoring on the daily lives of Americans.

The practices by which operators would have to monitor operations on their own infrastructure appear so ruthless and extensive that they do not seem in any way justifiable and implementable on a large scale. 

These are Zlatkin’s words within the letter:

“These rules would establish an incomprehensible and overly burdensome set of new reporting requirements that will degrade and replace the very services to taxpayers that the IRS is trying to improve.”

The Blockchain Association, a U.S. cryptocurrency advocacy group, also believes that this set of provisions could wreak havoc and deteriorate the industry in the country.

On the other hand, the usual detractors such as Senator Elizabeth Warren and other Democrats have urged the IRS to implement the new reform proposal as quickly as possible and advised it to dismiss industry complaints.

Now the government agency and the Treasury Department will have time to reflect until Oct. 30 based on the feedback received and must hold public hearings on the proposal on Nov. 7 and 8.

IRS proposal and form 1099-DA widely criticized by Coinbase

Going into more detail, the tax reform in question was initially proposed by the Treasury Department in August this year through a 300-page publication that was intended to comply with the Infrastructure Investment and Jobs Act of 2021.

It sets out what are the reporting requirements for crypto exchanges such as Coinbase, payment processors, some wallet providers and even decentralized exchanges.

As such, those who offer services dedicated to digital coin trading and/or direct exposure to this industry would have to report detailed information to the IRS on user profiles and details of transactions conducted.

The rule, strongly desired by Congress and regulators, aims to crack down on those entities that exploit the decentralization and pseudo-anonymity of cryptocurrencies to hide from tax obligations.

Indeed, there are individuals in the United States who repeatedly trade 6- or 7-zero figures and have never declared their virtual assets.

To simplify the work of exchanges and other crypto services, the Treasury has provided a form, called 1099-DA, that is intended to help determine whether an individual owes taxes without him or her having to do the calculation on capital gains.

The rule would cover cryptocurrencies, such as bitcoin and ether, as well as non-fungible tokens.

Brokers would have to send forms to both the IRS and digital asset holders to assist them with tax preparation.

Treasury estimates that the new reform could bring in nearly $28 billion over a decade to state coffers. These are its words in a memo:

“This is part of a broader effort on Treasury’s part to close the tax gap, address the risks of tax evasion posed by digital resources, and help ensure that everyone complies with the same set of rules.”

These are broadly the same set of reporting rules that financial traders in traditional markets must abide by, but applied to a totally different context where sometimes these rules might be complicated to put into practice.

Think, for example, of the whole DeFi world, where it is basically impossible to keep track of all information about protocol users, except by implementing KYC measures or violating their privacy.

The proposal itself hides a noble purpose, namely to make the crypto industry cleaner by pushing coin holders to pay the fees due by law, but it assumes a nonsensical and totally inappropriate tracking methodology that could halt the development of the industry by generating far greater damage than the current one to the United States.

Now the rules described, if they are finally approved, could be put into practice starting in 2025, with reporting requirements in 2026.