Rule2024-30496
Gross Proceeds Reporting by Brokers That Regularly Provide Services Effectuating Digital Asset Sales
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
December 30, 2024
Effective
February 28, 2025
Issuing agencies
Treasury DepartmentInternal Revenue Service
Abstract
This document contains final regulations regarding information reporting by brokers that regularly provide services effectuating certain digital asset sales and exchanges. The final regulations require these brokers to file information returns and furnish payee statements reporting gross proceeds on dispositions of digital assets effected for customers in certain sale or exchange transactions.
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[Federal Register Volume 89, Number 249 (Monday, December 30, 2024)]
[Rules and Regulations]
[Pages 106928-106960]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-30496]
[[Page 106927]]
Vol. 89
Monday,
No. 249
December 30, 2024
Part V
Department of the Treasury
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Internal Revenue Service
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26 CFR Part 1
Gross Proceeds Reporting by Brokers That Regularly Provide Services
Effectuating Digital Asset Sales; Final Rule
Federal Register / Vol. 89 , No. 249 / Monday, December 30, 2024 /
Rules and Regulations
[[Page 106928]]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 10021]
RIN 1545-BR39
Gross Proceeds Reporting by Brokers That Regularly Provide
Services Effectuating Digital Asset Sales
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations regarding information
reporting by brokers that regularly provide services effectuating
certain digital asset sales and exchanges. The final regulations
require these brokers to file information returns and furnish payee
statements reporting gross proceeds on dispositions of digital assets
effected for customers in certain sale or exchange transactions.
DATES:
Effective date: These regulations are effective on February 28,
2025.
Applicability dates: For dates of applicability, see Sec. 1.6045-
1(q).
FOR FURTHER INFORMATION CONTACT: Roseann Cutrone or Jessica Chase of
the Office of the Associate Chief Counsel (Procedure and
Administration) at (202) 317-5436 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Authority
This document contains amendments to the Income Tax Regulations (26
CFR part 1) by adding final regulations under section 6045 of the
Internal Revenue Code (Code) to require certain decentralized finance
industry participants to file and furnish information returns as
brokers. Section 6045(a) provides an express delegation of authority to
the Secretary of the Treasury or her delegate (Secretary) to require
every person doing business as a broker to make returns, in accordance
with such regulations as the Secretary may prescribe, showing the name
and address of each customer, with such details regarding gross
proceeds and such other information as the Secretary may by forms or
regulations require. Section 80603 of the Infrastructure Investment and
Jobs Act, Public Law 117-58, 135 Stat. 429, 1339 (2021) (Infrastructure
Act) amended section 6045 clarify the definition of broker as it
relates to persons responsible for regularly providing services
effectuating transfers of digital assets, to expand the categories of
assets for which basis reporting is required to include all digital
assets, and to provide a definition for the term digital assets.
Finally, the Infrastructure Act provided that these amendments apply to
returns required to be filed, and statements required to be furnished,
after December 31, 2023, and provided a rule of construction stating
that these statutory amendments shall not be construed to create any
inference for any period prior to the effective date of the amendments
with respect to whether any person is a broker under section 6045(c)(1)
or whether any digital asset is property which is a specified security
under section 6045(g)(3)(B).
The final regulations are also issued under the express delegation
of authority under section 7805(a) of the Code. Section 7805(a)
authorizes the Secretary to ``prescribe all needful rules and
regulations for the enforcement of [the Code], including all rules and
regulations as may be necessary by reason of any alteration of law in
relation to internal revenue.'' The Infrastructure Act amended section
6045, and the Secretary has determined that these final regulations are
needful for the enforcement of the Code because tax compliance would be
increased if brokers were required to file information returns, and
furnish payee statements, under section 6045. See Proposed Rules, Gross
Proceeds and Basis Reporting by Brokers and Determination of Amount
Realized and Basis for Digital Asset Transactions, 88 FR 59576 (August
29, 2023) (describing need for regulation and its anticipated impact on
tax administration).
Background
On August 29, 2023, the Treasury Department and the IRS published
in the Federal Register (88 FR 59576) proposed regulations (REG-122793-
19) (proposed regulations) relating to information reporting under
section 6045 by brokers. These proposed regulations included rules that
would apply to brokers that generally act as agents and dealers in
transactions with their customers involving digital assets, which are
defined generally as any digital representation of value that is not
cash and is recorded on a cryptographically secured distributed ledger
(that is, a database that records transactions across multiple
computers) or any similar technology. The proposed regulations also
included rules that would apply to brokers that act as digital asset
middlemen, a new category of broker proposed to address the use of
digital assets to make certain payments and to reflect the clarified
definition of broker under the Infrastructure Act. This proposed new
category of broker would include certain participants that operate
within the segment of the digital assets industry that is commonly
referred to as decentralized finance (DeFi).\1\ The DeFi industry
offers services that allow for transactions that use automatically
executing software commonly referred to as smart contracts based on
distributed ledger technology without any participant in the DeFi
industry (DeFi participant) taking custody of the private keys used for
accessing the digital asset customer's digital assets on a distributed
ledger. Additionally, the proposed regulations included specific rules
under section 1001 of the Code for determining the amount realized in a
sale, exchange, or other disposition of digital assets and under
section 1012 of the Code for calculating the basis of digital assets.
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\1\ This preamble's use of the DeFi term is not intended to
create any inference as to whether or not this segment of the
digital assets industry operates without any centralized
participants.
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The proposed regulations stated that written or electronic comments
provided in response to the proposed regulations must be received by
October 30, 2023. The due date for comments was extended until November
13, 2023. In response to the proposed regulations, the Treasury
Department and the IRS received over 44,000 written comments.\2\ All
posted comments were considered and are available at <a href="https://www.regulations.gov">https://www.regulations.gov</a> or upon request. A public hearing was held on
November 13, 2023. In addition, the Treasury Department and the IRS
continued to accept late comments through noon eastern time on April 5,
2024.
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\2\ Although <a href="https://www.regulations.gov">https://www.regulations.gov</a> indicated that over
125,000 comments were received, the Treasury and the IRS did not
actually receive over 125,000 comments. Instead, 125,000 reflects
the number of ``submissions'' that each comment self-reported as
being included in the comment, whether or not the comment actually
included such separate submissions.
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On July 9, 2024, the Treasury Department and the IRS published in
the Federal Register (89 FR 56480) final regulations (REG-122793-19)
(TD 10000) regarding information reporting by certain brokers and the
determination of amount realized and basis for certain digital asset
sales and exchanges. TD 10000 generally applies to digital asset
brokers that act as agents for a party in the transaction, such as
operators of custodial digital asset trading platforms, certain digital
asset hosted wallet providers, and certain processors of digital asset
payments (PDAPs), as well as persons that interact with their customers
as counterparties to transactions, such as owners of digital asset
kiosks, brokers who accept digital
[[Page 106929]]
assets as payment for commissions and certain other property, brokers
that transact as dealers in digital assets, and certain issuers of
digital assets who regularly offer to redeem those digital assets.
Additionally, TD 10000 finalized specific rules under section 1001 for
determining the amount realized in a sale, exchange, or other
disposition of digital assets and under section 1012 for calculating
the basis of digital assets.
TD 10000 did not finalize the definition of digital asset middleman
from the proposed regulations as applied to DeFi participants (referred
to in the preamble to TD 10000 as non-custodial industry participants)
because the Treasury Department and the IRS determined that additional
consideration of the issues and comments received with respect to these
participants was warranted. Instead, TD 10000 reserved on the proposed
definition of digital asset middleman that would have treated these
participants as brokers. The preamble to TD 10000 also indicated that
the Treasury Department and the IRS intend to expeditiously issue
separate final regulations with respect to these participants.
The Summary of Comments and Explanation of Revisions of these final
regulations summarizes the digital asset middleman provisions in the
proposed regulations that were reserved in TD 10000, which provisions
are explained in greater detail in the preamble to the proposed
regulations. After considering the comments to these provisions, the
reserved portion of the proposed regulations relating to the definition
of a digital asset middleman is adopted as amended by this Treasury
decision in response to such comments as described in the Summary of
Comments and Explanation of Revisions.
These final regulations concern Federal tax laws under the Internal
Revenue Code only. No inference is intended with respect to any other
legal regime, including the Federal securities laws and the Commodity
Exchange Act, or the Bank Secrecy Act and its implementing regulations,
which are outside the scope of these regulations.
Summary of Comments and Explanation of Revisions
I. Comparison of the Decentralized Digital Asset Ecosystem With the
Securities Industry
A few comments received in response to the proposed regulations
asserted that the definition of broker in the final regulations should
not extend beyond the scope of the definition of broker in the
regulations that apply to securities industry participants in carrying
out securities transactions. The Treasury Department and the IRS
disagree with these comments and address them in Part II of this
Summary of Comments and Explanation of Revisions. Before turning to
that discussion, however, the Treasury Department and the IRS believe
that a comparison of the functions carried out by brokers and other
participants in the securities industry with the functions carried out
by DeFi participants is useful in analyzing how the broker definition
should apply to DeFi participants.
A. The Securities Industry
In the securities industry, the sale of a security typically
involves three fundamental functions, each of which is necessary for
the trade to take place. First, a customer will give a trade order to
sell its securities to a securities broker, specifying the details of
the order, such as the quantity and identity of the securities to be
sold. Second, the securities broker will route the order details to a
trading center, such as a national securities exchange or an
alternative trading center, for example in the case of U.S. equities
the New York Stock Exchange (NYSE) or the Nasdaq Stock Market, to
execute the order. Third, once the exchange or other trading center
finds a counterparty to the customer's order, the matched trade will be
sent to a clearing organization that will record and settle the
transaction by moving the traded securities and funds between the
accounts of the two brokers representing the matched customers. While
other financial institutions may be involved in the sale transaction,
and the functions involved may involve additional steps, these three
functions are core functions.\3\
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\3\ See DTCC, Accelerating the U.S. Securities Cycle to T+1,
Figure 2: Illustrative T+1 settlement trade flow, at page 8
(December 1, 2021), available at <a href="https://www.dtcc.com/-/media/Files/PDFs/T2/Accelerating-the-US-Securities-Settlement-Cycle-to-T1-December-1-2021.pdf">https://www.dtcc.com/-/media/Files/PDFs/T2/Accelerating-the-US-Securities-Settlement-Cycle-to-T1-December-1-2021.pdf</a>; Financial Industry Regulatory Authority
(FINRA), The LifeCycle of a Trade (November 21, 2017), available at
<a href="https://www.finra.org/investors/insights/online-trade-lifecycle">https://www.finra.org/investors/insights/online-trade-lifecycle</a>
(describing the steps as the placement of an order by a customer and
the receipt of the order by the broker, the sending of the order by
a broker to an exchange or other trading center and the execution of
the order on that exchange or other trading center, and the clearing
and settling of the trade); Securities & Exchange Commission, Trade
Execution: What Every Investor Should Know (January 15, 2013),
available at <a href="https://www.sec.gov/about/reports-publications/investorpubstradexec">https://www.sec.gov/about/reports-publications/investorpubstradexec</a>.
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The securities broker that receives the customer's order may offer
additional services. For example, while retail customers many years ago
held physical stock and bond certificates themselves or with third-
party custodians, today a securities broker or affiliate of that broker
typically will hold a retail customer's securities as a custodian,
although there are still limited circumstances under which an
individual may hold physical securities certificates. For institutional
customers, it is common for a financial institution other than the
securities broker that receives the customer's trade order to hold the
customer's securities. In some cases, for example in the case of an
insurance company or pension plan, the customer's securities may be
held by a bank that offers specialized custodial services. In other
cases, for example in the case of a hedge fund, the customer's
securities may be held by its primary securities broker, referred to as
a prime broker, but the customer may give the order to a different
broker, referred to as an executing broker, that offers lower fees or
other terms preferred by the customer. If the securities broker taking
the customer's order does not hold the customer's securities, the
executing broker and the financial institution holding the customer's
securities will communicate with each other to ensure that the trade is
executed smoothly by the exchange or other trading center.
The market that executes the transaction may be a national
securities exchange, as described above. Alternatively, the trade may
be executed on an alternative trading center or by a single-dealer
platform or wholesale broker. The function of all these trading centers
is to match a sale order with a buy order.\4\ Another possibility is
that the securities broker may not go to an external trading center to
execute the trade. Instead, if the securities broker is also a dealer
in those securities, it may fill the order by acting as the
counterparty to the customer's trade. Alternatively, the securities
broker may match the sell order with a buy order from another customer.
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\4\ See FINRA, Where Do Stocks Trade? (September 28, 2023),
available at <a href="https://www.finra.org/investors/insights/where-do-stocks-trade">https://www.finra.org/investors/insights/where-do-stocks-trade</a>.
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The last step in the transaction is for the sale to be cleared and
settled. Clearing and settlement of a sale of securities involves
verifying that the terms of the buy and sell orders match and carrying
out the movement of securities from the account of the seller's
securities broker to the account of the buyer's securities broker
(which credits those securities to the buyer) and the movement of cash
in the reverse direction. This function is carried out by a specialized
financial institution that may be referred to as a clearing
organization.
[[Page 106930]]
Historically, communications between securities brokers and their
customers took place in person or by telephone. Customers now may
communicate a trade order to a securities broker through a mobile
device application (mobile device app) or a website accessible via a
computer or mobile device. The mobile device app or website provides a
user interface with visual elements that enable customers to see the
services offered and buttons and fill-in screens to enable customers to
communicate trading instructions to the broker through the mobile
device app or website. For example, a customer may access a mobile
device app or website offered by a securities broker to select among a
number of possible transactions, make its selection via buttons and
fill-in screens, and authorize the purchase or sale of securities by
clicking a button. Doing so generates a trade order in the form of
software code which is transmitted to the broker's systems and used to
initiate the remaining steps in the transaction. Similarly, each of the
other steps in the sale of a security typically now take place
electronically, through specialized software.
B. The Decentralized Digital Asset Ecosystem
DeFi service providers use distributed ledger technologies to offer
investment and other financial services, similar to those provided in
the securities industry by securities brokers and exchanges, that
enable customers to carry out trades of digital assets using
applications,\5\ sometimes referred to as DeFi applications or dApps,
without relying on a traditional centralized financial intermediary.
The services provided generally involve multiple DeFi participants
performing various functions throughout the process in order to
complete a customer's transaction, including: the intake of a
customer's trade order details and communication of that order to the
validation network for execution of the trade using the automatically
executing contracts of the DeFi protocol and for recordation and
settlement of the trade via a consensus mechanism. Because these steps
do not require the involvement of a centralized financial intermediary
(although some participants may in fact be structured as such), they
rely on software programs. Additional services and/or service providers
may also be involved in the transaction. For example, another type of
DeFi application, commonly referred to as a DeFi aggregator, may
communicate the customer's trade to the DeFi protocol with the most
favorable trade execution terms.
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\5\ In the context of the DeFi ecosystem, these final
regulations use the term execute to refer to the activation of the
automatically executing contracts of DeFi applications and not to
the simultaneous activities of validators that initiate this
activation.
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Several comments received in response to the proposed regulations
referenced or described a model, referred to by some in the DeFi
industry as the DeFi technology stack model or the DeFi stack reference
model, which describes the components and functions involved in the
communication, execution, and settlement of a typical DeFi transaction.
This DeFi technology stack model is also described in several scholarly
papers.\6\ The DeFi technology stack model classifies the technologies
involved in the communication, execution, and settlement of a typical
DeFi transaction into different technology layers, with each layer
representing the performance of a different function in carrying out
the overall transaction. In its simplest form, the DeFi technology
stack model describes three primary technology layers--the interface
layer, the application layer, and the settlement layer--even though
these layers can be further subdivided into sub-layers. See BIS Paper
at 4 (describing the application layer as having three sublayers).
Other scholars describe the DeFi technology stack model as having more
than three primary technology layers without subdivision within each
layer. See e.g., FRB Review at 155 (describing five primary layers).
Regardless of the number of layers described by any given model, the
functionality provided by each layer is generally needed to complete
the communication, execution, and settlement of a digital asset
transaction involving DeFi participants. See BIS Paper at 4. For
simplicity's sake, this preamble describes the DeFi technology stack
model with three primary layers because that model is sufficient for
the purpose of analyzing the issues raised by the comments received in
response to the proposed regulations.
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\6\ See e.g., R. Auer, B. Haslhofer, S. Kitzler, P. Saggese, and
F. Victor, The Technology of Decentralized Finance (DeFi), Bank for
International Settlements (January 2023) (BIS Paper), at 3,
available at: <a href="https://www.bis.org/publ/work1066.htm">https://www.bis.org/publ/work1066.htm</a>, and F.
