On15 November 2021, US President Joe Biden gave his assent to the Infrastructure Investment and Jobs Act (“Infrastructure Act”), a far-reaching legislation designed to rebuild the United States of America. Painted as a ‘once-in-a-generation investment’ by the White House, the Infrastructure Act soon became the cynosure. On the one hand, it is applauded for acting as a catalyst for spearheading infrastructural activities. On the other hand, it is assailed for instituting a stricter surveillance system for the cryptocurrency community by making amendments to the Internal Revenue Code, 1986 (“the IRC”).
In this article, the author deconstructs the portion of the legal text that subjects digital asset dealings to the new tax reporting requirements. In this regard, the author argues that the ‘unthoughtful drafting’ of the law endangers the cryptocurrency ecosystem. Subsequently, the author outlines what ‘keeping digital assets under observation’ signifies and submits that the additions made to the IRC trouble the unconcerned and fly in the face of the sacrosanct Fourth Amendment of the US Constitution (“Fourth Amendment”). Towards the end, the author focuses on the latest developments that can have a significant impact on the Infrastructure Act, and the author concludes his case with the hope that the US Senate will make an effort to make the Act more ‘digital asset friendly’.
A historic-cum-ambitious law,the Infrastructure Act, is all set to pave the way forspending $1.2 trillion on the USA’s transportation programs, internet connectivity, clean energy, drinking water supply, and many more. Naturally, the US government needs adequate funds to make these projects a reality. Therefore, to meet the expenses, the Infrastructure Act includes the ‘pay for’ sections under the heading ‘Other Provisions’. These provisions stipulate how the Government would raise revenue or pay for the costs associated with various facilities by altering the IRC, especially in reference to digital assets.
The most contentious component,Section 80603 of the Infrastructure Act titled ‘Information Reporting For Brokers And Digital Assets’, modifies Sections 6045 and 6050I of the IRC to bring digital assets under the tax umbrella. More precisely, the amendedSection 6045(c)(1) obliges a new category of a broker, anybody facilitating digital asset transactions on behalf of someone else, to make a tax return. Moreover, clause (iv) is inserted in Section6045(g)(3)(B) treating ‘digital assets’ as a ‘covered security’, implying that a broker will make a return with regard to the gross proceeds of the sale of a digital asset on an adjusted basis. Next, the updatedSection 6050I expands the definition of ‘cash’ to include digital assets within its ambit. Embracing the meaning of ‘digital assets’ as understood for the purposes of Section 6045, the law will now make it mandatory for ‘any person’ receiving more than $10,000 in the form of cryptocurrencies to file a return and submit the details of the payer/sender to the government. These revisions represent a major departure from the current method of taxing cryptocurrencies.Virtual currencies have been considered ‘property’ since 2014, and hence tax principles applicable to property transactions have a bearing on crypto transactions as well. Currently, paying taxes on cryptocurrency is limited to capital gains tax events, i.e. when it is used to purchase or sell goods, sent as a gift, sold for fiat, etc. However, the future treatment may not be the same as digital assets will soon take the shape of ‘covered security’ and ‘cash’.
There is a popular belief that these amendments can successfullycounter crypto tax evasion. According to theanalysis released by Barclays Plc, the tax gap from crypto trades, i.e. the difference between the revenue that the Internal Revenue Service (“IRS”) collects and what is actually owed to it, would be around $50 billion per year. To prevent this underreporting of tax on crypto income or gains, the members of Congress from both parties have passed the Infrastructure Act that puts crypto transactions on the radar of the IRS.
In the author’s opinion, a perusal of Section 80603 is a desideratum to decipher whether the changes made to the IRC establish an improved tax compliance apparatus or do more damage than good.
Unwarranted Scrutiny of Crypto-centric Affairs: The Problematic Scenario
It is necessary to study the intricacies of the taxation system and the consequences (mainly unintended) that may soon follow, in some detail. If everything goes as planned by the US Congress, those engaged in the buying and selling of digital assets, as well as those facilitating it, will be required to fill out two forms — a)Form 1099-B (connected to § 6045) and b)Form 8300 (concerned with § 6050I). In this segment, the author endeavours to explain the reshaping of Sections 6045 and 6050I of the IRC and punctiliously examine them.
