Thread by @CryptoTaxGuyETH

PROPOSED TAX REGS THREATEN US BLOCKCHAIN ACCESS

Yesterday the IRS proposed crypto broker reporting regs.

If finalized in their current form, the regs would require websites like those for @Uniswap, @opensea, and @etherscan, & many block builders, to geoblock US people.

A🧵...

2/ BACKGROUND. Section 6045 of the tax code requires brokers to provide customers and the IRS with 1099s showing the customer's name and address, proceeds from the sale, and basis of assets sold, and to "backup withhold" on customers who don't provide certain identifying info.

3/ The Infrastructure Investment & Jobs Act revised the def of "broker" to include "any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person."

The prop regs implement that change.

4/ DIGITAL ASSET. The reporting requirements apply to transfers of digital assets, which the tax code defines as "any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the Secretary."

5/ Most cryptos aren't technically "representations of value," either because they aren't semiotic (eg, BTC or ETH) or they represent financial positions (LP tokens), credentials (ENSs), or...cartoons (most NFTs).

So the tax code's definition of digital assets is ambiguous.

6/ The proposed regs retain that definition, and the preamble indicates it means anything transferrable onchain, including stablecoins, NFTs, semi-fungible tokens, and tokenized stock/bonds (with a coordination rule to avoid duplicative 1099s).

7/ That means assets whose sales would not be reportable if effected offchain (e.g., memorabilia or customer reward points) give rise to a reporting requirement when sold in tokenized form.

8/ BROKER. Current regs define a broker as "any person that in the ordinary course of a trade or business stands ready to effect sales to be made by others."

The proposed regs retain that definition, but redefine "effect" to turn virtually every crypto app into a broker.

9/ "Effecting" now would include acting as a digital asset middleman, which is someone providing facilitative services (other than validating) who is in a position to know the seller's identity.

"Facilitative services" include providing access to smart contracts.

10/ Someone is in a "position to know" a seller's identity if they could know it (e.g., by token-gating a website).

Thus, brokers can include: publishers of DEX sites or wallets with built-in token swap routing; DAOs; multisigs; and individual participants in the foregoing.

11/ Although the preamble and regs don’t explicitly say so, brokers also appears to include block builders if they earn MEV and would be in a position to geoblock call functions from US IP addresses.

12/ Moreover, reporting obligations apply to brokers even if they sit within a chain of other digital asset brokers. So, the publisher of a wallet with a swap button is a broker, even if the button just routes into a DEX app whose publisher also is a broker.

13/ It wouldn't be an understatement to describe the definition of “digital asset middleman” as an acute threat to the availability of blockchain technology to US taxpayers. More on this beginning tweet 18 below.

14/ REPORTING. Brokers have to report the name, address, proceeds, txnID, and wallet address for each sale they facilitate beginning 2025, & the asset’s basis beginning 2026.

Foreign brokers are exempt unless a sale has US indicia like an IP address "indicating" a US location.

15/ BASIS. Under the proposed regs, txn costs (including gas and broker fees) on a token swap are allocated 1/2 to each side of the txn, so the new token's basis is its fair market value plus 1/2 of the txn costs.

The preamble reminds us that paying gas is itself a tax event.

16/ SPECIFIC IDENTIFICATION. US taxpayers who don't "specifically ID" which tokens they are selling must use FIFO.

Specific ID is wallet-by-wallet and must be made in a taxpayer's books and records, or by instruction to a custodian broker, no later than the date of sale.

17/ The proposed regs’ wallet-by-wallet approach could be a trap for unwary US taxpayers who hold only low-basis assets in a wallet that they want to transact from. Those taxpayers should remember to first send their high basis assets to that wallet if they want to ID them.

18/ INITIAL REACTIONS. The proposed regs' definition of digital assets middleman would turn website developers into brokers if the websites "facilitate" digital asset sales.

That’s bad law and bad policy.

19/ BAD LAW. Websites for DEXes, NFT platforms, and many block explorers present info about the state of a chain relating to a specific set of smart contracts, and give users an intuitive interface to indicate what actions they want to perform through those smart contracts.

20/ The website translates that user input into a data object that can be fed into a separate wallet application and, if the user wants, submitted by the wallet for inclusion onchain.

(H/t @lex_node for this clear explanation: .)lexnode.substack.com/p/a-functional…

@lex_node 21/ Importantly, the website translates the user’s intentions into hypothetical function calls, but does not interact with the chain. That's true even when a token swap button is built into a wallet: the swap button creates a data object that the user may or may not deploy.

22/ The proposed regs thus interpret "effectuating transfers on behalf of another person" to include providing info that another person might use to effectuate transfers.

That's inconsistent with the statutory text and all historical notions of the broker-customer relationship.

@lex_node 23/ It’s also a woefully unclear standard. Presumably a static website isn't a broker. How about a site that generates code but requires the user to copy-paste it into their wallet?

How bad does the UX have to be to avoid broker status? And why should broker status turn on UX?

@lex_node 24/ POLICY. The effect of the regs would likely be a complete quarantine of US people from reputable blockchain technology. US people could speculate on tokens by buying them on a CEX, but couldn't access web apps that enable swaps.

@lex_node 25/ Websites that "turn a blind eye" to US users and don't comply with reporting reqiurements are likely to be hosted offshore and far from the reach of US regulators, making blockchain transactions generally more dangerous for even savvy US users.

@lex_node 26/ Consider Facebook marketplace, a virtual meeting hall for P2P transactions.

It’s in our national interest to keep the marketplace within the reach of US consumer protection laws. Using an offshore-hosted marketplace would be more dangerous for Americans.

@lex_node 27/ Facebook earns ad revenues for its marketplace, but isn't a broker if it doesn't intermediate sales.

DEXes & NFT platforms are analogous. They earn compensation for publishing information that makes it easier for people to sell their tokens. They don’t intermediate sales.

@lex_node 28/ The putative benefit of deputizing web publishers as brokers - specifically, TradFi-style transaction reporting for the IRS and users - doesn’t outweigh the cost of denying Americans safe access to blockchain infrastructure.

@lex_node 29/ The IRS could instead require CEXes to provide the public keys of any self-hosted wallets into which US taxpayers withdraw their funds. That would let the IRS determine taxpayers’ gain and loss just as we do - by plugging their wallet addresses into tax prep software.

@lex_node 30/ Moreover, the taxation of many crypto transactions, like LPing and dapp-layer staking, is still unclear. Requiring protocols to report them raises a lot of questions for any infrastructure providers that don’t geoblock US addresses.

@lex_node 31/ WHAT NOW? There are 60 days to comment on the proposed regs, after which the IRS will finalize them with any changes that it determines are appropriate based on those comments.

I urge you all to take this seriously if you care about Americans' access to blockchain tech.

@lex_node 32/ P.S.

In addition to treating website publishers as brokers, the regs probably capture:

- Anyone who earns MEV. Validators are exempt only if “solely” in the biz of validating.

- Uniswap v3 LPs. Fee setting is presumptive evidence of a “position to know” a user’s identity.