Sch[auml]r, Decentralized Finance: On Blockchain--and Smart
Contract-Based Financial Markets, Federal Reserve Bank of St. Louis
Review, at 153, 156 (2d Qtr. 2021) (FRB Review), available at:
<a href="https://research.stlouisfed.org/publications/review/2021/02/05/decentralized-finance-on-blockchain-and-smart-contract-based-financial-markets">https://research.stlouisfed.org/publications/review/2021/02/05/decentralized-finance-on-blockchain-and-smart-contract-based-financial-markets</a>.
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In general terms, the three-layer DeFi technology stack model
places the interface layer at the top of the DeFi technology stack
model because this is the layer with which most users of digital assets
interact. The interface layer is the layer that enables digital asset
users to communicate with DeFi participants operating on the other
layers for ultimate execution and settlement of the transaction. The
interface layer does so by providing software (sometimes referred to as
front-end services) that provides the digital asset user with tools--
including screens, buttons, forms, and other visual elements
incorporated in websites, mobile device apps, and browser extensions--
that users can use to trade digital assets in their unhosted wallets
\7\ using DeFi protocols or DeFi aggregators operating on the
application layer. The application layer is the layer that executes the
user's trade order as part of the validation process. It is comprised
of DeFi protocols that consist of automatically executing software
programs or smart contracts that, when called upon, perform a
predetermined series of actions, for example exchanging digital asset A
for digital asset B, when certain conditions are met. Finally, the
settlement layer is generally responsible for recording financial
transactions on the distributed ledger, including transactions
conducted by users that trade digital assets using DeFi protocols. Each
of these layers are described in more detail in Parts I.B.1., 2., and
3. of this Summary of Comments and Explanation of Revisions.
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\7\ References in this preamble to an owner holding digital
assets generally or holding digital assets in a wallet are meant to
refer to holding or controlling the keys to the digital assets and,
thus, the ability to transfer those digital assets. See Sec.
1.6045-1(a)(25)(iv).
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While not included in the three-layer model described in the BIS
Paper, an important component of a DeFi transaction is the use of an
unhosted wallet by digital asset users. A wallet is a means of storing,
electronically or otherwise, a user's private keys to digital assets
(more technically, the private keys to distributed ledger digital asset
addresses as defined in Sec. 1.6045-1(a)(20)) held by or for the user.
Private keys are required to conduct transactions with the digital
assets associated with those keys and are sometimes analogized to a
password to a bank or investment account. In contrast to a hosted
wallet, in which a custodial service electronically stores the private
keys to digital assets held on behalf of digital asset users, an
unhosted wallet is a non-custodial means of storing a user's private
keys to digital assets held by or for the user. See Sec. 1.6045-
1(a)(25)(i) and (iii). A broadly
[[Page 106931]]
analogous fact pattern (disregarding the technological differences) in
the securities industry would be the use of a home safe by an investor
to store the investor's securities certificates, so that only the
investor controls what happens with those certificates. Unhosted
wallets also typically include software that enables digital asset
users to use their private keys, generally by signing or authorizing a
transaction. Unhosted wallets may also provide wallet users with other
services, such as tools that enable users to interact with the DeFi
marketplace.
1. The Interface Layer
While DeFi protocols execute exchanges of digital assets,
interacting directly with a DeFi protocol requires the ability to write
software code that will communicate with other participants in the DeFi
ecosystem. Although some digital asset users possess these technical
skills, most retail digital asset users do not. Instead, most retail
digital asset users use the services provided by other participants in
the DeFi ecosystem that offer a more user-friendly way to specify the
details of the transaction they wish to carry out and to communicate
that order so that it can be carried out. These services are generally
referred to as front-end services because they are provided at the
front end of a transaction and are classified as the interface layer
because they are the services that most users face.
Providers of front-end services typically offer a suite of services
that enable their customers to view the market conditions relating to a
customer's proposed trade, to input their proposed trade, and then to
initiate the additional steps necessary to trade their digital assets
(trading front-end services). Providers of these trading front-end
services are referred to here as trading front-end service providers.
This suite of services may be offered as part of the enhanced services
offered by an unhosted wallet or alternatively by a website or mobile
app to which customers connect their unhosted wallets. In either case,
this service is provided through software that assists customers in
initiating digital asset transactions, such as an exchange of digital
asset A for digital asset B using a DeFi protocol. For example, when
digital asset user C seeks to trade digital assets in C's unhosted
wallet using a DeFi protocol, C may use a mobile device app or a
website accessible via computer or mobile device that is designed for
that purpose. Embedded in that mobile device app or website is software
that provides C with visual elements that enable C to see the services
offered, such as screens to view the distributed ledger market and
potential trade transactions and buttons for C to press to communicate
C's desired transaction order.
When customers use trading front-end services, they will typically
be provided with an array of available digital asset trading pairs
applicable to the digital assets they hold in their unhosted wallets.
For example, a customer that wishes to exchange a digital asset will be
shown a menu of the trading pairs available for exchange of the
customer's digital asset for different digital assets as well as the
current exchange rate for each potential trade. Some trading front-end
services also offer customers the ability to choose the DeFi trading
application that will execute their transaction. After a customer
reviews the available trading pairs and decides on a potential
transaction, the customer will input the necessary trade order
information. Thereafter, the trading front-end service will typically
ask the customer to confirm the specific trade order details. If the
trade order details are confirmed by the customer, the trading front-
end service will convert that trade order information into software
code in the form of a data object, referred to here as coded trade
order instructions. The coded trade order instructions include all of
the details of the transaction, including how many digital assets to
remove from the customer's unhosted wallet, the fees (if any) payable
to the trading front-end service provider, and whether these fees will
be withheld from the amount of digital assets disposed or the digital
assets received in the trade. The coded trade order instructions must
specify the particular DeFi trading protocol that will execute the
customer's trade. The coded trade order instructions also specify the
type of digital assets the customer will receive at the completion of
the transaction and may specify the digital asset address into which
the received digital assets should be transferred. In advance of
certain transactions requested by the customer, the provider of trading
front-end services will also obtain the customer's permission for the
particular DeFi protocol to move digital assets out of the customer's
wallet in one or more transactions. Without this service, many
customers' trades cannot be executed.
After the coded trade order instructions are complete, the next
step is for the customer to authorize or sign the transaction, for
example by clicking a button in the customer's wallet. Once the
customer authorizes the transaction in their wallet, the unhosted
wallet then forwards the signed transaction to a communication node for
broadcast to the distributed ledger network, where it will stay as a
pending transaction until a validator chooses to include it in a block,
and the block is added to the distributed ledger. As part of the
validator's processing of a DeFi protocol transaction, the coded trade
order instructions provided through the trading front-end services call
the applicable DeFi protocol's automatically executing smart contracts,
which execute the transaction by performing the operations it was coded
to perform without human intervention. In less technical terms, once
the customer authorizes the transaction, the coded trade order
instructions determine the subsequent steps in the transaction as it is
processed. In short, trading front-end services permit a customer to
select, confirm, and communicate the details of a trade transaction
that it wishes to carry out using a DeFi protocol so that the
transaction can be executed and settled by other DeFi participants.
Notwithstanding differences in the technology used and the details of
the mechanisms by which a customer's order is carried out, these
services are similar to those provided to a customer by a traditional
securities broker that does not hold or custody a customer's assets.
In some cases, a trading front-end service provider might take
control of the customer's digital assets by routing the customer's
digital assets to an address controlled by the trading front-end
service provider, for example, where the trading front-end services
include DeFi aggregator services.
Unhosted wallet providers do not necessarily offer the trading
front-end services described in the previous paragraphs. Unhosted
wallet providers may offer only more limited, basic wallet services or
they may offer both basic wallet services and trading front-end
services. As discussed in Part III.A.2. of this Summary of Comments and
Explanation of Revisions, a core function of an unhosted wallet is to
store private keys to distributed ledger digital asset addresses, so
that wallet users can securely hold their digital assets at those
addresses. In addition, as part of the basic wallet services, unhosted
wallet providers typically include software that enables their
customers to use those private keys to sign or authorize a transaction,
similar to inputting a password or passcode to authorize other types of
online transactions. Many providers of unhosted wallets also provide
basic wallet services that enable their customers to transfer digital
assets from
[[Page 106932]]
one wallet to another wallet. A customer that wishes to use trading
front-end services but whose unhosted wallet provider does not offer
the desired services or does not offer them at a competitive price, can
use the trading front-end services provided by a third-party website or
a mobile device app by connecting their unhosted wallet to that third-
party website. To carry out any transaction that will be recorded on
the distributed ledger, the unhosted wallet will broadcast the signed
transaction to the distributed ledger network, often through the use of
specialized communication nodes. The basic wallet services described in
this paragraph can be distinguished from the enhanced wallet services
in which the trading front-end services used to interact with a DeFi
protocol (described in the previous paragraphs in this part) or a DeFi
aggregator that communicates the customer's trade to the DeFi protocol
with the most favorable trade execution terms are provided by the
unhosted wallet.
2. The Application Layer
The application layer is in the middle of the three-layer DeFi
technology stack model. One of the core functions of the application
layer is to provide DeFi protocols that users can interact with to
trade digital assets. DeFi protocols provide a function that is
analogous to the function provided by a stock exchange or other trading
center for matching buy and sell orders in the securities industry,
although there are technological differences as to how that function is
carried out.
A DeFi protocol is comprised of computer software that utilizes
distributed ledger technology to provide digital asset exchange
services through automatically executing software that performs a
predetermined series of actions when certain conditions are met. BIS
Paper at 2. One type of DeFi protocol is an automated market maker. BIS
Paper at 4. Some DeFi protocols create an exchange marketplace by
pooling digital assets provided by multiple digital asset users to
create market liquidity. Id.
As discussed in I.B. of this Summary of Comments and Explanation of
Revisions, another type of DeFi application relevant to the purchase
and sale of digital assets is a DeFi aggregator. DeFi aggregators
interact with, and use the services of, other DeFi protocols. BIS Paper
at 4. A DeFi aggregator communicates a user's trade order to a DeFi
protocol that may offer the most favorable trade execution terms.
Although DeFi applications can facilitate many types of activities,
such as non-custodial staking and re-staking, this preamble focuses
only on DeFi protocols and DeFi aggregators that enable digital asset
users to exchange digital assets for different digital assets, referred
to respectively as DeFi trading protocols and DeFi trading aggregators
and collectively as DeFi trading applications.
Many of the comments describe DeFi trading applications as having
immutable software that cannot be changed. However, many of these DeFi
trading applications can simply be replaced by other applications that
have new or different features, thus allowing for software upgrades in
practice. In other cases, a DeFi trading application may have an
``administration key'' or similar tool that allows developers,
founders, or other persons to modify the software, such as by changing
or updating certain variables within the software. The details of the
changes that can be made to the software, and who can make them,
however, are different with each DeFi trading application.
3. The Settlement Layer
The settlement layer is at the bottom of the three-layer DeFi
technology stack model. The settlement layer is generally responsible
for completing financial transactions and discharging the obligations
of all involved parties. BIS Paper at 4. Settlement involves recording
financial transactions on the distributed ledger. This function is
comparable to the clearing and settling of securities transactions,
some of which are now being settled through distributed ledger
technology. Settlement of a digital asset transaction is achieved by
validators including the transaction in a block and adding that block
to the blockchain through a consensus mechanism that resolves potential
conflicts using consensus standards developed by the distributed ledger
network. Id. In addition to validators, there are other DeFi
participants, such as block builders, that may participate in this
process. Once recorded, transactions are generally immutable, meaning
they cannot be reversed. The recording of a transaction on the
settlement layer generally effects a ``state change'' in a distributed
ledger.
II. Statutory Authority To Treat DeFi Participants as Brokers
A. Background
Before the amendments made to the Infrastructure Act, the
definition of broker in section 6045(c)(1) included a dealer, a barter
exchange, and a person who (for consideration) regularly acts as a
middleman with respect to property or services. See section
6045(c)(1)(A), (B), and (C). The Infrastructure Act, in section
6045(c)(1)(D), added a new clause to the definition of broker: any
person who (for consideration) is responsible for regularly providing
any service effectuating transfers of digital assets on behalf of
another person.
Section 1.6045-1(a)(1) \8\ defines brokers that are required to
report under section 6045. Under this section, ``any person . . . that,
in the ordinary course of a trade or business during the calendar year,
stands ready to effect sales to be made by others'' is a broker
obligated to file information returns under section 6045. Section
1.6045-1(a)(10) of the pre-TD 10000 regulations defined effect for this
purpose to mean either to act as a principal with respect to a sale
(for example, a dealer in securities who buys a security from one
customer and then sells that security to another customer) or to act as
an agent with respect to a sale if the nature of the agency is such
that the agent ordinarily would know the gross proceeds of the sale.
Because the regulatory definition of the term broker includes a
reference to effecting sales, the definition of the term effect affects
the types of persons who are treated as brokers. In addition, Sec.
1.6045-1(a)(4) further defines a barter exchange that is a broker under
section 6045(c)(1)(B) as any person with members or clients that
contract either with each other or with such person to trade or barter
property or services either directly or through such person.
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\8\ Unless otherwise qualified, regulation section references
refer to the final regulations in effect before the effective date
of these final regulations. The final regulations in effect before
the effective date of TD 10000 will collectively be referred to as
the pre-TD 10000 regulations.
---------------------------------------------------------------------------
In Sec. 1.6045-1(a)(10)(i)(D), TD 10000 added to the definition of
effect: to act as a digital asset middleman for a party in a sale of
digital assets. Section 1.6045-1(a)(21)(i) defined a digital asset
middleman for this purpose as any person who, with respect to a sale of
digital assets, provides a facilitative service. Section 1.6045-
1(a)(21)(iii)(B)(1) through (4) defined a facilitative service by
referencing five specific services in which the broker acts either as
an agent or a counterparty in a digital asset sale.
Proposed Sec. 1.6045-1(a)(21)(iii)(A) would have also included in
the facilitative services definition any service that directly or
indirectly effectuates a sale of digital assets, such as providing a
party in the sale with access to an automatically executing contract or
protocol, providing access to digital asset trading platforms,
providing an automated market maker
[[Page 106933]]
system, providing order matching services, providing market making
functions, providing services to discover the most competitive buy and
sell prices, or providing escrow or escrow-like services to ensure both
parties to an exchange act in accordance with their obligations. To be
covered by this proposed rule, under proposed Sec. 1.6045-1(a)(21)(i),
the person providing facilitative services would have to ordinarily
know or be in a position to know the identity of the party making the
sale and the nature of the transaction. Proposed Sec. 1.6045-
1(a)(21)(iii)(A) would have excepted from the definition of
facilitative services certain validation services if conducted by a
person engaged in the business of providing distributed ledger
validation services and certain sales of hardware or licenses of
software by persons engaged in the business of selling hardware or
licensing software, for which the sole function is to permit persons to
control private keys which are used for accessing digital assets on a
distributed ledger. TD 10000 reserved on both the facilitative service
definition under proposed Sec. 1.6045-1(a)(21)(iii)(A) and the
definition of the ordinarily would know or position to know standard
(together referred to herein as the position to know standard) under
proposed Sec. 1.6045-1(a)(21)(ii). The proposed text for these
provisions is discussed more fully in Parts III.A.2., III.A.3., and
III.A.4. of this Summary of Comments and Explanation of Revisions.
B. Comments Received
1. The Statutory Language
The Treasury Department and the IRS received numerous comments
directed at the facilitative services definition under the proposed new
digital asset middleman rules. As a threshold matter, several comments
argued that this definition is inconsistent with the plain meaning of
the broker definition under section 6045(c)(1)(D). Other comments
asserted that the broker definition under section 6045(c)(1)(D) is
limited to persons acting as agents in digital asset transactions. One
comment cited Merriam-Webster Dictionary's definition of broker, as
``someone who acts as an intermediary: such as . . . an agent who
negotiates contracts of purchase and sale . . . [or] an agent who
arranges marriages,'' \9\ as support for this assertion. Other comments
reasoned that the term effectuate was meant to be synonymous with the
term ``effect'' in Sec. 1.6045-1(a)(10) of the pre-TD 10000
regulations, which, the comment stated, for over 35 years has required
the broker to act as an agent (or principal) in the transaction. See TD
7873, 48 FR 10302 (March 11, 1983). Another comment also focused on the
definition of ``customers'' in the pre-TD 10000 regulations to
similarly argue that section 6045(c)(1)(D) should not expand the scope
of the broker definition beyond persons acting as agents or principals
in a transaction. Specifically, the term customer is defined in Sec.