A. Section 6045 Amendment and Form 1099-B
Who is a ‘broker’ in digital asset transfers? This is the all-important question that the Infrastructure Act fails to properly answer. Section 80603(a)(3) of the Act amends Section 6045(c)(1) of the IRC by adding a new dimension to the term ‘broker’ — “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person”. There is no guidance as to how words should be construed, with the exception of “digital assets”, which is expressed as “any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the Secretary”— a different type of ‘covered security’ attached to Section 6045(g)(3)(B) of the IRC by Section 80603(b)(1) of the Infrastructure Act. Containing various unexplained expressions, such as ‘service’, ‘effectuating’, and ‘transfers’, the definition of ‘broker’ leads to confusion about ascertaining the distinct identity of a broker. Aside from being vaguely worded, itbrings every person dealing in cryptocurrencies, namely software developers, wallet providers, validators, cryptocurrency miners, node operators, and cryptocurrency exchanges within its sweep and unnecessarily makes it burdensome for all to report their crypto transactions to the IRS.
The inclusion of the aforenamed entities indicates that they will be officially constrained to issue Form 1099-B, a form that presents a summary of the customers’ gains or losses, to their customers and file a copy of the same with the IRS and the government. This cumbersome process demands that ‘every person doing business as a broker’collects Know-Your-Customer (KYC) information like name and address, together with other details, including crypto acquisition date and cost basis, from customers. Since the ‘digital assets’ are now regarded as ‘covered security’ and put on a par with bonds, debentures, etc., brokers are expected to show the customer’s adjusted basis in digital assets and determine the character of the gain or loss (long-term or short-term), in addition to stating the particulars previously mentioned. We must understand that there is no reason why a crypto exchange, or for that matter, a software developer, must be privy to the private information of their customers and that the same cannot prove to be useful or resourceful in their business activities. Hence, it cannot be gainsaid that the Infrastructure Act unfairly applies traditional reporting requirements to those who, in the real sense, are ‘non-brokers’.
B. Section 6050I Amendment and Form 8300
Section 80603(b)(3) of the Infrastructure Act broadens the purview of Section 6050I(d) of the IRC and identifies ‘digital assets’ as cash or cash equivalents. This simply means that ‘any person engaged in a trade or business’ obtaining $10,000+ in virtual currencies shall be liable to file Form 8300 with the IRS within 15 days of receipt. To ensure the submitted Form 8300 is error-free, the seller (receiver of crypto assets) has tofulfil two extremely crucial conditions:
1. furnish the name, birth date, address, taxpayer identification number (social security number or individual taxpayer identification number), and occupation of the payer/purchaser to the IRS [Section 6050I(b)] and;
2. provide a written statement to each party whose details appear on Form 8300. The written statement must show the seller’s (person filing the Form 8300) name, address, contact person, telephone number of business, etc. [Section 6050I(e)].
The author contends that this proposed twin compliance mechanism flagrantly flouts the hornbook financial privacy law of the USA. One cannot deny that sharing sensitive financial information with anyone (including the government) can have serious ramifications. The Supreme Court of California, inBurrows v. Superior Court, made it certain that “financial transactions can reveal much about a person’s activities, associations and beliefs” and “[a]t some point, governmental intrusion upon these areas would implicate legitimate expectations of privacy.” In a similar vein, inCarpenter v. U.S., the US Supreme Court, reasonably noted that digital records have the potential to open “an intimate window into a person’s life, revealing not only particular movements but through them [their] familial, political, professional, religious and sexual associations.” Following the settled position, it can be logically deduced that requiring participants of cryptocurrency transactions a) to dispense their personal information to others and b) to present the intimate details of the other party to the IRS is antithetic to theFourth Amendment.
Interestingly,Coin Center, a non-profit organisation that advocates for sensible crypto regulatory approaches (as its website asserts), espouses similar views. It has even moved the court against the amendment, and it is imperative to undertake a granular assessment of the legal action to uncover how the amendment disregards both ‘transactional’ and ‘associational’ privacy.
Litigation over Section 6050I Amendment: The Coin Center Suit
The amendment of Section 6050I of the Tax Code (“Section 6050I amendment”) impels the senders and receivers of cryptocurrency to disclose their ‘names’, ‘Social Security numbers’, ‘home addresses’, and ‘other sensitive personal identifying information’ to each other and the federal government. More onerous, the receivers are obligated to divulge the details of the parties involved and their transactions to the federal government within fifteen days of the transaction. Considering the Section 6050I amendment an ill-considered measure, in June 2022, Coin Center, along with Dan Carman, Raymond Walsh, and Quiet Industries,challenged its constitutionality in the United States District Court for the Eastern District of Kentucky (Lexington Division). Leading from the front, Coin Center, an independent research centre claiming to be an indefatigable defender of the rights of cryptocurrency users, has stoutly contended that the amendment to Section 6050I, among others, infracts the Fourth and First Amendments of the Constitution of the United States of America.
