IRS Cryptocurrency Tax Draft Defines Non-custodial Wallets as Brokers

The controversial tax schedule has not yet been finalized.

The Internal Revenue Service (IRS) released a draft version of its 1099-DA reporting form on April 19 and controversially included non-custodial cryptocurrency wallets in its target scope.

Ji Kim, the chief legal and policy officer of the Crypto Innovation Council, said that the IRS’s approach is regrettable because it does not realize that non-custodial wallet service providers have strict regulations on cryptocurrency transactions and the parties involved in each transaction. Knowledge and understanding are limited.

Shehan, Head of Tax at CoinTracker Chandrasekera also criticized the form. He pointed out that this approach may have an impact on ordinary users, who may need to conduct "know your customer" when creating non-custodial wallets or combining non-custodial wallets with services such as decentralized finance (DeFi) platforms ( KYC) verification procedures.

However, Chandrasekera said authorities are likely to target enforcement efforts at non-custodial wallet providers rather than end-users.

Non-custodial or non-custodial wallets do not store cryptocurrency balances in third-party services. They are different from custodial wallets, which includes most exchange wallets.

1099-DA Form

The 1099-DA form also requires brokers to provide certain on-chain data, including transaction IDs and wallet addresses associated with each sale. Brokers should report the transaction ID and address that initiated the sale of the cryptocurrency, and a secondary address if they “moved in” funds from their other custodial wallet address.

Experts have had mixed responses to this request. Chandrasekera warned that collecting and reporting data, especially wallet addresses, “could lead to significant privacy and security issues.”

However, Jessalyn Dean, vice president of tax information reporting at Ledgible, pointed out an exception to the rule. She said the form allows brokers to not have to provide addresses and transaction IDs if the relevant circumstances do not apply. She believes this exception is also "necessary," Because brokers often conduct transactions in their own internal accounting systems rather than operating directly on the blockchain.

Another key section reads, "Impossible Wash Sale Loss." According to Dean, this does not subject the cryptocurrency to wash sale rules. Instead, the provision is aimed at digital assets currently subject to wash sale rules, including stocks, securities and tokenized equity.

Rules have not yet beenfinalized

Cryptocurrency brokerage reporting rules have been in the works for some time.

In 2021, U.S. President Joe Biden’s infrastructure bill defines certain cryptocurrency service providers as brokers. Then in August 2023, the U.S. Department of the Treasury and Internal Revenue Service (IRS) released a proposal for Form 1099-DA, which largely matches the current draft form.

However, the text of the draft form indicates that the IRS has not finalized the form and brokers should not use it in current tax reporting.

According to Ledgible, there is a 60-day comment period on the form.

The United States Internal Revenue Service (IRS) has separate rules for individual cryptocurrency investors. The regulator issued a reminder on April 11 that cryptocurrency investors should report on various forms, including Form 1040. Recently, a senior member of the IRS also warned of tax evasion among cryptocurrency investors.

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