1.6045-1(a)(2) to mean the person that makes the sale if the broker
acts as an agent for such person in the sale, as a principal in the
sale, or as a participant in the sale responsible for paying to such
person or crediting to such person's account the gross proceeds on the
sale. Because the definition of customer under the pre-TD 10000
regulations requires that the broker-customer relationship be an
agency, principal, or payor relationship, this comment argued that
section 6045(c)(1)(D) should similarly be limited to persons acting as
agents or principals in the sale.
---------------------------------------------------------------------------
\9\ Merriam-Webster Dictionary, ``broker,'' accessed October 25,
2023, <a href="https://www.merriam-webster.com/dictionary/broker">https://www.merriam-webster.com/dictionary/broker</a>.
---------------------------------------------------------------------------
As discussed in Parts II.B.1.a. and II.B.1.b. of this Summary of
Comments and Explanation of Revisions, the Treasury Department and the
IRS do not agree that the statutory language defining broker under
section 6045(c)(1)(D) is limited only to persons that act as the
customer's agent (or as a principal/dealer) in a digital asset
transaction.
a. The Definition of Broker Prior to the Infrastructure Act
For over 35 years, the Code has set forth a broad definition of
broker under section 6045(c)(1). Under this definition, the term broker
is not limited to conventional securities brokers. Rather, the
statutory language defines the term broker to include several other
types of market participants. First, section 6045(c)(1)(A) treats a
dealer as a broker. Dealers typically hold inventory and act as
principals in sale transactions. George R. Kemon v. Commissioner, 16
T.C. 1026 (1951).
Second, under section 6045(c)(1)(B), the term broker includes a
barter exchange, which is defined in section 6045(c)(3) to mean any
organization of members providing property or services who jointly
contract to trade or barter such property or services. Long-standing
regulations define a barter exchange to mean any person with members or
clients that contract either with each other or with such person to
trade or barter property or services either directly or through such
person. See Sec. 1.6045-1(a)(4). The regulations require these barter
exchanges to report an exchange of property or services if the barter
exchange arranges a direct exchange of property or services among its
members or clients. See Sec. 1.6045-1(e)(2). That is, a barter
exchange is treated as a broker if it merely provides the service of
bringing together the parties to the exchange, without acting as either
an agent or a principal to the exchange.
Third, under section 6045(c)(1)(C), the statutory broker definition
includes certain middlemen with respect to property or services.
Because the statutory language must be given meaning, the term
middleman must include persons who would not otherwise be considered
brokers under the definition without section 6045(c)(1)(C). Pursuant to
this authority, the section 6045 regulations treat certain payors and
agents as brokers, including professional custodians as well as
dividend reinvestment agents that do not take custody of customer
securities. See Sec. 1.6045-1(b)(1)(ii) and (v) (Example 1).
Additionally, the flush language in section 6045(c) expressly exempts a
person that manages a farm on behalf of another person from the
definition of broker with respect to their farm management activities.
See H.R. Rep. No. 100-795, at 360 (1988) (the bill exempts farm
managers from the requirement of filing a Form 1099-B with respect to
their farm management activities because this information must already
be filed, in a more useful format, by these farm managers on a Schedule
F, thus, making the Form 1099-B duplicative). This farm-manager
exemption shows that Congress broadly construed the term middleman
beyond conventional securities brokers. In addition, Sec. 1.6045-
1(b)(2)(ii) and (vii) (Example 2) provide specific exclusions for stock
exchanges and clearing organizations, which, absent those exclusions,
would be middlemen treated as brokers. Indeed, virtually all other
persons that Sec. 1.6045-1(b)(2) (Example 2) illustrates as non-
brokers, including certain stock transfer agents for a corporation,
certain escrow agents or nominees, and certain floor brokers on a
commodities exchange, are examples of persons that could be considered
middlemen.
Thus, prior to the Infrastructure Act, the term broker under
section 6045(c)(1) included specified types of principals, custodial
agents, non-custodial agents, payors, and service providers, pursuant
to the statute and long-standing implementing regulations. See e.g.,
Sec. 1.6045-1(c)(3)(iv) and (c)(4)(iii), (iv), and (v) (Examples 3, 4,
and 5) (multiple
[[Page 106934]]
broker examples involving one broker that holds the customer's assets
and another broker that does not hold the customer's assets). The term
broker was not defined by reference to any particular type of property
or services. Accordingly, statutory authority existed before the
enactment of the Infrastructure Act to treat centralized digital asset
exchanges that act as traditional brokers or dealers as brokers for
purposes of section 6045(c)(1).
In addition, section 6045(c)(1) also provided statutory authority
to treat as a broker any other person that satisfied the definition of
broker, dealer, or a middleman with respect to property or services if
the middleman regularly acted as such for consideration. See Part
II.B.2. of this Summary of Comments and Explanation of Revisions, for a
discussion of the scope of this authority with respect to DeFi
participants.
b. The Definition of Broker Under Section 6045(c)(1)(D) as Enacted by
the Infrastructure Act
Section 6045(c)(1)(D) treats as a broker any person who (for
consideration) is responsible for regularly providing any service
effectuating transfers of digital assets on behalf of another person.
This statutory language explicitly addresses certain types of
activities not previously addressed expressly by section 6045(c)(1)
that are relevant to determining broker status. Section 6045(c)(1)(D)
refers to persons who provide specified types of digital asset
services, when regularly provided for consideration on behalf of
another person. The relevant services are those that effectuate
transfers of digital assets. The statutory language treats the person
providing those services as a broker.
Statutory language must be construed to avoid rendering it as
surplusage. See TRW, Inc. v. Andrews, 534 U.S. 19, 31 (2001) (noting
the ``cardinal principle'' of statutory interpretation requires that
``if it can be prevented, no clause, sentence, or word shall be
superfluous, void, or insignificant.''). Accordingly, the Treasury
Department and the IRS understand the statutory language to define the
term broker in a manner that does not merely restate what was the law
prior to the Infrastructure Act.
One comment asserted that the text in section 6045(c)(1)(D) merely
expands the broker definition with respect to the new types of assets
(digital assets) that must be reported and clarifies that the persons
reporting these new types of digital asset transactions must be
conducting otherwise similar activities to brokers included in the
existing definition of broker. The Treasury Department and the IRS do
not agree that section 6045(c)(1)(D) applies only to digital asset
brokers that fall within the broker definition under section 6045(c)(1)
prior to the Infrastructure Act amendments. As described in Part
II.B.1.a. of this Summary of Comments and Explanation of Revisions,
section 6045(c)(1) already provided authority to address at least some
digital asset brokers prior to the Infrastructure Act amendments.
Section 6045(c)(1)(D) was added to the Code because Congress recognized
that, in certain respects, the digital asset industry works differently
from the securities industry and that explicit statutory language
providing that certain additional digital asset service providers
should be treated as brokers was essential to providing clarity on how
information reporting rules apply to transactions involving digital
assets. Nothing in the text of section 6045(c)(1)(D) limits the scope
of digital asset brokers to those that fall within the broker
definition under section 6045(c)(1) prior to the Infrastructure Act.
Additionally, section 6045(c)(1)(D) does not limit the scope of digital
asset brokers to persons who act as agents, because by its terms the
statutory language refers to service providers. A person providing
services to a customer may or may not be acting as an agent for the
customer. Many service providers are not agents for their customers.
Section 6045(c)(1)(D) refers to persons providing services and,
therefore, is not limited to persons providing services only as agents.
Moreover, because persons acting as agents are already included in the
broker definition under section 6045(c)(1)(C), limiting section
6045(c)(1)(D) to persons providing services as agents for digital asset
transactions would render its text entirely superfluous.
Section 6045(c)(1)(D) also is not limited to persons who effectuate
transfers of digital assets. Section 6045(c)(1)(D) applies to any
person who provides ``any service effectuating transfers,'' not ``any
person who effectuates transfers.'' That is, the statutory language in
section 6045(c)(1)(D) applies to persons who provide services to
others, which services effectuate digital asset transfers. Given this
textual distinction, the Treasury Department and the IRS have
determined that section 6045(c)(1)(D) properly applies to persons that
supply customers with services that are used by those customers to
carry out digital asset transactions. As described in Part I.B.1. of
this Summary of Comments and Explanation of Revisions, that is exactly
the function provided by trading front-end service providers. For the
reasons described in that part, most digital asset users could not
easily carry out a DeFi sale or exchange of digital assets without the
services of a trading front-end service provider. Although trading
front-end service providers may not act as agents for their customers
in these transactions, the services provided by these trading front-end
service providers with respect to digital assets enable their customers
to trade their digital assets through other DeFi participants, just as
the services provided by securities brokers enable their customers to
trade their securities through other securities market participants.
That is, both trading front-end service providers and securities
brokers make it possible for a customer to review a range of options
for possible transactions, to make a selection and confirm that
selection, and to communicate the details of the transaction that the
customer wishes to carry out so that the transaction can be executed
and settled by other market participants. Similarly, in both cases, the
means by which those services are provided may include a website or
mobile device app that provides a series of visual elements, such as
forms, buttons that initiate actions, and dynamic page updates, that
enable customers to view the market conditions relating to their
proposed trades and to interact with that market by inputting their
trade orders.
Several comments argued that merely providing customers with
software that the customer can use to engage in digital asset
transactions does not constitute a ``service effectuating transfers.''
The Treasury Department and the IRS do not agree that the definition of
broker should turn on the technological implementation of the services
provided because the statute makes no reference to a particular form of
technology. Instead, the definition should turn on what those services
do. For example, the fact that, currently, a securities broker or
dealer takes customer orders or routes these orders electronically does
not change the nature of the services that the securities broker or
dealer provides. The provision of a suite of software that enables a
customer to interact with a distributed ledger network and effectuate
transactions using DeFi trading applications is an example of providing
a service that effectuates transfers.
Numerous comments argued that the term effectuate in section
6045(c)(1)(D) prevents the application of the broker definition to DeFi
participants because these participants do not control the
[[Page 106935]]
private keys to the customer's digital assets being traded. As support
for this argument, one comment cited a dictionary's definition of
effectuate as ``to cause or bring about (something)'' and a Supreme
Court interpretation of the meaning of ``effect'' as requiring a
``reasonably close causal relationship between a change in the physical
environment and the effect.'' See Effectuate, Merriam-Webster Online,
<a href="https://www.merriam-webster.com/dictionary/effectuate">https://www.merriam-webster.com/dictionary/effectuate</a>; Metro. Edison
Co. v. People Against Nuclear Energy, 460 U.S. 766, 774 (1984). This
comment also compared transactions in which DeFi participants do not
control the private keys to the customer's digital assets with those
carried out by traditional securities brokers in which the brokers hold
custody of the customer's securities and then asserted that the
definition of effectuate cannot apply to the services provided by DeFi
participants. Other comments argued that the word effectuate was meant
to apply only to the one person who carries out the transaction. These
comments concluded that expansion of the reporting regime under section
6045 to persons that do not possess traditional characteristics of a
broker in carrying out transactions exceeds the scope of the statute.
The Treasury Department and the IRS do not agree that the actions
of only one person, whether within the traditional securities industry
or within the DeFi industry, causes a transaction to be carried out (or
effectuated), which is why the pre-TD 10000 regulations contain a
multiple broker rule. The Treasury Department and the IRS do agree,
however, that a comparison of the persons involved in the steps
necessary to carry out a securities transaction with the services
involved in the steps necessary to carry out a DeFi transaction is
helpful to understanding what it means to effect or effectuate a
transaction. For purposes of this analysis as well as throughout these
final regulations, the term person has the meaning provided by section
7701(a)(1) of the Code, which provides that the term generally includes
an individual, a legal entity, and an unincorporated group or
organization through which any business, financial operation or venture
is carried on, such as a partnership. The term person includes a
business entity that is treated as an association or a partnership for
Federal tax purposes under Sec. 301.7701-3(b). Accordingly, a group of
persons providing services that together carry out a customer's digital
asset transaction may be treated as a broker whether or not the group
operates through a legal entity if the group is treated as a
partnership or other person for U.S. Federal income tax purposes.
As discussed in Part I.A. of this Summary of Comments and
Explanation of Revisions, in the securities industry, the steps of a
transaction typically begin when an investor communicates a trade order
to a securities broker, who may or may not have custody of the
investor's securities, and authorizes the securities broker to carry
out the trade. The securities broker generally will assess how to
obtain the best execution for the customer. That assessment could lead
the broker to fill the order from its own account or match the trade
with an offsetting trade order from another customer. The broker could
also decide to route the investor's order to a trading center, such as
a national securities exchange, an alternative trading system, or a
dealer. The exchange or other trading center generally will attempt to
find a counterparty to the investor's order. If the order is executed,
transaction information typically will be sent to a clearing
organization that will move the funds and securities between the
appropriate accounts at the clearing organization to settle the
transaction. The regulations under section 6045 treat only one of these
securities industry participants as the broker with reporting
obligations. See Sec. 1.6045-1(b)(2)(ii) and (vii) (Example 2) (not
treating certain stock exchanges and clearing organization as brokers).
Notwithstanding this rule, each of these participants technically meets
the definition of a person who effects (or ``act[s] as . . . an agent
for a party [albeit not the customer] in the sale'' if it ordinarily
would know from its services the gross proceeds from the sale). See
Sec. 1.6045-1(a)(10)(i)(A). Accordingly, it is the actions of all
these securities industry participants--along with those of the
customer--that collectively cause the transaction to be carried out.
Similarly, as discussed in Parts I.B. and I.B.1. through I.B.3. of
this Summary of Comments and Explanation of Revisions, the DeFi
technology stack model shows that, in addition to the customer, there
are multiple DeFi participants involved in causing a digital asset
transaction to be carried out. In the DeFi industry, when a customer
inputs a trade order on a mobile device app or a website accessible via
computer or mobile device, a trading front-end service provider
receives that trade order and has the customer confirm the trade order
details. Once the trade order details are confirmed by the customer on
the customer's computer or mobile device, the trading front-end
services translate those details into coded trade order instructions
which are sent to the customer's unhosted wallet to obtain the
customer's signature or authorization. Thereafter, the wallet transmits
the coded trade order instructions to the distributed ledger network
for the eventual interaction with the applicable DeFi trading
application for matching and for settlement pursuant to the services of
DeFi participants operating at the settlement layer. Importantly, like
the traditional securities transaction, the actions of the customer and
all these DeFi participants collectively cause the transaction to be
carried out. Accordingly, like in the securities industry, in which the
customer, the securities broker, the securities exchange, and the
clearing organization are all typically needed to carry out a
securities transaction, in a DeFi transaction, the customer, the
trading front-end service provider, the DeFi application, and the
validator are all typically needed to carry out the DeFi transaction.
Regarding the comment that the definition of effectuate cannot
apply to DeFi participants that do not control the private keys to the
customer's digital assets, as discussed in Part II.B.5. of this Summary
of Comments and Explanation of Revisions, the Treasury Department and
the IRS do not agree with this comment because the current broker rules
as applied to the securities industry treat persons without custody of
a customer's assets as a broker under section 6045. See e.g., Sec.
1.6045-1(c)(3)(iv) and (c)(4)(iii), (iv), and (v) (Examples 3, 4, and
5) (examples treating persons that do not hold the customer's assets as
brokers).
2. Title of the Broker Definition in the Infrastructure Act
Several comments argued that the existing scope of activities that
give rise to treating a person as a broker should not be expanded to
cover DeFi participants because section 80603(a) of the Infrastructure
Act titled the new broker definition as a ``clarification of [the]
definition of broker.'' One comment stated that the definition of
broker under section 6045(c)(1)(D) is limited to agents and principals.
Another comment stated that a broker under section 6045(c)(1)(D) must
be a middleman. Another comment stated that a middleman under section
6045(c)(1)(D) must be an intermediary. The Treasury Department and the
IRS do not agree that limiting the meaning of section 6045(c)(1)(D) to
persons
[[Page 106936]]
acting as the customer's agent or a principal in the transaction is
required by the definition of broker under section 6045(c)(1)(A)
through (C) because, except for section 6045(c)(1)(A), which is
specifically limited to dealers, the definition of broker includes no
such limitation. As discussed in Part II.B.1.a. of this Summary of
Comments and Explanation of Revisions, under section 6045(c)(1)(B) and
the regulations thereunder, the term broker includes a barter exchange
that is not acting as a customer's agent or as a dealer or principal.
Similarly, under section 6045(c)(1)(C), the term broker includes any
other person who (for a consideration) regularly acts as a middleman
with respect to property or services.