The well-drafted lawsuit clearly brings to the fore the enormity of the issues that the Section 6050I amendment turns a blind eye to. Some of them are elaborated below:
A. Violation of the Fourth Amendment:
Assigning human dignity and privacy primordial importance, the Fourth Amendment provides that “[t]he right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures, shall not be violated, and no Warrants shall issue, but upon probable cause, supported by Oath or affirmation, and particularly describing the place to be searched, and the persons or things to be seized.” The US courts, in a catena of judgments, have opined that the Fourth Amendment shielding the right to privacy and/or expectation of the right to privacy is the cornerstone of personal liberty, which cannot be compromised. For instance, inCamara v. Municipal Court of City and County of San Francisco, the US Supreme Court held that the ‘basic purpose’ of the Fourth Amendment is “to safeguard the privacy and security of individuals”. Interpreting it in its widest amplitude, the US Supreme Court, inUnited States v. Morton Salt Co., observed that the Fourth Amendment “is not confined literally to searches and seizures as such, but extends as well to the orderly taking under compulsion of process”. Placing reliance on the aforementioned verdicts, Coin Center avers that the government’s act of acquiring personal details is tantamount to prying into the lives of individuals and hence violates the Fourth Amendment. Further, the Section 6050I amendment is not saved by the ‘third-party doctrine’, a sweeping exception to the Fourth Amendment. According to theDoctrine, “a person has no legitimate expectation of privacy in information he voluntarily turns over to third parties”. This legal precept, as rightly argued, does not apply to the instant case as there is no involvement of any third parties, such as banks and telephone companies in the cryptocurrency transactions. More importantly, the Section 6050I amendment attaches no value to the ‘voluntariness’ rule and rather ‘coerces’ the parties to transactions to reveal their personal information to each other.
B. Violation of the First Amendment:
TheFirst Amendment guarantees the ‘freedom of speech’, ‘freedom of the press’, ‘the right to assemble peaceably’, and ‘the right to petition’. Inherent in it is “the right to associate with others in pursuit of a wide variety of political, social, economic, educational, religious, and cultural ends”. It is noteworthy that the ‘freedom to associate’, in some circumstances, does not survive alone butcoexists with the ‘right to associational privacy’. Taking into account the same, Coin Center appositely asserts that the amended Section 6050I infringes privacy in associations by depriving an individual the right to stay anonymous when participating in ‘associational activities’, the failure of which may expose them to harassment or retaliation. A fitting example in this regard, as mentioned in the suit, is that the government would be able to “determine that five years earlier [a person] gave $5 worth of Bitcoin to a dissident journalist or a minority religious sect” because the Section 6050I amendment authorises it to extract the information from a public ledger that has all the cryptocurrency transactions of the parties involved stored in it. Ergo, it cannot be gainsaid that the forced disclosure as envisaged by the new Section 6050I is a perfect recipe for unwanted surveillance.
Since the matter is sub judice, the US judiciary will now decide the fate of the amendment. It will be fascinating to watch how it unpacks the question — of whether the Section 6050I amendment is in harmony with the letter and the spirit of US constitutional principles.
The Responsible Financial Innovation Act: The Real Game Changer
The Responsible Financial Innovation Act (“the RFIA Bill”), introduced by Senator Cynthia Lummis and Senator Kirsten Gillibrand in June 2022, is an endeavour to establish a comprehensive framework to keep cryptocurrencies and digital assets in check. Principally, the RFIA Bill aims to bring the crypto markets under the ‘simple to decode regulatory regime’ by injecting definitional clarity into the digital asset system. For instance, Section 101 (Definitions) of the RFIA Bill prescribes a broadly worded definition of ‘digital asset’, according to which a digital asset means:
“(A) a natively electronic asset that — “(i) confers economic, proprietary, or access rights or powers; and (ii) is recorded using cryptographically secured distributed ledger technology, or any similar analogue; and
(B) includes: (i) virtual currency and ancillary assets, consistent with section 2(c)(2)(F) of the Commodity Exchange Act; (ii) payment stablecoins, consistent with section 403 of the Legal Certainty for Bank Products Act of 2000 (7 U.S.C. 27a); and (iii) other securities and commodities, subject to subparagraph (A).”
