IRS draft tax form for crypto defines unhosted wallets as brokers

The IRS published a draft version of its 1099-DA reporting form and controversially included unhosted crypto wallets among its targets on April 19.

Ji Kim, Chief Legal and Policy officer at the Crypto Council for Innovation, wrote that the IRS’ approach is “unfortunate” as it does not recognize that unhosted wallet providers lack knowledge about crypto transactions and the parties involved in each transaction.

Shehan Chandrasekera, Head of Tax at CoinTracker, similarly criticized the form. He argued the effects could spill over to end users, who may need to engage in KYC verification when they create unhosted wallets or use unhosted wallets with services such as DeFi platforms.

However, Chandrasekera said that authorities will likely aim their enforcement efforts at unhosted wallet providers instead of end users.

Unhosted or non-custodial wallets do not store crypto balances with a third-party service. They are distinct from custodial wallets, a category that includes most exchange wallets.

Form 1099-DA

Form 1099-DA also asks brokers to provide certain on-chain data, including transaction IDs and wallet addresses related to each sale. Brokers should report the transaction ID and address originating the sold crypto — and a secondary address if they “transferred in” the funds from another of their hosted wallet addresses.

Experts responded to the requirement differently. Chandrasekera warned that collecting and reporting data, especially wallet addresses, “could lead to major privacy and security concerns.”

However, Ledgible’s VP of Tax Information Reporting, Jessalyn Dean, noted an exception to the rule. She said the form allows brokers not to provide addresses and transaction IDs if not applicable. She called the exception “necessary” because brokers often perform transactions in their internal recordkeeping systems rather than on-chain.

Another critical section reads, “Wash sale loss disallowed.” According to Dean, this does not bring crypto under wash sale rules. Instead, the section applies to digital assets currently subject to wash sale rules, such as stock, securities, and tokenized equities.

Rules not yet finalized

Crypto brokerage reporting rules have been in the making for some time. President Joe Biden’s Infrastructure Act in 2021 categorized certain crypto services as brokers in 2021. In August 2023, the Treasury and the IRS published a proposal for 1099-DA that largely resembles the contents of today’s draft form.

However, the draft form’s text indicates that the IRS has not finalized the form and that brokers should not use it in their current tax reports.

According to Ledgible, there is a 60-day comment period on the form.

The IRS has established separate rules for individual crypto investors. The regulator published a reminder on April 11 that crypto investors should report on various forms, including Form 1040. A top IRS member also recently warned of tax avoidance among crypto investors.