Although the term middleman is not defined in the statute, the term
is used in other tax information reporting rules to refer generally to
persons acting in a variety of capacities relevant to the particular
function, for example, making payment. See e.g., Sec. 1.6049-
4(a)(2)(ii) (the term ``payor'' includes a middleman as defined in
Sec. 1.6049-4(f)(4)); Sec. 1.6049-4(f)(4)(i) (middleman means any
person who makes payment of interest for, or collects interest on
behalf of, another person, or who otherwise acts in a capacity as
intermediary between a payor and a payee, and also includes a trustee).
Outside tax law, however, the term is used more broadly to include
persons that make referrals to others so that these others can
negotiate a sale between themselves in addition to those that act as
agents for others. See e.g., Dickson Marine Inc. v. Panalpina, 179 F.3d
331 (5th Cir. 1999). In Dickson Marine Inc., the court found that an
intermediary making a referral was a middleman and not the agent of
another person where that other person did not assert sufficient
control over the intermediary to establish an agency relationship. See
also Rauscher Pierce Refsnes, Inc. v. Great Sw. Savs., F.A., 923 S.W2d
112, 115 (Tex. App.1996) (middleman means a broker whose ``duty
consists merely of bringing the parties together so that, between
themselves, they may negotiate a sale, . . . [without that broker]
necessarily [acting as] the `agent' of either party.'')
Thus, the middleman reference in section 6045(c)(1)(C) can be
understood as broad enough to cover a person that is not an agent or
principal to a transaction but brings parties together so that those
parties can negotiate and finalize the transaction. That is, DeFi
participants provide persons with technological services that enable
those persons to carry out DeFi transactions. Treating section
6045(c)(1)(D) as a clarification of section 6045(c)(1)(C) renders it
unnecessary to determine the full scope of the term middleman in
section 6045(c)(1)(C) as applied to digital asset brokers. The
legislative history to section 6045(c)(1)(D) supports this
interpretation of section 6045(c)(1)(D) as a clarifying change intended
to eliminate the need to determine which digital asset participants
might qualify as middlemen. See the Joint Committee on Taxation's
description of section 6045(c)(1)(D) as a clarification of the then-
existing broker definition to resolve uncertainty over whether certain
market participants are brokers, as entered into the Congressional
Record. 167 Cong. Rec. S5702, 5703 (daily ed. August 3, 2021) (Joint
Committee on Taxation, Technical Explanation of Section 80603 of the
Infrastructure Act). This conclusion is also supported by the fact that
the clarified broker definition, along with the other changes made by
the Infrastructure Act to sections 6045, 6045A, and 6050I, were
estimated by the Joint Committee on Taxation to raise $28 billion over
10 years.\10\ In contrast, an interpretation of section 6045(c)(1)(D)
as confined to just middlemen acting as agents or principals would not
have raised as much revenue because digital asset brokers acting in
this capacity were already covered by the definition of broker under
section 6045(c)(1)(C).
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\10\ See JCT, JCX-33-21, Estimated Revenue Effects of the
Provisions in Division H of an Amendment in the Nature of a
Substitute to H.R. 3684, Offered by Ms. Sinema, Mr. Portman, Mr.
Manchin, Mr. Cassidy, Mrs. Shaheen, Ms. Collins, Mr. Tester, Ms.
Murkowski, Mr. Warner and Mr. Romney, The ``Infrastructure
Investment and Jobs Act'' (August 2, 2021).
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The policy behind the statute's clarification of the broker
definition also supports this broader interpretation of section
6045(c)(1)(D). Congress extended the information reporting rules under
section 6045 to digital assets to close or significantly reduce the
income tax gap from unreported income and to provide information about
these transactions to taxpayers. See 167 Cong. Rec. S5702, 5703 (daily
ed. August 3, 2021) (Joint Committee on Taxation, Technical Explanation
of Section 80603 of the Infrastructure Act). According to the
Government Accountability Office (GAO), limits on third party
information reporting to the IRS is an important factor contributing to
the tax gap. GAO, Tax Gap: Multiple Strategies Are Needed to Reduce
Noncompliance, GAO-19-558T at 6 (Washington, DC: May 9, 2019). Third
party information reporting generally leads to higher levels of
taxpayer compliance because the income earned by taxpayers is made
transparent to both the IRS and taxpayers. An information reporting
regime requiring reporting to the IRS on digital asset transactions
would benefit tax compliance by helping to close the information gap
with respect to digital assets. See TIGTA, Ref. No. 2020-30-066, The
Internal Revenue Service Can Improve Taxpayer Compliance for Virtual
Currency Transactions, 10 (September 2020); GAO, Virtual Currencies:
Additional Information Reporting and Clarified Guidance Could Improve
Tax Compliance, 28, GAO-20-188 (Washington, DC: February 2020).
Reducing the tax gap and providing information to taxpayers is no less
important when a DeFi participant, acting as a middleman, provides
parties with technological services that enable those parties to carry
out the DeFi transaction. Indeed, clear information reporting rules
that require reporting of gross proceeds from a sale of digital assets
in DeFi transactions will help the IRS identify taxpayers who have
engaged in these transactions. These rules will also remind taxpayers
who engage in DeFi transactions that the transactions are taxable,
thereby reducing the number of inadvertent errors or noncompliance on
their Federal income tax returns. Any exception to the information
reporting rules for DeFi participants that have access to the necessary
information about the transactions simply because they are offering
their services through software, instead of through human interaction,
would reduce the effectiveness of the information reporting rules.
Moreover, such an exception could have the unintended effect of
incentivizing taxpayers to change how they undertake digital asset
transactions, thus thwarting voluntary compliance and IRS enforcement
efforts to identify taxpayers engaged in digital asset transactions
that have not reported their income properly.
3. Legislative History
As support for interpreting section 6045(c)(1)(D) as applicable
only to persons acting as agents (or principals/dealers), several
comments cited to several statements made by Senators as the
Infrastructure Act was being considered. For example, one comment cited
Senator Portman's statements made during a colloquy with Senator Warner
(the colloquy), which referred to the intended purpose of the reporting
rule not being ``to impose new reporting requirements on people who do
not meet the definition of brokers.'' 167 Cong. Rec. S6095 (daily ed.
August 9,
[[Page 106937]]
2021). Several comments cited Senator Warner's statements made during
the colloquy referencing the intended application of the reporting rule
to ``digital asset exchanges or hosted wallet providers, often called
custodians, or other agents involved in effectuating digital asset
transactions.'' 167 Cong. Rec. S6095 (daily ed. August 9, 2021).
Finally, another comment argued that Congress meant to limit the
definition of broker to custodial brokers and referenced as support an
article that quoted Senator Toomey saying that the definition of broker
in the legislation was overly broad and ``sweeps in nonfinancial
intermediaries like miners, network validators, and other service
providers . . . [that] never take control of a consumer's assets and
don't even have the personal-identifying information needed to file a
1099 with the IRS.'' \11\
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\11\ Laura Weiss, Wyden wants tweaks to infrastructure bill's
cryptocurrency rules, Roll Call (August 2, 2023), available at:
<a href="https://rollcall.com/2021/08/02/wyden-wants-tweaks-to-infrastructure-bills-cryptocurrency-rules/">https://rollcall.com/2021/08/02/wyden-wants-tweaks-to-infrastructure-bills-cryptocurrency-rules/</a> (last visited October 17,
2024).
---------------------------------------------------------------------------
The Treasury Department and the IRS do not agree that these
statements limit the Secretary's authority under section 6045(c)(1)(D)
to only persons acting as agents (or principals/dealers). The plain
language of the statute is the authoritative statement of a statute's
meaning, and that language does not impose any such limitation.
Moreover, the Senators' statements referred to in these comments, when
read in full, reflect a fundamental concern with the potential
application of section 6045(c)(1)(D) to persons that do not have access
to the information needed to be reported, such as certain validators
and developers of computer hardware and software for unhosted wallets.
This fundamental concern was also reflected in a compromise amendment
the Senate considered that would have revised the broker definition to
``any person who (for consideration) regularly effectuates transfers of
digital assets on behalf of another person.'' Importantly, this
compromise amendment also included two rules of construction providing
that the amended definition of broker shall not be construed to create
any inference that such definition includes any person ``solely engaged
in the business of--(A) validating distributed ledger transactions,
without providing other functions or services, or (B) selling hardware
or software for which the sole function is to permit persons to control
private keys which are used for accessing digital assets on a
distributed ledger.'' See 167 Cong. Rec. S6131-2 (daily ed. August 9,
2021) (Senate Amendment 2656). See also 167 Cong. Rec. S6096 (daily ed.
August 9, 2021) (Senator Warner's statement in the colloquy that
persons solely engaged in validating transitions and persons solely
engaged in selling hardware or software with the sole function of
permitting someone to control private keys used to access digital
assets will not be treated as brokers under the proposed compromise
amendment).
Although this compromise amendment was not adopted due to issues
unrelated to the broker definition, the Treasury Department and the IRS
have long held the view that the broker definition under section
6045(c)(1) should not apply to ancillary parties who cannot get access
to information that is useful to the IRS. Indeed, notwithstanding the
authority provided by section 6045(c)(1)(C) to treat middlemen as
brokers, the section 6045 regulations impose broker reporting
obligations only on those market participants in the securities
industry that have the requisite information about the securities sales
of their customers even though other market participants that do not
have this information also act as middlemen in carrying out these
sales. See e.g., Sec. 1.6045-1(b)(2)(i) (stock transfer agent that
ordinarily would not know the gross proceeds from sales not treated as
broker); 1.6045-1(b)(2)(v) (floor broker that maintains no records with
respect to the terms of sales not treated as broker).
Several comments cited to private sector publications describing
unenacted prior drafts of the Infrastructure Act legislation and in
particular drafts of the broker definition to argue that the definition
in section 6045(c)(1)(D) cannot be interpreted to apply to DeFi
platforms. According to a source cited by one comment, one prior draft
would have provided that a broker includes ``any person who (for
consideration) regularly provides any service responsible for
effectuating transfers of digital assets, including any decentralized
exchange or peer-to-peer marketplace.'' \12\ According to another
source cited by a different comment, another prior draft would have
provided that a broker includes ``any person who (for consideration)
regularly provides any service or application (even if noncustodial) to
facilitate transfers of digital assets, including any decentralized
exchange or peer-to-peer marketplace.'' \13\ The Treasury Department
and the IRS do not agree that these reported drafts of the broker
definition support the more limited definition proposed by the
comments. The text of the bills referred to in these comments does not
reflect consideration by any member of Congress because these draft
bills were not introduced. As such, they are not legislative history
for the enacted amendments to section 6045.
---------------------------------------------------------------------------
\12\ Ella Beres, Crypto Tax Enforcement Update: The New Broker
Definition in the Information Reporting Requirement Provision of the
Infrastructure Bill Aims to Exclude Node Operators, Miners, and
Validators, Davis Wright Tremaine LLP (August 3, 2021); available
at: <a href="https://www.dwt.com/insights/2021/08/crypto-tax-enforcement-update">https://www.dwt.com/insights/2021/08/crypto-tax-enforcement-update</a>.
\13\ Jason Brett, New Language For Crypto Tax Reporting Excludes
Decentralized Exchanges, Miners Still Vulnerable, Forbes (August 2,
2021); available at: <a href="https://www.forbes.com/sites/jasonbrett/2021/08/02/new-language-for-crypto-tax-reporting-excludes-decentralized-exchanges-miners-still-vulnerable/?sh=41b5027b5f56">https://www.forbes.com/sites/jasonbrett/2021/08/02/new-language-for-crypto-tax-reporting-excludes-decentralized-exchanges-miners-still-vulnerable/?sh=41b5027b5f56</a>.
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One comment referenced several proposals to amend the current
definition of broker that were introduced after the Infrastructure Act
was enacted. These post-enactment proposals would limit the broker
definition to persons who effect sales at the direction of their
customers rather than persons who provide services effectuating
transfers. See e.g., Lummis-Gillibrand Responsible Financial Innovation
Act, S. 2281, 118th Cong. 802 (2023) (defining the term ``broker'' to
mean ``any person who (for consideration) stands ready in the ordinary
course of business to effect sales of crypto assets at the direction of
their customers''); Keep Innovation in America Act, H.R. 1414, 118th
Cong. 2 (2023) (defining ``broker'' to include ``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''). The comment argued that these proposals indicate an
intent to clarify the meaning of the broker definition under section
6045(c)(1)(D) so that the provision does not apply to DeFi
participants. The Treasury Department and the IRS do not agree that the
language within proposals to amend a statute offered after that statute
is enacted are persuasive authority for how to interpret the meaning of
the enacted statute. If anything, if the purpose of the proposed
legislation is to change the language of the statute to prevent the
application of the broker definition to DeFi participants, that would
support the interpretation that the statute as enacted applies to such
participants.
[[Page 106938]]
4. Comparison of the Broker Definition With Standards Applied by Other
Governmental Bodies
Several comments argued that the definition of broker as applied to
digital assets should conform to standards developed by governmental
bodies outside the purview of title 26. The Treasury Department and the
IRS do not agree that rules or regulations outside the purview of title
26 should determine the scope of these final regulations.
Several comments argued that the definition of broker as applied to
digital assets should be confined to persons acting as agents so that
it would be consistent with the standard recommended by the Financial
Action Task Force (FATF), an inter-governmental body that includes the
United States and 39 other member nations and aims to prevent global
money laundering and terrorist financing. In 2018, FATF modified its
recommendations to member nations to address virtual assets and virtual
asset service providers (VASPs).\14\ In 2021, FATF issued updated
guidance intended to help national authorities and private sector
entities to develop and understand anti-money laundering/counter-
terrorism financing rules as applied to virtual asset activities and
VASPs. This guidance specifically addresses DeFi arrangements.\15\ The
Treasury Department and the IRS do not agree that the standard set
forth in the 2021 FATF Guidance is limited to persons acting as agents.
The 2021 FATF Guidance specifically states that creators, owners and
operators, and some other persons who maintain control or sufficient
influence in the DeFi arrangements, even if those arrangements seem
decentralized, may fall under the FATF definition of a VASP when they
provide or actively facilitate VASP services. Moreover, FATF's Targeted
Update on Implementation of the FATF Standards on VAs and VASPs issued
in June 2024 reports that nearly half of surveyed jurisdictions either
require certain DeFi arrangements to be licensed or registered as
VASPs. Over 40 percent of remaining surveyed jurisdictions reported
taking steps to identify and address risks in the DeFi ecosystem.\16\
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\14\ FATF (2018), Report to the G20 Leaders' Summit, available
at <a href="https://www.fatf-gafi.org/content/dam/fatf-gafi/reports/Report-G20-Leaders-Summit-Nov-2018.pdf">https://www.fatf-gafi.org/content/dam/fatf-gafi/reports/Report-G20-Leaders-Summit-Nov-2018.pdf</a>.
\15\ FATF (2021), Updated Guidance for a Risk-Based Approach,
Virtual Assets and Virtual Asset Service Providers, ] 67-69, pp. 27-
28, FATF, Paris. (2021 FATF Guidance), available at: <a href="https://www.fatf-gafi.org/publications/fatfrecommendations/documents/guidance-rba-virtual-assets-2021.html">https://www.fatf-gafi.org/publications/fatfrecommendations/documents/guidance-rba-virtual-assets-2021.html</a>.
\16\ See FATF (2024), Targeted Update on Implementation of the
FATF Standards on Virtual Assets and Virtual Asset Service
Providers, ] 53, p. 28. FATF, Paris, France, available at <a href="https://www.fatf-gafi.org/content/dam/fatf-gafi/recommendations/2024-Targeted-Update-VA-VASP.pdf.coredownload.inline.pdf">https://www.fatf-gafi.org/content/dam/fatf-gafi/recommendations/2024-Targeted-Update-VA-VASP.pdf.coredownload.inline.pdf</a>.
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Several comments suggested that the broker definition under section
6045(c)(1)(D) should be limited to custodial digital asset brokers so
that it would be consistent with the broker reporting rules of other
jurisdictions. As support, one comment cited the definition of
``Reporting Crypto-Asset Service Provider'' (RCASP) under the Crypto-
Asset Reporting Framework (CARF),\17\ a framework for the automatic
exchange of information between countries on crypto-assets developed by
the Organisation for Economic Co-operation and Development (OECD), to
which the United States is a party. Specifically, this comment argued
that the proposed definition of broker would be inconsistent with the
definition of RCASP, which provides that an RCASP includes someone that
acts as a counterparty or intermediary in exchange transactions or that
otherwise makes available a trading platform.\18\ Another comment
argued that the definition of crypto asset services under the European
Union's Markets in Crypto-Assets Regulation (MICA) \19\ also includes
only centralized exchanges and custodial brokers.
