The U.S. Senate has passed the “Build America Act of 2021” also known as the bipartisan infrastructure bill, that includes new reporting for cryptocurrency transactions and brokers of cryptocurrency and provides for non-compliance penalties. These new requirements, along with the application of the Bank Secrecy Act to artwork and collectibles which includes nonfungible tokens, means a major rethink of estate planning and fiduciary selection.
The Bill would require businesses that transmit digital assets to file tax information reports similar to the Form 1099 requirements for securities brokers. The definition of a person responsible for filing such reports is broad: “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets.” This is intended to require information reporting for cryptocurrency exchanges but could be interpreted to cast a wider net to require other segments of the blockchain industry, such as cryptocurrency payment service providers, to file information reports.
As tax-free Section 1031 like-kind exchange rules do not apply to the conversion of one cryptocurrency for another cryptocurrency, the Bill could be interpreted to include information reporting on all exchanges of digital assets, regardless of whether the exchange involves U.S.-dollar or any other fiat currency. Similarly, the Bill may also require reporting any involuntary receipt of cryptocurrencies in hard forks, airdrops, or other rewards. Generally, airdrops occur when a new blockchain project distributes free tokens to existing holders of specific cryptocurrencies such as Bitcoin and Ethereum.
The term “digital asset” is defined as “…any digital representation of value which is recorded on a cryptographically secured distributed ledger or similar technology…” This would apply not just transactions but also to an interest in a company represented by a blockchain token, utility tokens, visual and audio works in the medium of non-fungible tokens (NFTs) or any other cryptographic representation of value that may unfold in the future. Since an art dealer selling NFTs is doing so for consideration, the IRS might require dealers who sell NFTs to file tax information reports on the sale of such digital assets, even if the dealer is using a third-party platform to sell NFTs rather than its own platform to execute its sales.
The IRS will also be able to trace the transfer of digital assets when there is no sale or exchange that would otherwise trigger an IRS reporting requirement by requiring a dealer or broker to file tax information returns to report transfers of digital assets not part of a sale, or exchanges from an account maintained by brokers to an account that is not maintained by, or an address not associated with, a person that the broker knows or has reason to know is a broker. This intends to cover a transaction where a holder of cryptocurrency on an exchange transfers the cryptocurrency to a personal wallet or a wallet maintained on another exchange, and any business that receive digital assets in excess of $10,000 in a single transaction file an information return with the IRS.
The Bill means that estate plans including any sort of digital asset in an estate will become more complicated. Not only does the planning have to preserve the benefits of digital assets, such as security, privacy, and convenience that digital assets now enjoy, but now protect from the risks of failure to report transactions as well as the issues of loss of a private key or seed phrase, value fluctuation, and the most important fact that few, if any, institutional fiduciaries are willing or able to handle these digital assets. The lack of such fiduciaries readily available means that many of the estate planning tactics, such as those using trusts, may become unworkable. This is particularly true if under the new application of the Bank Secrecy Act to artwork and collectibles includes nonfungible tokens, they will be liable for the heavy penalties for not reporting these transactions to the IRS.
This Bill has yet to pass the House and there is opposition on the broad scope of the information reporting provision. If the Bill is enacted in its current form, the proposed changes would affect digital assets acquired on or after Jan. 1, 2023, and apply to returns required to be filed, and statements required to be furnished, after Dec. 31, 2023.