Evidently, the definition goes beyond the approach adopted in the Infrastructure Act thatconfines a digital asset to “any digital representation of value recorded on a cryptographically secured distributed ledger”. Here, it not only encompasses virtual currencies but also grants a digital asset a ‘commodity’ status and equates it with commodities such as coffee, gold, crude oil, etc., thereby making the Commodity Futures Trading Commission (“CFTC”) the key regulator of the digital asset market. Section 403 of the RFIA Bill appends paragraph F, phrased ‘Commission Jurisdiction Over Digital Asset Transactions’, toSection 2(c)(2) of the Commodity Exchange Act, 1936, which confers exclusive jurisdiction over fungible digital assets on the CFTC. This entails, inter alia, granting the CFTC’sfuture commission merchants the liberty to ‘hold their customers’ money, assets and property’ to mitigate the customer’s risk of loss in getting access to the money, assets, and property. Additionally,by defining ‘ancillary asset’, i.e. “the asset offered, sold or otherwise provided in connection with the purchase and sale of a security through an arrangement or scheme that constitutes an investment contract”, the Bill makes it abundantly clear under what conditions or circumstances a digital asset can be pigeonholed as a commodity or security. Unlike the Infrastructure Act, the RFIA Bill considers multiple situations that may decide the nature of digital assets (commodity or security) and hence offer a more organised reporting structure for digital assets.
Besides, the RFIA Bill recognises a ‘broker’ as “any person who (for consideration) stands ready in the ordinary course of a trade or business to effect sales of digital assets at the direction of their customers” in the context of the Internal Revenue Code, 1986. This denotation matches thepopular meaning of a ‘broker’, a person or an entity that plays the role of an intermediary and facilitates transactions between a buyer and a seller for a commission (consideration). Above all, as opposed to the description of a broker provided in the modified Section 6045(c)(1) of the IRC, the version of a broker here is narrower, unambiguous (you can compare the two), and does not impose the tax collection agenda on other stakeholders.
The RFIA Bill, as discussed above, surmounts the obstacles the Infrastructure Act purposely or accidentally presents, and places innovation in the digital asset industry and regulation of the digital asset industry on an equal footing.
Section 80603, which did not appearuntil 10 August 2021, today occupies a conspicuous space in the Infrastructure Act and will soon be responsible for changing the dynamics of the crypto landscape. ‘Soon’ because the provision will be put into action on1 January 2023 and be effective for returns to be filed after 31 December 2023. Once enacted, it would be a full-frontal assault on digital assets. In the garb of improving tax collection, Section 80603(a)(3) attempts to label almost every person related to crypto transactions (closely or remotely) as a ‘broker’, which is definitely a cause for alarm primarily for two reasons: 1) it blurs the distinction between someone who arranges agreements between buyers and sellers of crypto assets and an entity who does not negotiate these contacts for their customers/users; and 2) necessitates the ‘non-brokers’ to gather personal information of customers and submit Form 1099-B to the IRS and the state and therefore needlessly makes them report sales of digital assets and incur a tax liability.
Section 80603(b)(3) dictates an intrusive procedure whereby: a) the receiver of digital assets will have to transmit Form 8300 to the IRS containing delicate personal details of the sender of digital assets; and b) the receiver will also have to send a yearly written statement to the sender, this time putting the specifics of their private life on display. It is worth noting that the outcome of a ‘wilful violation’ of any of the two will be aprison term of up to 5 years. Clearly, the Section 6050I amendment is more draconian as it lays down severe punishment for the party who wishes to transact digital assets anonymously and not communicate their personal identifying information to the IRS (of the federal government). Succinctly, what is at stake is the person’s informational privacy. At this stage, whether the right to privacy in financial transaction data remains safe in the US will depend on the court’s verdict.
Lastly, the author believe that the RFIA Bill can remedy the shortcomings of the Infrastructure Act. The US Senate must explore the option of adopting the definitions put forth by the Bill as they surely do not authorise the authorities to have knowledge of an individual’s movements, ideological inclinations, conversations, etc.
About the Author
Mr. Daksh Aggarwal is an Advocate and will be joining the Master of Corporate Law program at the University of Cambridge (2022-2023).
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Preferred Method of Citation
Daksh Aggarwal, “The US Infrastructure Act and Digital Assets: A Match Triggering Taxation Rigmarole Posing Constitutional Predicaments” (IJPIEL, 19 August 2022)