---------------------------------------------------------------------------
\17\ International Standards for Automatic Exchange of
Information in Tax Matters: Crypto-Asset Reporting Framework and
2023 update to the Common Reporting Standard, OECD Publishing,
Paris, June 8, 2023, available at: <a href="https://www.oecd.org/en/publications/international-standards-for-automatic-exchange-of-information-in-tax-matters_896d79d1-en.html">https://www.oecd.org/en/publications/international-standards-for-automatic-exchange-of-information-in-tax-matters_896d79d1-en.html</a> (Crypto-Asset Reporting
Framework).
\18\ See Rules, Section IV.B., Crypto-Asset Reporting Framework.
\19\ Markets in Crypto-Assets Regulation (MICA) Regulation (EU)
2023/1114 of the European Parliament and the Council of 31 May 2023
on markets in crypto-assets, Official Journal of the European Union,
Volume 66, June 9, 2023, available at: <a href="https://eur-lex.europa.eu/eli/reg/2023/1114/oj">https://eur-lex.europa.eu/eli/reg/2023/1114/oj</a> (MICA).
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The Treasury Department and the IRS do not agree that the CARF
definition of RCASP is inapplicable to DeFi participants. Indeed, a
frequently asked question (FAQ) relating to this issue was recently
published by the OECD Committee on Fiscal Affair's Working Party 10,
which is the OECD group that developed the CARF. The question addressed
in the FAQ is whether the definition of RCASP excludes non-custodial
services that effectuate exchange transactions.\20\ The term RCASP is
defined as ``any individual or Entity that, as a business, provides a
service effectuating Exchange Transactions for or on behalf of
customers, including [. . . ] by making available a trading platform.''
\21\ The FAQ answer explains that, for purposes of that definition, a
trading platform may be made available by an individual or Entity with
or without offering custodial services. Accordingly, the CARF
definition of RCASP does not exclude DeFi participants.
---------------------------------------------------------------------------
\20\ OECD, Crypto-Asset Reporting Framework: Frequently Asked
Questions, September 2024, available at <a href="https://www.oecd.org/content/dam/oecd/en/topics/policy-issues/tax-transparency-and-international-co-operation/faqs-crypto-asset-reporting-framework.pdf">https://www.oecd.org/content/dam/oecd/en/topics/policy-issues/tax-transparency-and-international-co-operation/faqs-crypto-asset-reporting-framework.pdf</a>.
\21\ See Rules, Section IV.B, Crypto-Asset Reporting Framework.
---------------------------------------------------------------------------
Finally, the Treasury Department and the IRS do not agree that the
MICA definition of crypto-asset services is limited only to centralized
exchanges and custodial brokers. Title 1, Article 3 of MICA defines
crypto-asset services to include the operation of a trading platform
for crypto-assets and the custody and administration of crypto-assets
on behalf of clients. Recital 22 of MICA makes it clear that crypto-
asset services that are in part ``performed in a decentralised manner''
fall within its scope and excludes crypto-asset services only when they
are ``provided in a fully decentralised manner without any
intermediary.'' To the extent that assertedly decentralized DeFi
crypto-asset service providers in fact have a degree of centralized
control, MICA treats those service providers as within its scope.
Moreover, financial laws or regulations of a non-U.S. government or
union of governments do not determine the scope of U.S. tax rules.
5. Miscellaneous Comments
One comment suggested that the broker definition under section
6045(c)(1)(D) is limited to custodial brokers because any application
to non-custodial brokers would be an unprecedented expansion of the
section 6045 reporting obligations. As support for this position, this
comment stated that the application of the transfer statement
requirements under section 6045A(a) to certain transfers of digital
assets to brokers reflects Congress's focus on custodial brokers
because those rules apply only to transfers to custodial brokers.
Additionally, this comment argued that the new reporting obligation
under section 6045A(d), which requires reporting on certain transfers
of digital assets from accounts maintained by a broker, also reflects
Congress's focus on custodial brokers. The Treasury Department and the
IRS do not agree that the broker definition under section 6045(c)(1)(D)
is limited to only custodial
[[Page 106939]]
digital asset brokers. Section 6045A(a) cross references section
6045(c)(1) for the definition of broker, and there is no custodial
broker limitation in the definition of broker in section 6045(c)(1). As
discussed in the securities industry background in Part I.A. of this
Summary of Comments and Explanation of Revisions, a securities broker
may or may not hold customer assets in custody. The pre-TD 10000
regulations applied to securities brokers whether or not they provide
custodial services. Additionally, dealers that are brokers under
section 6045(c)(1)(A) can transact with customers without providing
custodial services to those customers. Members of barter exchanges that
are brokers under section 6045(c)(1)(B) can similarly exchange property
or services with other members without the barter exchange holding
custody of the traded property or services. See Sec. 1.6045-
1(e)(2)(i). Finally, the multiple broker rules under long-standing
regulations illustrate fact patterns that demonstrate that not all
persons treated as brokers under section 6045 are custodial brokers.
See e.g., Sec. 1.6045-1(c)(3)(iv) (cash on delivery) and (c)(4)(iii)
and (iv) (Examples 3 and 4).
One comment suggested that the final regulations should treat as
the broker only the DeFi participant that performs the actions without
which the transaction could not be carried out. As the DeFi technology
stack model shows, however, this proposed ``but for'' standard would
most likely result in all the DeFi participants being treated as
performing essential actions without which the transaction could not be
carried out. The DeFi technology stack model shows that, in addition to
the customer, there are multiple DeFi participants involved in causing
a digital asset transaction to be carried out. Each of these DeFi
participants provide services that are necessary to effectuate a
transaction. The section 6045 regulations treat multiple parties in the
securities industry that are involved in effecting a securities
transaction as brokers and include a multiple broker rule to avoid
duplicative reporting. As is discussed in Part III.A.1. of this Summary
of Comments and Explanation of Revisions, however, these final
regulations treat only one of these DeFi participants as the broker
based on a determination of which DeFi participant is in the best
position to provide the necessary reporting on the digital asset
transactions of customers.
Several comments argued that retaining the broker definition in
Sec. 1.6045-1(a)(1) of the pre-TD 10000 regulations for digital asset
broker reporting oversteps the statutory authority given to the
Secretary because that definition fails to include a requirement that
the broker's activities be undertaken ``regularly'' and ``for
consideration'' as required under section 6045(c)(1)(D). Another
comment recommended that this ``for consideration'' requirement be
added to the ``trade or business'' requirement in the broker definition
under the regulations. The Treasury Department and the IRS do not agree
that the broker definition fails to include these requirements. A
broker is defined in Sec. 1.6045-1(a)(1) as ``any person . . . that,
in the ordinary course of a trade or business during the calendar year,
stands ready to effect sales to be made by others.'' Under Groetzinger
v. Commissioner, 480 U.S. 23 (1987), persons ``engaged in a trade or
business . . . must be involved in the activity with continuity and
regularity . . . for income or profit.'' Accordingly, the requirement
that the person effect sales in the ``ordinary course of a trade or
business'' is sufficient to ensure that the person treated as a broker
under section 6045(c)(1)(D) ``regularly'' effects those sales ``for
consideration.''
One comment requested further guidance on what the ``for
consideration'' requirement means in the context of the DeFi industry.
Another comment argued that the ``for consideration'' requirement in
the statute requires that the person providing the effectuating
services earn consideration from each specific transaction effectuated
to be included in the broker definition. The Treasury Department and
the IRS do not agree that the text of the statute mandates such a
narrow interpretation of this requirement or that it is necessary for
these final regulations to address its meaning in the context of the
DeFi industry. The same ``for consideration'' requirement has existed
in the broker definition under section 6045(c)(1)(C) for over forty
years, yet there is no exception for brokers providing services on an
overall flat-fee basis or as a percentage of total invested assets.
Moreover, such an exception would likely incentivize DeFi participants
or other brokers to modify their fee models to avoid reporting, a
result that would thwart the goals of information reporting.
III. Definitions of a Digital Asset Middleman and an Effectuating
Service
Section 1.6045-1(a)(21)(i) defines a digital asset middleman as any
person who, with respect to a sale of digital assets, provides a
facilitative service. Section 1.6045-1(a)(21)(iii)(B)(1) through (4)
defines a facilitative service by referencing five specific services in
which the broker acts either as an agent or a counterparty in a digital
asset sale. As discussed in the Background, TD 10000 reserved on the
portion of the facilitative services definition included in proposed
Sec. 1.6045-1(a)(21)(iii)(A) that would have defined a facilitative
service as any service that directly or indirectly effectuates a sale
of digital assets, such as providing a party in the sale with access to
an automatically executing contract or protocol, providing access to
digital asset trading platforms, providing an automated market maker
system, providing order matching services, providing market making
functions, providing services to discover the most competitive buy and
sell prices, or providing escrow or escrow-like services to ensure both
parties to an exchange act in accordance with their obligations.
Several comments argued that the proposed definition of
facilitative services was too broad because it referred to services
that both directly and indirectly effectuate sales of digital assets.
Another comment argued that a standard that captures services that
indirectly effectuate transactions would have no discernible limits.
Several comments stated that this broad definition would apply the
broker definition to internet browsers, smartphone manufacturers,
internet service providers, and many other persons not even considered
part of the DeFi industry because these participants arguably
``indirectly'' effectuate transactions. One comment said that the
definition's inclusion of services that ``indirectly'' effectuate
transactions would treat as brokers persons who are not in the chain of
proceeds settlement, such as fund administrators, which provide
ancillary administrative services relating to a sale. Many of these
comments recommended narrowing the definition of facilitative service
to only include services that directly effectuate a sale.
The Treasury Department and the IRS agree that the proposed
facilitative services definition's reference to services that
indirectly effectuate sales of digital assets is too broad. The
Treasury Department and the IRS did not intend to include in the
definition of broker persons not within the DeFi industry, such as
internet service providers, internet browsers, or computer or
smartphone manufacturers. Accordingly, to address this concern, as
discussed in Parts III.A. through III.C. of this Summary of Comments
and Explanation of Revisions, the final
[[Page 106940]]
regulations narrow the scope of DeFi participants that meet the
definition of a digital asset middleman. Additionally, to make it clear
that the reach of the digital asset middleman definition in this regard
is not any broader than the broker definition under section
6045(c)(1)(D), the final regulations change the term facilitative
services used in the proposed definition of digital asset middleman to
the term effectuating services.
One comment stated that the definition of facilitative services
would capture all participants described in the DeFi technology stack
model resulting in duplicative reporting. Another comment stated that
the facilitative services definition results in disparate treatment for
DeFi participants in a digital asset transaction than is applied under
current law to securities industry participants providing analogous
services in a securities transaction. For example, this comment argued
that the NYSE and Nasdaq are not brokers for section 6045 purposes, but
analogous businesses in the DeFi industry would be brokers under the
proposed facilitative services definition. Although, as discussed in
Part II.B.1.b. of this Summary of Comments and Explanation of
Revisions, the definition of broker under section 6045(c)(1)(D) is
broad enough to include multiple DeFi participants involved in a DeFi
transaction, the Treasury Department and the IRS have determined that
such a broad definition could result in duplicative reporting.
Accordingly, the Treasury Department and the IRS have determined that
in these final regulations the only DeFi participants that should be
treated as brokers are trading front-end service providers. This
determination was made for several reasons, which are discussed in more
detail in the remainder of this Part III. of this Summary of Comments
and Explanation of Revisions. First, such providers are the DeFi
participants that have the closest relationship to customers and
therefore are in the best position to obtain customer identification
information. Second, numerous commenters expressed concerns regarding,
in the view of the comments, the difficulty in identifying operators of
DeFi trading applications and the potential difficulty such operators
would have in changing the potentially immutable code of those DeFi
trading applications. Those concerns are not as salient to trading
front-end service providers because those providers typically are legal
entities or individuals and the software used to provide trading front-
end services is not immutable. Accordingly, the persons responsible for
carrying out broker diligence and reporting will be easy for taxpayers
and the IRS to identify, and those providers have the capability to
modify their operations to comply with these regulations.
Appropriately, these DeFi participants are also the participants that
provide services that are most analogous to the functions performed by
brokers in the securities industry.
A. Interface Layer Activities
1. In General
In addition to other listed services, the proposed regulations
would have included in the definition of facilitative services certain
services that are described in the DeFi technology stack model as
interface layer services and which are referred to in this preamble as
trading front-end services. Specifically, proposed Sec. 1.6045-
1(a)(21)(iii)(A) would have included in the definition of facilitative
services any service that provides a party in the sale with access to
an automatically executing contract or protocol or digital asset
trading platform. To illustrate the meaning of providing a party with
such access, proposed Sec. 1.6045-1(b)(17) (Example 17) describes a
website that matches buyers and sellers of digital assets and
thereafter directs such buyers and sellers to use automatically
executing contracts to settle their matched transactions and concludes
that the website is an example of providing these access services.
One comment suggested that instead of referring to the services
that provide ``access to an automatically executing contract or
protocol or digital asset trading platform,'' the final regulations
should refer to these services as ``front-end services'' because the
front-end term captures not only the visual elements provided by a
website that offers these services but also the software that powers
the interactive features of the website or mobile app, such as forms,
buttons that initiate actions, and dynamic page updates without full
page refreshes. The Treasury Department and the IRS agree with this
recommendation and have adopted the front-end services terminology
referred to herein as trading front-end services.\22\
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\22\ This preamble also uses the trading front-end services term
in describing the comments received even when those comments refer
to these services using different terms, such as user interface
services or application programming interface.
---------------------------------------------------------------------------
One comment stated that DeFi systems, including those created by
software developers, operators of DeFi protocols, and trading front-end
service providers, are purely software infrastructure used for
communication and coordination. This comment argued that these services
are akin to those of a phone service provider, and therefore none of
these DeFi participants participate in the buying or selling of digital
assets. Another comment asserted that the definition of facilitative
services should not apply to trading front-end services used by
customers to interact with DeFi trading applications because these
services are merely informational services, much like those provided by
Google, Yahoo! Finance, or Wikipedia to internet users seeking
information. This comment argued that, in all these cases, the service
provider is merely generating and displaying information in response to
user inputs, and, as such, should not be treated as carrying out what
the user does with the provided information. Another comment suggested
that trading front-end services should not be treated as facilitative
services because these services are merely tools that are used by
customers to access the DeFi ecosystem. Another comment similarly
argued that trading front-end service providers merely provide tools
through which customers can participate on their own in a DeFi
transaction. This comment likened coded trade order instructions to a
torque wrench that a person purchases to repair their own car as
opposed to engaging a licensed mechanic who already owns a torque
wrench to repair the person's car. One comment argued that the final
regulations should treat DeFi trading applications as brokers, not
trading front-end service providers. In contrast to these comments, a
few comments acknowledged that trading front-end service providers
should be the DeFi participant treated as brokers that are required to
report under section 6045. One comment requested that the final
regulations clarify that trading front-end service providers are
brokers. This comment also noted that the software used by trading
front-end service providers to perform these services can be modified
and customized to comply with regulatory requirements and are already
being modified by some market participants to comply with anti-money
laundering (AML) and Know Your Customer (KYC) obligations under the
Bank Secrecy Act (BSA) (31 U.S.C. 5311 et seq.).
The Treasury Department and the IRS agree that the suite of
services offered by a trading front-end service provider, including the
generation of customized coded trade order instructions, are
[[Page 106941]]
provided through software that is used for communication and
coordination of functions on the distributed ledger network. The
Treasury Department and the IRS do not agree, however, that persons
providing trading front-end services that enable their customers to
interact with DeFi trading applications are akin to those of a phone
service provider or are merely providing informational services like
that of a search engine or that such services are analogous to buying
off-the-shelf tools to repair one's own car because trading front-end
services enable customers to engage in DeFi transactions. As discussed
in Part I.B.1. of this Summary of Comments and Explanation of
Revisions, trading front-end service providers offer a suite of
services that enable their customers to view an array of choices
relating to their proposed trades, to input their proposed trades, and
then to initiate the additional steps necessary to trade their digital
assets by interacting with other DeFi participants operating within the
distributed ledger network. The suite of trading front-end services
also includes, in some cases, interacting with customers in advance of
a trade order to obtain their permission for a DeFi trading protocol to
move digital assets out of the customers' wallets and converting these
customer permissions into software code that can later interact with
the DeFi trading protocol when a transaction is executed by the DeFi
trading protocol. Once the customer authorizes the transaction, the
coded trade order instructions prepared by the trading front-end
services determine the subsequent steps in the transaction as it is
processed, including calling the applicable DeFi protocol's
automatically executing contracts for automatic execution and
settlement if the transaction is included in a block and added to the
blockchain by a validator. Consequently, not only do the suite of
services offered by the trading front-end service provider supply the
customer with information, but these services are also essential and
integral to enabling the customer's order to be communicated,
understood, and executed by the other DeFi participants operating
within the distributed ledger network. Accordingly, the suite of
services provided by a trading front-end service provider are not
analogous to a torque wrench used to repair one's own car because, once
customers authorize or sign the transaction in their wallets, the
functions conducted thereafter within the distributed ledger network
are all initiated by the services provided by the trading front-end
service provider (including the coded trade order instructions) whereas
buyers of torque wrenches need to use their own skill to repair their
cars. In the former case, the services provided to the customer
effectuate the transaction via the coded trade order instructions
whereas in the latter case, the buyer of the torque wrench, not the
torque wrench itself, repairs the car.
