House of Representatives Moves to Repeal DeFi Regulation
The House of Representatives has taken a significant step by voting to repeal a regulation imposed during the Biden administration that targets decentralized finance (DeFi). This legislative action aims to overturn the “DeFi Broker Rule,” which was introduced by the Treasury in December 2024. The rule mandated specific reporting obligations for front-end service providers that engage directly with users in digital asset transactions. DeFi encompasses financial services that operate on blockchain technology, allowing users to engage in crypto transactions without the involvement of banks or traditional financial institutions.
Understanding DeFi Brokers and Tax Implications
Defining DeFi brokers can be complex, as stakeholders have noted following the announcement of the regulations. Although this rule was new, it did not introduce a new tax; individuals who own digital assets have always been liable for taxes on sales or exchanges of these assets. However, in line with the Infrastructure Investment and Jobs Act (IIJA), these new reporting requirements align with those already set for conventional financial services, aiming to assist taxpayers in accurately filing their returns and fulfilling their tax obligations.
New Reporting Requirements: Form 1099-DA
The final regulations included the introduction of a new reporting requirement through Form 1099-DA, specifically for Digital Asset Proceeds from Broker Transactions. This form, which the IRS had previously drafted, would have placed DeFi brokers under the same reporting guidelines as traditional securities brokers and custodians of digital asset trading platforms. It’s essential to note that the issuance of Form 1099-DA does not alter the tax status of a transaction; it serves solely as a means of reporting. One of the primary motivations behind this new form and associated rules is to enhance compliance. Historically, tax compliance rates tend to exceed 90% when income is reported by third parties, in contrast to only 55% compliance when individuals self-report their income.
Importance of Basis Reporting for Taxpayers
The introduction of Form 1099-DA also offers a secondary advantage: basis reporting. For many taxpayers, navigating the buying and selling of digital assets across various platforms and wallets can complicate the calculation of taxable gains. The IRS classifies cryptocurrency as a capital asset, and in 2014, it clarified that capital gains regulations apply to any profits or losses incurred. When trading cryptocurrency as an investment, individuals need to determine gains and losses similarly to how they would with stocks. However, if cryptocurrency is spent directly or exchanged for goods or services, each transaction can result in gains or losses that need to be assessed for tax purposes. Essentially, taxpayers must track how their basis—the original cost of the asset—changes from the time of acquisition until a taxable event occurs, such as a sale or gift.
Challenges in Tax Reporting for Cryptocurrency
The challenge lies in the fact that if an individual cannot accurately determine their basis, they cannot compute their tax obligations correctly. Assets held for over a year are classified as long-term gains or losses, while those held for a year or less are considered short-term. The fluctuations in cryptocurrency values are significant, but only the initial and final values matter for tax purposes; interim value changes do not impact realized gains or losses. To recognize a gain or loss for tax purposes, a transaction must occur, such as selling or disposing of the asset. During tax season, any realized gains and losses are reported on Schedule D. If there are no realized gains or losses, no Schedule D is necessary, as mere changes in value without transactions do not require reporting.
Industry Reactions and Concerns
While there has been general support within the industry for efforts to simplify processes for digital asset owners, there are concerns about how these regulations might affect other market participants. This is particularly true regarding the new reporting requirements. When the rules were first announced, Jessalyn Dean, vice president of tax information reporting at Ledgible, a digital asset tax accounting platform, expressed concerns that the regulations could extend to software operators that do not provide financial services. Additionally, DeFi brokers operate in a decentralized manner and typically do not gather user information required for compliance with the new rule. Imposing such reporting obligations on these entities could stifle innovation and business growth, as Dean warned.
Current Status of the Legislation
The House of Representatives voted decisively, with a tally of 292-132, to repeal the DeFi regulation. The Senate had previously voted to overturn the rule but will need to reconsider this version of the bill. The House has now sent the legislation back to the Senate, where it is anticipated to pass before being forwarded to the President. If it reaches this stage, the President is expected to sign the repeal into law.
