IRS Issues Final Regs, Penalty Relief for Certain Digital Asset "Middlemen"

(Parker Tax Publishing January 2025)

The IRS issued final regulations under Code Sec. 6045(a) regarding information reporting by brokers that operate within the segment of the digital assets industry commonly referred to as decentralized finance (i.e., DeFi brokers); the final regulations impose the same information reporting rules that apply to brokers for securities and operators of custodial digital asset trading platforms. The IRS also provided transitional relief from penalties for DeFi brokers who fail to report sales of digital assets or fail to furnish payee statements for sales of digital assets effected in 2027. T.D. 10021; Notice 2025-3.

Background

In August of 2023, the IRS published proposed regulations (REG-122793-19) (proposed regulations) relating to information reporting under Code Sec. 6045 by brokers. The proposed regulations included rules for brokers that generally act as agents and dealers in transactions with their customers involving digital assets, which are defined generally as any digital representation of value that is not cash and is recorded on a cryptographically secured distributed ledger (that is, a database that records transactions across multiple computers) or any similar technology.

The proposed regulations also included rules for brokers that act as digital asset middlemen, a new category of broker proposed to address the use of digital assets to make certain payments and to reflect the clarified definition of broker under the Infrastructure Investments and Jobs Act (Pub. L. 117-58) (2021). This proposed new category of broker includes certain participants that operate within the segment of the digital assets industry that is commonly referred to as decentralized finance (DeFi). The DeFi industry offers services that allow for transactions that use automatically executing software commonly referred to as smart contracts based on distributed ledger technology without any participant in the DeFi industry (DeFi participant) taking custody of the private keys used for accessing the digital asset customer's digital assets on a distributed ledger. Additionally, the proposed regulations included specific rules under Code Sec. 1001 for determining the amount realized in a sale, exchange, or other disposition of digital assets and under Code Sec. 1012 for calculating the basis of digital assets.

In July of 2024, the IRS published final regulations in T.D. 10000 regarding information reporting by certain brokers and the determination of amount realized and basis for certain digital asset sales and exchanges. The final regulations in T.D. 10000 generally require brokers to report gross proceeds for digital asset sales occurring on or after January 1, 2025. Additionally, T.D. 10000 requires basis reporting for sales occurring on or after January 1, 2026, but only with respect to digital assets the customer acquired from, and held with, the same broker on or after January 1, 2026.

T.D. 10000 generally applies to digital asset brokers that act as agents for a party in the transaction, such as operators of custodial digital asset trading platforms, certain digital asset hosted wallet providers, and certain processors of digital asset payments (PDAPs), as well as persons that interact with their customers as counterparties to transactions, such as owners of digital asset kiosks, brokers who accept digital assets as payment for commissions and certain other property, brokers that transact as dealers in digital assets, and certain issuers of digital assets who regularly offer to redeem those digital assets. Additionally, T.D. 10000 finalized specific rules under Code Sec. 1001 for determining the amount realized in a sale, exchange, or other disposition of digital assets and under Code Sec. 1012 for calculating the basis of digital assets. T.D. 10000 did not finalize the definition of digital asset middleman from the proposed regulations as applied to DeFi participants (referred to in the preamble to T.D. 10000 as non-custodial industry participants) because the IRS determined that additional consideration of the issues and comments received with respect to these participants was warranted.

T.D. 10021

On December 30, the IRS published final regulations (T.D. 10021) regarding reporting requirements for DeFi brokers.

The final regulations narrow the definitions of "digital asset middleman" and "effectuating service." Reg. Sec. 1.6045-1(a)(21)(i) defines a digital asset middleman as any person who, with respect to a sale of digital assets, provides a facilitative service. Reg. Sec. 1.6045-1(a)(21)(iii)(B)(1) through (4) defines a facilitative service by referencing five specific services in which the broker acts either as an agent or a counterparty in a digital asset sale. T.D. 10000 reserved on the portion of the facilitative services definition included in Prop. Reg. Sec. 1.6045-1(a)(21)(iii)(A) that would have defined a facilitative service as any service that directly or indirectly effectuates a sale of digital assets, such as providing a party in the sale with access to an automatically executing contract or protocol, providing access to digital asset trading platforms, providing an automated market maker system, providing order matching services, providing market making functions, providing services to discover the most competitive buy and sell prices, or providing escrow or escrow-like services to ensure both parties to an exchange act in accordance with their obligations.

Several commenters argued that the proposed definition of facilitative services was too broad because it referred to services that both directly and indirectly effectuate sales of digital assets. The IRS agreed, noting that it did not intend to include in the definition of broker persons not within the DeFi industry, such as internet service providers, internet browsers, or computer or smartphone manufacturers. Accordingly, the final regulations narrow the scope of DeFi participants that meet the definition of a digital asset middleman. Additionally, to make it clear that the reach of the digital asset middleman definition in this regard is not any broader than the broker definition under Code Sec. 6045(c)(1)(D), the final regulations change the term facilitative services used in the proposed definition of digital asset middleman to the term effectuating services. The final regulations also provide that the only DeFi participants that should be treated as brokers are trading front-end service providers. The IRS stated that this determination was made in part because such providers are the DeFi participants that have the closest relationship to customers and therefore are in the best position to obtain customer identification information.

Observation: In a December 27 press release, the Treasury Department states that the final regulations do not change or impose any new tax obligations on digital assets. Instead, the final regulations require brokers, not digital asset holders, to report on the gross proceeds of the sale of their digital assets on Form 1099-DA, Digital Asset Proceeds From Broker Transactions. According to the Treasury Department, the final rules ensure that DeFi brokers of digital assets are subject to the same information reporting rules as brokers for securities and operators of custodial digital asset trading platforms.

The final regulations issued in T.D. 10021 apply to sales of digital assets on or after January 1, 2027.

Notice 2025-3

In Notice 2025-3, the IRS provides transitional relief from penalties for brokers providing trading front-end services, as described in Reg. Sec. 1.6045-1(a)(21)(iii)(A) of the final regulations issued in T.D. 10021 (i.e., DeFi brokers), who fail to report sales of digital assets on Form 1099-DA or fail to furnish payee statements under Code Sec. 6045.

Specifically, in order to provide DeFi brokers with additional time to develop appropriate procedures to comply with these new reporting requirements, the IRS will not impose penalties under Code Secs. 6721 and 6722 on DeFi brokers that fail to file information returns and furnish payee statements under the final regulations with respect to sales of digital assets effected during calendar year 2027, provided that such brokers make good faith efforts to file accurate and timely Forms 1099-DA and furnish accurate and timely payee statements.

In addition, because DeFi brokers may not have enough time to obtain a certified taxpayer identification number (TIN) from a payee prior to the date of a digital asset sale by that payee during 2027, the IRS is also postponing the application of backup withholding with respect to sales of digital assets for an additional year to provide DeFi brokers with additional time to develop appropriate procedures for collecting TINs from customers and to otherwise comply with the backup withholding requirements on digital asset sales. Accordingly, backup withholding under Code Sec. 3406 will not be required on any digital asset sale effected by DeFi brokers during calendar year 2027.

For a discussion of sales, exchanges, or other dispositions of digital assets, see Parker Tax ¶119,610. For a discussion of information reporting requirements for brokers, see Parker Tax ¶116,180.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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