Additionally, it should be noted that trading front-end services
are analogous to the services provided by securities brokers in the
securities industry. When a securities broker receives an investor's
order to sell securities, it will generally have some mechanism to
verify the order details. The securities broker will then route the
order to a securities exchange or other trading center for execution or
fill or match the order internally. If a transaction is ultimately
executed, the transaction information typically will be sent to a
clearing organization that will record and settle the transaction by
moving the traded securities and funds between the appropriate
accounts. That is, once the customer has provided the trade order
details to the securities broker and authorized the transaction, the
remaining steps in a transaction that is executed by a securities
exchange or other trading center take place pursuant to the securities
broker's communications with other market participants. The securities
broker functions as the recipient of the customer's order and the
intermediary that typically communicates the customer's trade order to
other market participants for eventual execution of that order.
Like the services provided by securities brokers in the securities
industry, a trading front-end service provider receives a customer's
trade order, verifies the order details, and obtains confirmation from
the customer. Although the trading front-end service provider may not
obtain the customer's final authorization for the transactions or
transmit the coded trade order instructions to the distributed ledger
network, the services provided by the trading front-end service
provider enable the customer's trade order to be communicated to the
other DeFi participants, including the specific DeFi trading protocol
called by the coded instructions and the other DeFi participants
operating on the settlement layer, to execute the transaction. Indeed,
the coded trade order instructions provided by the trading front-end
service provider are analogous to the coded trade order instructions
that a securities broker sends to a securities exchange or other
trading center in a traditional securities transaction and are
essential to carrying out the overall transaction. Accordingly, because
these trading front-end services provide essential services that enable
their customers to carry out DeFi transactions, the Treasury Department
and the IRS have determined that it is also appropriate to treat these
services as effectuating services.
Further, the Treasury Department and the IRS understand that
trading front-end services are typically offered by a legal entity or
individual, which means there is a person within the meaning of section
7701(a)(1) that would be obligated to comply with broker reporting.
Additionally, because persons providing trading front-end services
generally host websites, these persons provide services that interact
directly with customers undertaking DeFi transactions. Indeed, there
generally is an agreement between trading front-end service providers
and their customers, under which, as part of customary onboarding
procedures, customers are treated as having agreed to general terms and
conditions. These agreements may be part of the compliance program used
by trading front-end service providers to assess the customer's
suitability with respect to economic sanctions programs administered
and enforced by Treasury Department's Office of Foreign Assets Control
(OFAC).\23\ As such, a person providing trading front-end services is
the DeFi participant that is closest to the customer. In contrast, as
discussed in Part III.B. of this Summary of Comments and Explanation of
Revisions, some comments argued that DeFi trading applications are not
operated by persons within the meaning of section 7701(a) and do not
interact directly with the customer undertaking DeFi transactions.
Additionally, unlike the potentially immutable code used by DeFi
trading applications, the suite of services provided by trading front-
end service providers typically utilize software that is mutable.
Accordingly, the Treasury Department and the IRS have determined that
it is appropriate to treat trading front-end service providers as
brokers under section 6045(c)(1)(D) for the following reasons. First,
trading front-end service providers are the DeFi participants that have
the closest relationship to the customers and therefore are in the best
position to obtain customer identification information. Second, trading
front-end
[[Page 106942]]
service providers are legal entities or individuals that can be
identified by taxpayers and the IRS. Third, trading front-end service
providers typically do not utilize immutable code in providing these
services and therefore can make changes to their operations to comply
with these regulations. Therefore, with respect to any digital asset
sales \24\ effected by these brokers that are subject to reporting,
these brokers must file Forms 1099-DA, Digital Asset Proceeds From
Broker Transactions, to report the information required by that form as
appropriate and must retain the information for seven years as required
to be retained by Sec. 1.6045-1(d)(11)(i), such as the transaction ID
of the reported transaction and the digital asset address from which
the digital asset was transferred in connection with the sale. In
addition, the required information must also be made available for
inspection upon request by the IRS. For a discussion of the reasons why
the Secretary exercised discretion in not treating other DeFi
participants, such as persons that operate DeFi trading applications
and persons that perform functions on the settlement layer, as brokers
under section 6045(c)(1)(D), see Parts III.B. and III.C. of this
Summary of Comments and Explanation of Revisions.
---------------------------------------------------------------------------
\23\ See OFAC, Frequently Asked Questions: Questions on Virtual
Currency: 560, available at: <a href="https://home.treasury.gov/policy-issues/financial-sanctions/faqs/560">https://home.treasury.gov/policy-issues/financial-sanctions/faqs/560</a> (discussing OFAC compliance
obligations for transactions using digital currency).
\24\ Like centralized brokers, however, these trading front-end
service providers treated as brokers are not required to report on
the transactions identified in Notice 2024-57, 2024-29 I.R.B. 67
(July 15, 2024), for which brokers are not required to make a return
under section 6045(a) until further guidance is issued.
---------------------------------------------------------------------------
Several comments argued that the facilitative services definition
should not apply to trading front-end service providers (including
certain unhosted wallet providers as discussed in Part III.A.2. of this
Summary of Comments and Explanation of Revisions) because the customer
must authorize the transaction in the customer's wallet after the
wallet receives the coded trade order instructions from the trading
front-end service provider and because it is the customer's wallet, not
the trading front-end service provider, that sends the coded trade
order instructions to the distributed ledger. One comment asserted that
trading front-end service providers do not monitor whether a customer
deploys the coded trade order instructions received from the trading
front-end service provider, just as an encyclopedia does not monitor
whether a reader uses information obtained from its pages. Another
comment argued that, to be consistent with standards applied by other
offices of the Treasury Department, these final regulations must adopt
the standard used by the Financial Crimes Enforcement Network (FinCEN)
in its guidance relating to virtual currencies. See Fin-2019-G001,
Application of FinCEN's Regulations to Certain Business Models
Involving Convertible Virtual Currencies, May 9, 2019 (2019 FinCEN
Guidance). Specifically, in the view of this comment, FinCEN's 2019
Guidance looked to whether a user had ``total independent control over
the value [of digital assets]'' in determining whether digital asset
businesses providing services to that user are money services
businesses subject to AML obligations under the BSA and FinCEN's
implementing regulations. See 31 CFR chapter X.
The Treasury Department and the IRS considered these comments but
do not agree that trading front-end service providers should be
excluded from the broker definition for the following reasons. First,
although it may be the wallet, and not the trading front-end service
provider, that sends the coded trade order instructions to the
distributed ledger network, it is the coded trade order instructions
generated by the suite of services offered by the trading front-end
service provider that ultimately call for the interaction with the DeFi
trading protocol's automatically executing contracts and, once the
transaction is selected for validation and included in a block, cause
the validator to settle the transaction. These trading front-end
services provide an essential communication function notwithstanding
that the coded trade order instructions may not be broadcast to the
distributed ledger network by the trading front-end service provider.
In addition, although the preamble to TD 10000 looked to the
application of the BSA's AML obligations as support for the conclusion
that operators of custodial digital asset trading platforms, digital
asset hosted wallet providers, and digital asset kiosks have
information about their customers, the Treasury Department and the IRS
are not required to follow the BSA or the 2019 FinCEN Guidance in
determining whether trading front-end service providers should be
brokers under section 6045(c)(1)(D). The AML obligations in FinCEN's
regulations issued under the BSA apply generally to financial
institutions, whereas information reporting under section 6045 applies
to persons included in the definition of broker under section
6045(c)(1). Because section 6045 did not condition the definition of
broker on such person being a financial institution under the BSA, the
extent to which AML obligations apply to trading front-end service
providers does not limit the Secretary's ability to treat such persons
as brokers under section 6045(c)(1)(D). Cf. section 6050I(c)(1)(B)
(explicit reference to BSA).
These final regulations are issued under title 26, and this
preamble therefore does not address the proper interpretation of
FinCEN's total independent control standard in the 2019 FinCEN
Guidance. In any event, the Treasury Department and the IRS do not
agree that a total independent control standard is the appropriate
standard for determining whether a DeFi participant, such as a trading
front-end service provider, provides a service that effectuates a
transfer of digital assets as required by section 6045(c)(1)(D), or
that a user of trading front-end services has sole control over its
assets when it uses a trading front-end service. Trading front-end
service providers offer a suite of services that include the
translation of the customer's trade order input into coded trade order
instructions that ultimately call for the interaction of the customer's
digital assets with the DeFi trading application and, once the
transaction is selected for validation and included in a block, cause
the validator to settle the transaction. For example, these coded trade
order instructions specify the number and type of digital assets to be
removed from the customer's wallet and the type of digital assets to be
deposited into the customer's wallet in exchange. Additionally, the
trading front-end services also may include obtaining the customer's
permission for the DeFi protocol to remove digital assets out of the
customer's wallet and translating that permission into a separate set
of instructions that will be broadcast to the distributed ledger for
use by the DeFi protocol in future transactions authorized by the
customer. Moreover, in some cases, a trading front-end service provider
might take control of the customer's digital assets by routing the
customer's digital assets to an address controlled by the trading
front-end service provider. Accordingly, despite not holding the
digital asset customer's private keys, once the customer authorizes or
signs the transaction, the services provided by the trading front-end
service provider exercise a degree of control over the customer's
digital assets involved in transactions.
Numerous comments argued that trading front-end service providers
should not be treated as brokers because they are unable to backup
withhold from the digital assets disposed by the customer in the
transaction or the
[[Page 106943]]
digital assets received in the transaction because trading front-end
service providers do not have custody of the private keys used for
accessing a customer's digital assets. Another comment recommended
that, if trading front-end service providers are treated as brokers,
they should be exempt from any obligation to backup withhold in DeFi
transactions. The final regulations do not adopt these comments. Backup
withholding is an essential enforcement tool to ensure that complete
and accurate information returns can be filed by brokers with respect
to payments made to their customers. Accurate taxpayer identification
numbers (TINs) provided by the customers of brokers and other
information provided by brokers are critical to matching such
information with income reported on a customer's Federal income tax
return. Customers that fail to provide their TINs to a broker as
requested may be liable for penalties under section 6723 of the Code. A
complete exception from backup withholding for DeFi sales of digital
assets would increase the likelihood that customers will not provide
correct TINs to their brokers. Trading front-end service providers
exercise a degree of control over their customer's digital assets once
the transaction has been authorized or signed in the customer's
unhosted wallet to withhold their fees from the customer's digital
assets and can similarly satisfy their obligation to backup withhold
from either the digital assets disposed by the customer in the
transaction or the digital assets received in the transaction should
the customer fail to provide its name, address, and TIN. The Treasury
Department and the IRS are aware, however, that not all arrangements
between trading front-end service providers and their customers
currently provide for backup withholding. The Treasury Department and
the IRS intend to publish a notice of proposed rulemaking under Sec.
31.3406(h)-2(b) with proposed regulations that would provide trading
front-end service providers with greater flexibility to satisfy their
backup withholding obligations with respect to these transactions.
One comment argued that the delivery of application-programming
interfaces is merely the provision of hardware or software that enables
customers to access digital assets, and the legislative history is
clear that such activities ought not cause a person to be a broker. The
Treasury Department and the IRS agree that persons that provide
application-programming interface services, which is another name for
trading front-end services, write the software code that translates the
details of the customer's trade order into coded trade order
instructions. The Treasury Department and the IRS do not agree that the
definition of broker should turn on the technological nature of the
services provided. Instead, the definition should turn on what those
services do. Because trading front-end service providers provide
services that their customers need in order to engage in DeFi
transactions and that are designed specifically for that purpose, that
is, by offering a menu of transactions for a customer to choose from
and translating the details of the customer's trade order into coded
trade order instructions that are used to communicate with other DeFi
participants in order to engage in DeFi transactions, it is appropriate
to treat these services as effectuating transfers of digital assets
under section 6045(c)(1)(D).
Several comments argued that because some digital asset users can
themselves write the software code that is included in the coded trade
order instructions, trading front-end service providers that provide
this software coding service should not be treated as brokers. The
final regulations do not adopt this comment because trading front-end
service providers offer a suite of services to customers that enable
them to engage in DeFi transactions. Moreover, that some sophisticated
digital assets users are able to interact with DeFi trading protocols
without the services provided by trading front-end service providers
should not affect the obligation of trading front-end service providers
to report on the transactions of customers that do utilize their
services. Additionally, as discussed in Part III.B. of this Summary of
Comments and Explanation of Revisions, the IRS intends to evaluate the
information reported by trading front-end service providers and the
extent to which changes in the industry enable retail digital asset
users to use DeFi trading applications without using trading front-end
services.
In sum, for all these reasons, the Treasury Department and the IRS
have concluded that trading front-end services that enable customers to
interact with DeFi trading applications should be treated as
effectuating services for purposes of the digital asset middleman rule.
Accordingly, final Sec. 1.6045-1(a)(21) defines a digital asset
middleman as any person who is responsible for providing an
effectuating service with respect to a sale of digital assets. Final
Sec. 1.6045-1(a)(21)(i) defines an effectuating service as any trading
front-end service where the person providing that service ordinarily
would know or be in a position to know the nature of the transaction
(as defined in final Sec. 1.6045-1(a)(21)(iii)(B) and discussed in
Part III.A.3. of this Summary of Comments and Explanation of Revisions)
or any other service set forth in Sec. 1.6045-1(a)(21)(iii)(B)(1)
through (5) (previously referred to as a facilitative service in TD
10000). The final regulations use the term ``trading front-end
service'' rather than ``front-end service'' to make it clear that only
the front-end services that enable customers to interact with DeFi
trading applications are included in the effectuating services
definition. Specifically, final Sec. 1.6045-1(a)(21)(iii)(A)(1) limits
the definition of a trading front-end service to a service that, with
respect to a sale of digital assets, receives a person's order to sell
and processes that order for execution by providing user interface
services, including graphic and voice user interface services, that are
designed to: (i) enable such person to input order details with respect
to transactions to be carried out or settled on a distributed ledger or
similar technology; and (ii) transmit those order details so that the
transaction can be carried out or settled on a distributed ledger or
similar technology, including by transmitting the order details to the
person's wallet in such form that, if authorized or signed by the
person, causes the order details to be transmitted to a distributed
ledger network for interaction with a digital asset trading protocol.
The Treasury Department and the IRS are aware that technology evolves
rapidly. Accordingly, this definition is intended to apply broadly to
any front-end service that enables customers to input their order
details for interaction with a digital asset trading protocol
regardless of the order of the steps necessary to carry out that
transaction on the distributed ledger network. It is also intended that
this definition will apply to any front-end service that enables
customers to interact with aggregation protocols as well as digital
asset trading protocols.
Additionally, final Sec. 1.6045-1(a)(21)(iii)(A)(2) provides
additional rules for determining whether services are trading front-end
services. First, services are defined as trading front-end services
without regard to whether the digital assets received upon execution of
the transaction at a digital asset address in the wallet controlled by
the person using the trading front-end services to dispose of digital
assets (first person) or at a digital asset address in a wallet
controlled by a second person,
[[Page 106944]]
including the provider of the front-end services itself. Thus, for
example, if a first person uses services that otherwise meet the
definition of trading front-end services to exchange digital asset A
for digital asset B and the order details include an instruction to
deliver digital asset B to a digital asset address in a wallet
controlled or owned by a second person, for example, as a payment, the
services provided by the front-end service provider will be treated as
trading front-end services.
