Why the Form 1099B is emerging as a 'gold standard' for crypto tax reporting

In March 2020, the Internal Revenue Service (IRS) convened a group of tax and crypto professionals for a “summit” aimed at fostering dialogue between the U.S. tax authority and an industry that’s often skeptical of government interference.

One theme that emerged from the event: crypto exchanges wanted more clarity on tax guidance, down to the forms they need to issue to their users. Exchange reps pressed the point that the lack of clear guidance meant heightened legal risks and a higher cost of doing business.

Over a year later, the IRS has made it clear that it’s cracking down on crypto-related tax noncompliance. Effective guidance remains elusive, though global developments indicate that tax authorities are inching toward releasing more comprehensive information on this front, including work being done by the Organisation for Economic Co-operation and Development (OECD).

But effective guidance remains elusive, creating a source of friction for one of the agency’s biggest sources of income data. 

Ultimately, tax reporting requirements fall on the individual taxpayer, not the exchanges on which they trade. But a lack of standards on which forms exchanges need to send to the IRS has created additional headaches for both the filer and the agency itself.

According to tax professionals, however, that’s beginning to change — and that’s partly because some crypto exchanges are leaning on a particular tax form that provides a particularly comprehensive crypto transaction history: the 1099-B.

Focus on exchange issues

Last October, the Treasury Inspector General for Tax Administration (TIGTA) released a report that outlined how crypto exchanges took “inconsistent positions from one another on information reporting requirements.” 

Of nine reviewed cases, only four exchanges issued 1099-Ks from 2015 to 2018, and only one issued a 1099-B. 

This state of affairs led TIGTA to recommend that the IRS create an information reporting regime that would require all cryptocurrency exchanges to report all transactions to the IRS in a standardized way. 

“The IRS cannot easily identify taxpayers with virtual currency transactions because of the lack of third-party information reporting that specifically identifies virtual currency transactions,” TIGTA said at the time.

According to tax professionals, different forms can present varying pictures of a taxpayer’s activities. The 1099-K form details gross proceeds from all transactions, which in some cases could make it seem like traders generated huge sums of unreported income. A form 1099-B, on the other hand, does track cost basis. Professionals say exchanges filing 1099-Bs would provide a fuller picture by doing so.

The use of 1099-K forms by exchanges like Coinbase and others emerged after a landmark IRS legal case against Coinbase, through which the tax agency sought records in a bid to sniff out potential tax cheats, according to Daniel Hannum, COO of crypto tax service Zenledger.

More broadly, the IRS has taken steps to collect more information from crypto-holding taxpayers. The agency moved its crypto question to the top of the 1040 form this year, meaning all filers will have to disclose if they conducted any taxable activity with crypto. It’s made strides in clarifying what individuals are responsible for, but it hasn’t standardized how broker-dealers fit in the picture. 

Drawing lessons from TradFi

Most people in traditional finance use one online broker-dealer for trading, but in the crypto space, traders are more likely to interact with multiple venues. For example, trades may buy crypto through a fiat onramp and then transfer those funds to different marketplaces for sure.

Because of this, tax professionals say the 1099-B is emerging as the best option. Because it reflects the cost basis for transactions, it’s best for the circuitous world of crypto trading, as opposed to the K and the 1099-MISC, which is mainly used for rewards, forks, airdrops and income. 

Hannum said the MISC could be considered a step above the K, but B remains “the gold standard.” At this point, he said the industry is pretty split between the B and the MISC and has all but scrapped the K.

“We're still seeing a pretty big split in the industry of probably 50 to 60 percent using miscellaneous and 40 to 50 percent using B, and we’re working with a few different firms on both at the moment,” he said.

Retail products like Lukka and Zenledger collect data from various places to help consumers fill out Form 8949, which tracks gain and loss information to be sent to the IRS. A Form 8949 compliments the information in a 1099-B from the individual’s side. If a venue files a 1099-K or 1099-MISC, which doesn’t reflect cost basis in its gain/loss reporting, it could look like the individual failed to report large sums of income in certain cases.

For one, the agency mistakenly sent warning notices to Coinbase users in November of last year, claiming some had failed to pay up hundreds of thousands. That wasn’t the case, and the confusion arose from the forms Coinbase sent to the IRS. At the time, Coinbase sent form 1099-K. 

Why hasn’t the shift happened yet?

As for why exchanges don’t uniformly file 1099-B, experts say the answer lies in the multi-platform approach taken by market participants. 

For example, spot exchanges often can’t track cost basis if a purchase wasn’t made on their platform. That’s why some of them at least attempt to file 1099-Ks, according to Robert Materazzi, CEO of tax software firm Lukka.

“They were reporting based on information that they had, but those Ks don't have very useful information for crypto to actually satisfy the reporting requirements to the IRS,” he said. “So I think that's why we're seeing fewer of them continue to do Ks, because it caused more confusion than it helped at the end of the day.”

Indeed, Coinbase is opting for the 1099-MISC this year. Gemini said it files Ks when necessary, but mainly connects users with resources to file their own 8949. Kraken enables users to export their history for tax purposes but doesn’t provide forms or statements.

It’s simpler to start with derivatives venues, said Materazzi. Because funds don’t move until contracts are settled, it’s a bit easier to track necessary data points since funds aren’t moving in and out of the venue as quickly as they would on a spot exchange. For that reason, you’ll probably see derivatives exchanges issue Bs first. 

Information services giant IHS Markit is collaborating with Lukka to make that a reality. The two firms first partnered to distribute Lukka’s crypto data on IHS’s platform to woo Wall Street clients towards crypto. 

Now the data partnership is being used to help crypto companies provide info to the IRS, initially by helping crypto derivatives exchange LedgerX issue 1099-Bs to its clients. Lukka collects the crypto data, while IHS generates the forms and files them with the IRS. 

The ability to issue Bs could get a little easier for Lukka and IHS clients, at least. William Sheridan, managing director of tax solutions at IHS, said the partnership could lead to additional services in this vein. Meanwhile, Zenledger has been adding partners like Abra and Celcius.

Looking ahead, Sheridan expects that inevitably, the tax guidance picture will improve over time. 

The OECD has said it plans to present a framework for crypto tax reporting in 2021, and IHS anticipates it’ll include the reporting of sales proceeds. 

“So it’s going to be almost like a domino effect,” he said. “The likelihood is that we’re going to see the U.S. issuing some type of guidance here in the states for cost basis and reporting of broker purchases, and then we’ll probably see something very similar towards the end of Q4, back end of 2021, that will be occurring outside of the U.S. with the OECD.”