How crypto brokers can prepare for tax reporting
Published: August 19, 2021
H.R. 3684 - Infrastructure Investment and Jobs Act is currently working its way through the US legislative process and will be one of the first steps to formalise the US tax reporting of crypto and other digital assets. The scope and impact of these rules is widely covered in other publications so here we are going to have a look at how crypto brokers can prepare for this and future global tax reporting (like DAC8 in the European Union and OECD CARF for the rest of the world).
We will broadly refer to this as crypto broker reporting for purposes of this discussion, rather than Form 1099-B reporting, as the IRS may ultimately issue a different Form type. We expect that the concepts will remain the same as Form 1099-B: gross proceeds, cost basis, acquisition dates, disposal dates, covered securities, non-covered securities, broker transfers, and more. It is worth mentioning, as you can see in other widely distributed publications, that the definition of a broker is greatly disputed right now and may end up being modified in the end. For purposes of this discussion, crypto brokers will refer to all possible crypto service providers that may be in scope of the regulations even if in their normal business marketing they do not consider or advertise themselves as brokers.
Other than the asset class being different, these regulations and their intended outcomes are not new. Crypto brokers will be well suited to learn from the successes, failures, and do-overs of brokers that came before them.
Where to start?
In order to set the direction into tax reporting, crypto brokers should first decide if they view tax reporting as 1) a service that can enhance the experience of their customers or 2) strictly as a regulatory requirement. A steering committee within your organisation (also discussed later) should consider the merits of both. This will set the tone for the rest of the topics discussed here today. Keep in mind that because all crypto brokers must adhere to these rules, it has never been widely seen as a competitive advantage for financial institutions or other entities. With that said, this decision can drive how you communicate with your customers, technology build vs buy decisions, and more.
Form steering committees (plural)
Your internal steering committee should consist of, at a minimum, individuals from legal, compliance, tax, product, technology, marketing, internal training, and customer service. In our experience, all of these views factor into how tax reporting is not only delivered to the government but to your customer. Getting the implementation of tax reporting wrong can land crypto brokers in the news. It can be a high profile mistake that your organisation doesn’t want.
External steering committees can be equally important both from a regulatory and customer experience perspective. Crypto brokers need to come to consensus on how to interpert and implement certain parts of broker reporting rules, particularly with regard to transfer rules (a customer at Broker A transfers their cryptocurrency to the custody of Broker B, and the tax reporting and cost basis needs to move with them). Additionally, you do not want to be in a place where your customer has an account with multiple brokers and they see that you are doing things differently than other brokers.
For example, in the traditional banking industry there are deadlines that must be adhered to for reporting but you can request an extension if needed. If all of your broker peers are hitting the original deadline on time and you are the only one taking the extension, this could negatively impact the perception your customers have of your service. Refer back to our earlier points: does your organisation see this as a customer service or simply a regulatory requirement that must be met?
The blockchain and crypto industries already have steering committees in place. If your committees do not yet have a sub-committee for tax reporting then pick your representative, have them raise their hand to chair it, and get moving on collaboration.
Recruit and hire the right people
Expertise in tax reporting is niche and hard to come by. This is also called tax information reporting, US withholding and reporting, tax transparency, and more. You will find it difficult to recruit exceptional talent. Be prepared to offer high compensation packages when you have identified the right candidates. You need to be prepared to attract them away from their current position. Some important skills to seek out (not for a single person but these can be spread amongst your various team/department that you form):
You will need a Head of Tax Information Reporting - all around vision lead
Tax technical expertise - knowing the rules inside and out
Operations rockstar - they know how to implement business processes and make decisions around practical ways that they can be implemented in the least disruptive way
Project manager - during implementation it is clear that this role is needed but when you move to business-as-usual this role turns to delivering regular reporting on time and in accordance with the deadlines
Communication governance - they know how your organisation should communicates with customers, without giving tax advice; they can effectively and accurately communicate with the IRS
Data mastermind - regardless of a build vs buy decision, someone on your team needs to know how to handle, cleanse, manipulate, and tell stories with data
Training leader - this stuff is hard and you need someone who can educate the organisation without jargon and in a clear way
Consultants - some aspects of implementation do not require permanent hires so consider what parts you will supplement with expertise from external consultants
Team reporting structure
Where this new team lands in your organisation can be a hot potato. There is no perfect answer other than there must be collaboration between the operations and tax departments. The Head of the team needs the right resources and the power to make decisions for the organisation. Here are some pros and cons to consider.
Operations
This can be the natural landing place for this function as it is about “customer taxes” rather than the taxes of the organisation itself (corporate tax level). However, if something goes wrong and your organisation faces a big penalty or fine then it is the Internal Revenue Service (IRS) that comes knocking on the door. As such, the tax department must be kept sufficiently informed and comfortable with the decisions being made. You need a good relationship and effective partnership with the tax department. More commonly, these relationships are adversarial and need a lot of work. The downside of building this team inside of operations is that it will usually be allocated less budget for salaries than the tax department. This can make it difficult to pay the appropriate salaries for the niche technical expertise that you need to hire. A last point of consideration is that while you need strong, niche, tax technical expertise, tax people are notoriously uncomfortable working in operations department. People that start their careers in a traditional tax function are usually more comfortable remaining in that environment. You will need to find a tax person that enjoys a faced paced operations environment where they must interact primarily with people that do not have a tax background.
Tax
This can be the more natural landing place where broker reporting is seen as a regulatory obligation and less of a customer service. This allows the tax department to maintain control over governance and relationships with the IRS and other tax authorities as reporting grows globally. Placing the team in the tax department will usually allow for a larger budget to compensate the niche expertise that needs to be recruited. The downside of building this team inside of tax is that it will have less customer-focused decision making. A strong partnership with the customer service and marketing department is critical as well as a strong, innovative technology mindset.
Other considerations
There may be additional training or hiring that must occur in the compliance and internal audit departments. It should be considered what the relationships of these departments will be to your new tax reporting team.
Plan your implementation design
Build vs buy: in addition to existing big players from the old Form 1099-B and cost basis days, there are already some exciting startups on the market that have been working on crypto tax reporting. You must decide if you want to build or buy your own reporting and cost basis solutions.
Managed services vs in-house: tax reporting can be built in-house or completely outsourced to a so called “managed service” that takes on responsibility for most of the lifecycle of tax reporting. You should decide how much control you want to retain over the process. An in-house team can present greater control and flexibility but can also create single-source-of-failures.
Understand the whole lifecycle of tax reporting:
The customer onboarding journey will be significantly impacted as new customer identification procedures will be required (and some catchup on existing customers)
Where existing customers refuse to provide the new customer identification documentation (Form W-9 or W-8), you must be prepared for tax withholding in USD fiat currency upon the sale of crypto by the customer
Once reporting is submitted to the IRS and to the customer, the process isn’t over: IRS governance includes reconciling records against IRS transcripts, annual IRS penalties for late filing or name and tax ID number mismatches, so-called IRS B and C Notices, and more
Set out your documentation structure:
Written policies (high level, 1 page)
Written procedures (what we do, why we do it, and what departments do it)
Desktop workplace instructions (specifically how we do it step-by-step)
Global training programs (how do we educate the whole organisation about their role in it)
How can Dune Consultants help?
We can help you in all aspects of implementation and advise your organisation in all of the topics discussed here. Contact us today to discuss at info@duneconsultants.com.