Final Sec. 1.6045-1(a)(21)(iii)(A)(2) also provides that the
transmission of order details to a distributed ledger network for
interaction with a digital asset trading protocol includes the direct
or indirect transmission to a distributed ledger network of order
details that call upon or otherwise invoke the functions of
automatically executing contracts that comprise a digital asset trading
protocol. Accordingly, the addition of intermediate steps before the
digital asset customer's transaction can be broadcast to a distributed
ledger network or before the transaction can otherwise cause the
interaction with a digital asset trading protocol, whether for business
purposes or in an attempt to avoid meeting the trading front-end
services definition, will not prevent the services provided by the
trading front-end service provider from being treated as trading front-
end services. Thus, for example, the transmittal of a customer's order
details for interaction with a DeFi aggregator application before
interaction with a specific DeFi trading protocol that offers the most
favorable transaction terms is an indirect transmission to a
distributed ledger network for interaction with a digital asset trading
protocol described in final Sec. 1.6045-1(a)(21)(iii)(A)(1)(ii). This
rule would not, however, treat basic speech-to-text interface services
that merely translate customer's voice commanded trade orders to
written text orders as trading front-end services because basic text-
to-speech interface services do not invoke the functions of the DeFi
protocol as required by final Sec. 1.6045-1(a)(21)(iii)(A)(1)(ii).
Instead, the translated speech-to-text trade order would be sent to a
trading front-end service provider that would, in turn, convert that
written trade order into coded trade order instructions.
In addition, final Sec. 1.6045-1(a)(21)(iii)(C) provides
exceptions for certain wallet services and validation services, which
exceptions are discussed in Parts III.A.2. and III.C. of this Summary
of Comments and Explanation of Revisions. Additionally, final Sec.
1.6045-1(a)(21)(iii)(D) defines a digital asset trading protocol as a
distributed ledger application consisting of computer software,
including automatically executing contracts, that exchange one digital
asset for another digital asset pursuant to instructions from a user.
One comment requested guidance regarding whether persons that offer
front-end services for users to provide liquidity to liquidity pools or
users to stake their assets through staking pools that issue receipts
or tokens in exchange for the users' digital assets would be treated as
brokers under the broker definition. Although the definition of trading
front-end services under these final regulations could apply to front-
end services that enable users to contribute their digital assets to
liquidity pools and to staking pools in exchange for receipts or
tokens, brokers are not required to make returns on these transactions
under section 6045 until a determination has been made that these
transactions are subject to such reporting. See Sections 3.03 and 3.04
of Notice 2024-57, 2024-29 I.R.B. 67 (July 15, 2024). The Treasury
Department and the IRS anticipate that any termination to the no-
reporting relief in Notice 2024-57 for such transactions will take into
account that the termination may cause persons not currently required
to report to start doing so and therefore such persons would need some
time to build or buy systems to comply with reporting. Finally, in
response to the comment requesting clarification as to whether
providing staking as a service could cause the provider to be treated
as a broker, to the extent that such services do not give rise to the
sale of a digital asset, the provision of those services would not
cause the provider to be treated as a broker.
2. Unhosted Wallet Services
Proposed Sec. 1.6045-1(a)(21)(iii)(A) included two sentences in
the proposed definition of facilitative services that addressed the
extent to which unhosted wallet services were included in the
definition. The first sentence would have specifically excluded from
the definition of facilitative services the selling of hardware or the
licensing of software for which the sole function is to permit persons
to control private keys which are used for accessing digital assets on
a distributed ledger if such functions are conducted by a person solely
engaged in the business of selling such hardware or licensing such
software. The second sentence illustrated the limits of this proposed
exclusion by stating that software that provides users with direct
access to trading platforms from the wallet platform is not an example
of software with the sole function of providing users with the ability
to control private keys to send and receive digital assets. Proposed
Sec. 1.6045-1(b)(23) (Example 23) illustrated the wallet exclusion
rule by describing a wallet that neither provides ``access'' nor
``connection services'' to a digital asset trading platform, and
proposed Sec. 1.6045-1(b)(22) (Example 22) illustrated the limits of
the wallet exclusion rule by describing a wallet that provides
``access'' to a digital asset trading platform.
One comment argued that the wallet exclusion rule's application
only to wallets the ``sole function'' of which is to permit persons to
control private keys was too narrow because the purpose of wallet
software is to allow users to interact with other blockchain addresses
(including smart contracts). The Treasury Department and the IRS do not
agree that this exclusion is too narrow. The rationale behind the
wallet exclusion was to exclude ancillary parties who cannot obtain
information about sales of digital assets. Senator Warner's statements
made during the colloquy make it clear that he intended this wallet
exclusion to be limited to providers of those wallets for which the
only function is to permit persons to control private keys which are
used for accessing digital assets on a distributed ledger. 167 Cong.
Rec. S6095-6 (daily ed. August 9, 2021). Senator Warner's expressed
intent to provide only a limited exclusion for wallet providers is made
even more clear when he said later in the colloquy, ``[o]f course, if
these [wallet providers] . . . provide additional services for
consideration that would qualify as brokerage, the rules would apply to
them as any other broker.'' 167 Cong. Rec. S6096 (daily ed. August 9,
2021).
Many comments argued for a complete exclusion from the facilitative
services definition for wallet services because, the comments stated,
wallet providers and wallet developers typically do not have the
information necessary to know the nature of transactions processed nor
are they generally able to obtain that information. One comment stated
that once the private key is exported, the wallet provider may not even
be aware that a transaction happened if the transaction originates with
a third-party trading front-end service provider, even though the
digital assets disposed of in the transaction are removed from the
user's wallet and the digital assets received in the transaction are
received in the user's wallet. Another comment stated that unhosted
wallet providers
[[Page 106945]]
may be able to see the digital assets leaving a wallet, but they cannot
know the underlying details of the transaction. One comment stated that
unhosted wallet providers do not typically know the functionality of a
given protocol that a wallet user interacts with using the user's
wallet.
As discussed in Part I.B. of this Summary of Comments and
Explanation of Revisions, providers of unhosted wallets often provide
customers with an assortment of services. Because the rationale behind
the wallet exclusion is to exclude ancillary parties who cannot obtain
information about sales of digital assets, it is important to examine
each of these services to determine if they enable the person providing
the wallet services to obtain information about customers' sales of
digital assets contained in the wallet. Services provided by the wallet
for key storage and transaction authorization are performed in every
transaction undertaken with digital assets in the customer's wallet.
These services, however, do not provide any information to the person
providing the wallet services regarding the underlying nature of the
transaction. Services enabling customers to transfer native and non-
native digital assets on the distributed ledger similarly do not
provide any information to the person providing the wallet services
regarding the underlying nature of the transaction. Additionally, the
connection that enables a customer to go to a third-party trading
front-end service provider for trading front-end services also does not
provide the person providing the wallet services with information with
respect to the transaction because the coded trade order instructions
in that case are created by the third-party trading front-end service
provider. Thus, despite the transaction being sent to the customer's
wallet for authorization or signature before it is then transmitted by
the wallet to the distributed ledger for interaction with the DeFi
trading application, the person providing the wallet services does not
have visibility into the coded trade order instructions if the
instructions are created by a third-party trading front-end service
provider. Accordingly, the Treasury Department and the IRS have
determined that it is appropriate to treat all these basic wallet
services as excluded from the definition of effectuating services under
the final regulation.
In contrast, when the person providing the wallet services also
provides trading front-end services for a transaction, this wallet
provider creates the coded trade order instructions that includes the
specifics of the customer's trade order. In that circumstance, the
person providing these enhanced wallet services has the information
about the underlying sale. Additionally, these persons also interact
directly with their customers and, as such, can obtain the customer's
identity. Accordingly, it is appropriate in these cases to treat these
enhanced wallet trading front-end services as effectuating services
under the final regulation and a person providing these enhanced wallet
services as a digital asset middleman.
Several comments requested guidance regarding the extent to which a
developer of wallet software that provides a service that is considered
to be a ``service effectuating'' transfers should be treated as a
provider of that service. The extent to which a software developer
would be treated as the provider of the software's services is a
question of fact that depends on how the software sale or licensing
transaction is structured and the activities provided by the software
developer thereafter. For example, if a developer licenses or sells the
developed software to a third party, who thereafter uses the software
without any continuing involvement by the software developer to provide
wallet services to customers, the software developer would not be the
provider of the wallet services. In contrast, if the software developer
licenses the wallet services directly to customers, the developer would
be the provider of the wallet services. The Treasury Department and the
IRS disagree with the comment in so far as it can be read to suggest
that the final regulations should incorporate additional guidance
regarding each potential factual scenario.
One comment stated that persons providing unhosted wallet services
do not know the identities of their customers taking part in the
transaction. Another comment stated that these persons may have
difficulty determining who is the beneficial owner of the digital
assets held within the wallet, such as when more than one customer
knows the private key or when one person opens an account on behalf of
another person. The Treasury Department and the IRS do not agree that
persons providing wallet services are not able to obtain the identities
of their customers. On the contrary, a person providing wallet services
is the DeFi participant in the best position to obtain that information
because there generally is an agreement between the person providing
wallet services and the customer under which, as part of customary
onboarding procedures, such customers are treated as having agreed to
general terms and conditions. Those terms and conditions can address
the need to obtain customer identification information. Although, as
suggested by the comments, it may be difficult for the person providing
wallet services to be certain that the person controlling the private
keys in the wallet is the beneficial owner of the digital assets held
within the wallet, this concern is no different from any other business
that transacts with customers electronically.
Many comments stated that, taken together, the wallet exclusion in
the proposed regulations would result in treating all providers of
wallet software as brokers. Several comments argued that this wallet
exclusion was too narrow because all wallet software provides users
with ``access'' to digital asset trading platforms, thus, no wallet
provider will qualify for the exclusion. Several comments stated that
the wallet exception's reference to software that provides wallet users
with ``direct access to trading platforms from the wallet platform''
made it difficult to understand how the overall wallet exclusion was
intended to apply because ``trading platform'' and ``wallet platform''
were not defined in the proposed regulations. One comment argued that
the wallet connection services referred to in proposed Sec. 1.6045-
1(b)(23) (Example 23) should not be considered a facilitative service
because this software merely permits a wallet user to authorize
transactions involving digital assets in the user's wallet with respect
to a transaction initiated outside of the wallet. Some comments argued
that this broad application of the facilitative services definition to
persons providing wallet services was inconsistent with the stated
intent of the proposed regulations and the legislative history of the
amendment to section 6045.
Several comments argued that the wallet services described in the
wallet exclusion rule should not be limited to persons ``solely''
engaged in the business of selling such hardware or licensing such
software. These comments argued that even if a person is engaged in
other activities that constitute acting as a broker with respect to one
transaction, those activities should not affect whether the person is a
broker with respect to the wallet services described in the wallet
exclusion provided with respect to a second transaction. That is, when
a person who is a wallet provider engages in broker activities with
respect to the first transaction, this does not affect whether that
wallet provider can obtain the information necessary to report the
second transaction. Several comments
[[Page 106946]]
argued that a precise interpretation of the wallet exclusion rule as
written would result in treating wallet providers that conduct any
other activities (even non-business hobbies) as providing facilitative
services and as brokers for all activities. Another comment argued that
although a well-advised wallet provider could put exempt activities
into different legal entities to achieve a more rational result, it
would be more appropriate to modify the rule to remove this
restriction. Another comment suggested that this requirement would
create a ``cliff effect'' for wallet providers, whereby a wallet
provider that offers one service that falls within the broker
definition will be treated as a broker for all transactions undertaken
by customers using that provider's wallet services.
The Treasury Department and the IRS agree that the exclusion for
wallet services should not be limited to persons that are ``solely''
engaged in the business of selling such hardware or licensing such
software. Additionally, the requirement should not cause wallet
providers to be brokers for all transactions undertaken by customers
using that provider's wallet services if the provider offers one
service that falls within the broker definition. For that reason, final
Sec. 1.6045-1(a)(21)(iii)(C)(2) provides that if a person licenses
software or sells hardware that provides unhosted wallet services that
include both trading front-end services with respect to some sales of
digital assets and other services that are not trading front-end
services (or other effectuating services under final Sec. 1.6045-
1(a)(21)(iii)(B)) with respect to other sales of digital assets, then
that person will be treated as providing effectuating services only
with respect to the sales of digital assets that are carried out using
the trading front-end services provided by the unhosted wallet.
Accordingly, persons providing unhosted wallet services must make
information returns with respect to customer sales that are undertaken
using the wallet's trading front-end services, but those persons are
not required to make information returns with respect to customer sales
that are undertaken using a third-party front-end service provider's
trading front-end services. A wallet provider that does not provide
trading front-end services but provides other effectuating services
described in final Sec. 1.6045-1(a)(21)(iii)(B), however, would
nonetheless be required to report on customer sales effected using
those other services. Thus, for example, if a person providing unhosted
wallet services also operates a digital asset kiosk, that person would
be required to report on sales of digital assets undertaken by
customers using that kiosk even if the digital assets sold were stored
in an unhosted wallet provided by that person. Additionally, Sec.
1.6045-1(b)(2)(x) (Example 2) has been modified to conform to this
final rule.
3. Position To Know
Under proposed Sec. 1.6045-1(a)(21)(i), a person performing
facilitative services with respect to a sale would meet the definition
of a digital asset middleman only if the nature of the services
arrangement is such that the person ordinarily would know or be in a
position to know the identity of the party that makes the sale and the
nature of the transaction potentially giving rise to gross proceeds
from the sale.
a. Position To Know the Identity of the Customer
Proposed Sec. 1.6045-1(a)(21)(ii)(A) would have treated a person
as ordinarily knowing or in a position to know the identity of the
party that makes the sale if that person maintains sufficient control
or influence over the provided facilitative services so as to have the
ability to set or change the terms under which its services are
provided to request that the party making the sale provide that party's
name, address, and TIN, in advance of the sale. The proposed rule also
would have treated this sufficient control or influence standard as
being met if the person providing the facilitative services has the
ability to change the fees charged for those services.
Several comments recommended that the final regulations retain only
the ordinarily would know standard as applied to knowing the identity
of the customer. Other comments stated that the position to know
standard has no reasonable limitation because virtually any provider
could theoretically request customer information or modify the terms of
its arrangement or fee structure. Several comments criticized the new
standard because it does not use an objective test but rather an
``ability'' standard which is not based on the DeFi participant's
business model but instead is based on hypothetical circumstances. One
comment asserted that persons that provide wallet services and
application-programming interface services do not meet the position to
know standard with respect to a customer's identity because, the
comment stated, these providers have no information on the customer. In
contrast, several comments stated that providers of user interface
services have sufficient control or influence to add the services
necessary to comply with the position to know standard and the proposed
broker reporting requirements. Indeed, one comment stated that these
interfaces can be modified and customized to comply with regulatory
requirements and are already being modified by some market participants
to permit AML/KYC compliance.
As discussed in Part III.A.1. of this Summary of Comments and
Explanation of Revisions, persons that provide trading front-end
services work directly with customers to translate their trade order
details into coded trade order instructions for later use. These
services are provided pursuant to general terms and conditions that the
customers agree to as part of customary onboarding procedures.
Accordingly, trading front-end services can update these general terms
and conditions as necessary to learn the identity of their customers.
Given that trading front-end service providers have access to their
customers and, therefore, can query them about their identity, the
Treasury Department and the IRS have determined that it is not
necessary in the final regulations to include the position to know
standard as applied to the identity of the party that makes the sale.
It should be noted that there is currently no knowledge standard for
any other brokers regarding the identity of the customer because these
rules only treat persons that have access to customers as brokers.
b. Position To Know the Nature of the Transaction
Proposed Sec. 1.6045-1(a)(21)(ii)(B) would have treated a person
as ordinarily knowing or in a position to know the nature of the
transaction potentially giving rise to gross proceeds from a sale if
that person maintains sufficient control or influence over the
facilitative services provided to have the ability to determine whether
and the extent to which the transfer of digital assets involved in a
transaction gives rise to gross proceeds, including by reference to the
consideration that the person receives or pursuant to the operations
of, or modifications to, an automatically executing contract or
protocol to which the person provides access. The proposed rule also
would have treated this sufficient control or influence standard as
being met if the person providing the facilitative services has the
ability to change the fees charged for those services.
One comment asserted that persons that provide application-
programming interface services do not meet the position to know
standard with respect to the nature of the transaction because these
providers have no information on
[[Page 106947]]
whether the underlying transaction actually took place. Another comment
agreed with the proposed position to know standard's reference to
sufficient control or influence because it is consistent with the FATF
standard, which provides that creators, owners, and operators or some
other persons who ``maintain control or sufficient influence'' in the
DeFi arrangements may fall under the FATF definition of a VASP where
they are providing or actively facilitating VASP services. 2021 FATF
Guidance at ] 67, p. 27. Several comments stated that trading front-end
service providers do not have visibility into the nature of the
transaction because they do not monitor whether a customer deploys,
through the customer's wallet, the coded trade order instructions that
they provided. One comment questioned whether a person meets this
standard if the person needs to implement technological changes to be
in a position to know the nature of the transaction. Several comments
requested that the final regulations eliminate the position to know
standard and instead only apply the ordinarily would know standard
because the position to know standard would force trading front-end
service providers to modify their services to comply with the final
regulations. One comment explained that although some trading front-end
service providers might receive contingent trade-based fees, others
receive non-contingent payments for their services. For example, this
comment stated that some trading front-end services provided by
blockchain explorers provide services that require considerable
sophistication for customers to use and, as a result, receive their
compensation from sources other than these customers, such as
advertising revenue, donations, or sales of blockchain data. Trading
front-end service providers might alternatively receive non-contingent
periodic payments under a services agreement with a DeFi governance
organization, such as a foundation or decentralized autonomous
organization (DAO). This comment stated that, in the case of a services
agreement with a DeFi governance organization, a trading front-end
service provider might collect data on protocol use (such as, the
number of transactions and average transaction size) in setting its
periodic fees. The comment argued that the reviewed data on the
protocol is anonymized by the blockchain technology and not specific
enough to the transactions undertaken pursuant to the front-end's
services to provide definitive information about whether these
transactions were authorized or signed by the customer and then settled
on the distributed ledger. Finally, regarding the proposed rule's
reference to a person's ability to change its fees in determining
whether a person has sufficient control or influence over its services,
one comment requested that final regulations provide more guidance
regarding what is meant by fees charged.
The Treasury Department and the IRS do not agree that trading
front-end service providers do not have the ability to know if a
transaction for which they provided coded trade order instructions was
ultimately executed and settled on the distributed ledger. As stated by
the referenced comment, trading front-end service providers may receive
contingent, trade-based fees as consideration for their services. To
ensure that these fees are paid, trading front-end service providers
include in the coded trade order instructions a direction for the
requisite fee (whether withheld from the traded-away digital assets or
the traded-for digital assets) to be sent to a wallet address owned by
the trading front-end service provider. Because this fee will not be
paid unless the customer authorizes the transaction in the customer's
wallet and the transaction is settled on the distributed ledger, the
receipt of these fees provides the trading front-end service provider
with the information necessary to know that the transaction took place.
Trading front-end service providers that receive non-contingent fees
for their services also have the ability to determine whether a
transaction created through their trading front-end services was
carried out. For example, these providers could include in the coded
trade order instructions a direction to notify the trading front-end
service provider when the transaction is settled on the distributed
ledger similar to the way the sender of an email can receive a read
receipt. Indeed, these providers inherently have more information about
the transaction than other persons searching the blockchain, so they
are in a better position to obtain relevant information from the
blockchain. Although these final regulations may require trading front-
end service providers receiving non-contingent consideration to make
changes in the coded instructions solely for the purpose of complying
with these broker reporting rules, this is not different from any other
broker that makes changes in their operations to comply with these
broker reporting rules. Accordingly, regardless of the structure of the
trading front-end service provider's compensation, trading front-end
service providers maintain control or sufficient influence over the
suite of services that they offer (including the coded trade order
instructions) to have the ability to determine whether and the extent
to which the transfer of digital assets involved in a transaction gives
rise to gross proceeds.
Although trading front-end service providers should always be
treated as maintaining control or sufficient influence over the suite
of services that they offer (including the coded trade order
instructions) to meet the position to know standard, the final
regulations nevertheless have retained a modified version of the
proposed position to know standard to ensure that other front-end
service providers that might inadvertently be treated as providing
trading front-end services under final Sec. 1.6045-1(a)(21)(iii)(A)
will not be treated as providing an effectuating service under this
definition. Accordingly, pursuant to final Sec. 1.6045-1(a)(21)(ii), a
person providing a trading front-end service ordinarily would know or
be in a position to know the nature of the transaction potentially
giving rise to gross proceeds from a sale of digital assets if that
person maintains control or sufficient influence over the trading
front-end services to have the ability to determine whether and the
extent to which the transfer of digital assets involved in a
transaction gives rise to gross proceeds. The sufficient control or
influence language used in the proposed regulations is modified to
control or sufficient influence to draw from the language used in the
2021 FATF guidance. See 2021 FATF Guidance at ] 67, p. 27.
Final Sec. 1.6045-1(a)(21)(ii) also adds three examples of when a
person would meet this control or sufficient influence standard. These
examples are not intended to be the exclusive examples that would meet
this standard. First, the section provides that a person providing
trading front-end services will be considered to maintain control or
sufficient influence over such services if that person has the ability
to amend, update, or otherwise substantively affect the terms under
which the services are provided or the manner in which the order is
processed. Second, similar to the proposed regulations' reference to a
person's ability to change their fees in determining whether a person
has sufficient control or influence over its services, final Sec.
1.6045-1(a)(21)(ii) provides that a person that has the ability to
collect the fees charged for the trading front-end services from the
transaction flow (that is, from the digital assets disposed or the
digital assets received in the trade order) would be
[[Page 106948]]
treated as a person that maintains control or sufficient influence over
the trading front-end services provided. This result would apply
whether or not the person providing trading front-end services actually
collects fees in this manner for its services. Third, final Sec.
1.6045-1(a)(21)(ii) provides that a person providing trading front-end
services will be considered to maintain control or sufficient influence
over such services if that person has the ability, in connection with
processing the order, to add to the order a sequence of instructions to
query the distributed ledger to determine if the processed order is, in
fact, executed or to use another method of confirmation based on
information known to that person as a result of providing the trading
front-end services. In contrast, a front-end service provider that
provides services that enable a website to be accessed on a computer or
mobile device but does not translate the customer's trade order into
coded trade order instructions that can be sent to the customer's
wallet for authorization would not be considered maintaining sufficient
control or influence over the services provided to know the nature of
the transaction. Finally, to ensure that trading front-end service
providers do not take steps to artificially avoid meeting the position
to know standard, final Sec. 1.6045-1(a)(21)(ii) provides that, except
as provided by the Secretary, a contractual or other restriction not
required by law that limits the ability of the person providing trading
front-end services to amend, update, or otherwise substantively affect
the terms under which the services are provided or the manner in which
the order is processed will be disregarded for purposes of determining
if a person meets the position to know standard. Thus, trading front-
end service providers cannot contract with their customers or with
operators of digital asset trading protocols to limit their coding
ability to avoid falling within the effectuating services definition.
4. Other Policy Considerations
Several comments raised policy considerations in opposing the
application of the digital asset middleman rules to DeFi participants.
Some of these comments focused specifically on front-end service
providers while others focused on DeFi trading applications or more
generally on any DeFi participant that ultimately could be made subject
to these rules. Several comments noted that because DeFi participants
do not have custody of the digital asset user's private keys, they are
not currently subject to any comprehensive regulatory oversight, such
as rules requiring the implementation of cyber-security programs,
business continuity or disaster recovery programs, or comprehensive
insurance policies. One comment suggested that not being required to
turn over personally identifiable information (PII), including their
names, addresses, and TINs, is a key reason why digital asset users
engage with DeFi tools and that adding this requirement would deter
these users from interacting with DeFi trading applications. One
comment argued that developers of DeFi systems should not be treated as
brokers because they face much steeper difficulties in setting up
information collection and reporting regimes because they have
historically focused on technology development rather than financial
services.
The Treasury Department and the IRS do not agree that DeFi
participants should be excluded from the information reporting rules
under section 6045 because of a lack of financial services experience
or because of a purported lack of comprehensive regulatory oversight.
Persons with technology expertise that operate trades or businesses
relating to financial services should comply with the same rules as any
other person operating financial services businesses. Regarding the
regulatory oversight comments, these final regulations concern Federal
tax laws under the Internal Revenue Code only. The purported absence of
regulatory oversight under any other legal regime that is outside the
scope of these regulations does not govern the implementation of a
provision under title 26. Therefore, the Treasury Department and the
IRS are not bound to use those regimes as models in determining whether
DeFi participants should be required to comply with an entirely
separate set of information reporting rules under section 6045.
Several comments argued that the application of the final
regulations to DeFi participants would jeopardize the security of
millions of Americans' personal data because DeFi participants are too
small and undercapitalized to be able to store PII safely. The Treasury
Department and the IRS did not adopt this comment for the final
regulations because traditional brokers, including smaller brokers,
have operated for many years and have implemented their own security
policies and protocols.
One comment stated that many DeFi participants are run by anonymous
providers, which further increases the risk to customer PII. Another
comment warned that if front-end service providers are treated as
brokers under the final regulations, well-meaning front-end service
providers and their customers are likely to fall victim to security
breaches. This comment predicted the proliferation of ``spoof'' front-
end service providers set up by nefarious actors to harvest the
personal data of digital asset users. The Treasury Department and the
IRS do not agree that these supposed risks justify not applying the
information reporting rules under section 6045 to the DeFi industry.
Information reporting is essential to the integrity of the tax system.
The argument offered by these comments could be applied to every
industry required to file information returns. The fact that nefarious
actors could ``spoof'' such persons or otherwise compromise customer
PII systems is not a reason to entirely abandon a reporting regime that
is essential to ensuring that the income (and resulting income tax)
from these transactions are reported by taxpayers. Like other
businesses that are obligated to collect PII and file information
returns with the IRS, trading front-end service providers can build
their own technologically innovative data collection and storage
systems or they can contract with reliable third-party vendors with
expertise in securing confidential data to do the same on their behalf.
One comment touted the policy benefits brought by the DeFi
industry, including reduced dependence on traditional intermediaries,
increased financial inclusion, stimulation of capital formation, and
democratization of financial services for traditionally oppressed
Americans. Another comment stated that the proposed rules reflect an
anti-technology bias that would discourage the adoption of these
innovative privacy-preserving peer-to-peer payment technologies and
jeopardize America's competitiveness with foreign nations. Another
comment suggested the application of the proposed reporting rules to
DeFi was financial discrimination. One comment suggested that the
recent collapse of digital asset custodial exchanges, such as FTX,
supports not applying the reporting regulations to DeFi participants,
such as unhosted wallets.
The Treasury Department and the IRS do not agree that these final
regulations reflect a bias against the DeFi industry or that these
regulations will discourage the adoption of this technology by law-
abiding customers. The information reporting rules under section 6045
have applied in some form to brokers in the securities industry for
over 40 years. As Senator Portman's statements made in the colloquy
make clear, the digital asset reporting provisions were ``designed to
[[Page 106949]]
bring more clarity and legitimacy to the cryptocurrency industry by
more closely aligning the reporting requirements with those of more
traditional financial services, and . . . in doing so will help provide
more certainty for people looking to invest in digital assets.'' 167
Cong. Rec. S6096 (daily ed. August 9, 2021). Beginning for sale
transactions on or after January 1, 2025, the regulations promulgated
in TD 10000 will also apply to brokers acting as agents or
counterparties in their customer's digital asset transactions. The
application of these final regulations to the DeFi industry merely
treats this industry like these other industries and thereby provides a
benefit to the overall industry and to people investing in digital
assets. Moreover, in addition to closing or significantly reducing the
income tax gap from unreported income, one goal behind information
reporting by brokers is to remind taxpayers who engage in DeFi
transactions that these transactions are taxable and need to be
reported on their Federal income tax returns. Therefore, these rules
will also reduce the number of inadvertent errors or intentional
misstatements shown on these taxpayers' Federal income tax returns.
Accordingly, these final regulations will result in trading front-end
service providers being able to provide to their customers the same
useful information regarding gross proceeds as custodial brokers will
provide because of the application of TD 10000. Finally, these final
regulations concern Federal tax laws under the Internal Revenue Code
only. The potential policy benefits brought by the DeFi industry raised
by these comments are outside the purview of title 26.
Several comments argued that the final regulations should not apply
to DeFi participants because these participants cannot report on the
customer's cost basis. One comment argued that the onus of reporting
tax information in DeFi transactions should fall upon the customers of
DeFi services, not DeFi participants providing those services. Other
comments argued that the information reporting rules should not apply
to DeFi transactions because these transactions are not so-called
``off-ramp transactions'' that convert the owner's overall digital
asset investment into a non-digital asset investment. The Treasury
Department and the IRS do not adopt these comments. An exchange of one
type of digital asset for another type of digital asset may be a
taxable transaction despite it not being an off-ramp transaction. See
Notice 2014-21, modified by Notice 2023-34, 2023-19 I.R.B. 837 (May 8,
2023). In addition, notwithstanding that DeFi participants generally do
not provide custodial services for their customers and thus would not
be required to report on the customer's cost basis in a sale
transaction, this does not lessen the importance of information
reporting for gross proceeds. Clear information reporting rules that
require reporting of gross proceeds for taxpayers who engage in digital
asset transactions will help the IRS identify taxpayers who have
engaged in these transactions, and thereby help to reduce the overall
tax gap.
Several comments recommended that the final regulations take a more
innovative approach to broker reporting. For example, one comment
recommended that the final regulations create a third-party reporting
person regime, partially modeled after existing regimes to streamline
information reporting and withholding in the cross-border payment and
employment contexts, with which DeFi trading applications and trading
front-end service providers could contract to store customer PII and to
file required information returns. One comment stated that it is
possible to innovate and build AML compliant DeFi platforms. Another
comment recommended the use of new types of digital asset tokens,
called tax attestation tokens, that could support DeFi brokers in
reporting the information required under section 6045. The final
regulations do not prescribe the tools that brokers must use in
complying with the reporting requirements under section 6045. The
Treasury Department and the IRS welcome input from the DeFi industry
regarding regulatory reform or market developments that could
facilitate innovative approaches to reporting information required
under section 6045.
B. DeFi Application Activities
Proposed Sec. 1.6045-1(a)(21)(iii)(A) would have included in the
definition of facilitative services any service that provides a party
in the sale with an automated market maker system, order matching
services, or market making functions.
Many comments argued that the definition of facilitative services
should not apply to persons operating DeFi trading applications, for a
variety of different reasons. One comment stated that DeFi trading
applications operate using immutable automatically executing software
that cannot be changed to accommodate broker reporting. Another comment
similarly stated that DeFi trading applications that are operated by
DAOs cannot be altered because although these DAOs may allow votes by
their governance token holders on smart contracts involving
predetermined fee tiers and other predetermined matters, they do not
allow votes on the overhaul of the entire application to build in the
systems required for information reporting and backup withholding. In
contrast, another comment stated that ownership of governance tokens is
often concentrated among a small group of investors--perhaps even a
majority held by a single investor--that can exercise complete control
over the development of the protocol. Several comments stated that
existing DeFi trading applications, which do not provide for
information reporting, cannot start reporting or be shut down to avoid
operating without complying with section 6045 requirements because the
existing smart contracts cannot be modified. One comment stated that
some of DeFi trading applications generally do not have operators that
are persons within the meaning of section 7701(a)(1) as support for the
assertion that they could not be expecting to file and furnish
information returns. One comment argued that DAO governance token
holders and other operators of DeFi trading applications should not be
brokers because they do not have access to DeFi customers and do not
have the ability to maintain practical control over customers'
transactions conducted using the DAO or DeFi trading applications.
Another comment requested more guidance with clear, objective
percentage standards regarding whether governance token holders have
control over a DAO, such as those provided in other areas of the tax
law. See e.g., sections 957(a) (controlled foreign corporation); 267(f)
(controlled group); 304(c) (control). One comment argued that DeFi
trading applications would not be in a position to know the customer's
identity if the transaction made use of ``zero-knowledge proof''
technology. Another comment asserted that there is no privity of
contract between DeFi trading applications and digital asset users;
therefore, it would be inappropriate to treat those operating these
applications as brokers. One comment stated that although persons are
involved in writing the underlying software code and deploying that
software code within DeFi trading applications, these persons are not
involved in running those applications once the code has been deployed.
One comment requested that the final regulations permit operators of
DeFi protocols (other than those that are fully
[[Page 106950]]
decentralized) to employ third-party service providers to assist in
tracking the information about transactions that take place on the
platform to comply with tax reporting. This comment stated that at
least one DeFi protocol operator has already supported a tax services
provider with tax-ready data and reports for its customers to use in
filing their Federal income tax returns.
The Treasury Department and the IRS do not agree with all of the
assertions made by these comments. However, as discussed in Parts III.
and III.A. of this Summary of Comments and Explanation of Revisions,
the only DeFi participants that are treated as brokers in these final
regulations are trading front-end service providers. As explained in
Parts III. and III.A. of this Summary of Comments and Explanation of
Revisions, trading front-end service providers typically are legal
entities or individuals that can more easily be identified by taxpayers
and the IRS; the software code they write is not immutable; they are
best suited to obtain information from customers; and the services they
provide are most analogous to the services provided by conventional
securities brokers. Accordingly, the Treasury Department and the IRS
have determined that operators of DeFi trading applications should not
be treated as providing services that meet the definition of
effectuating services under the final regulations, unless these DeFi
trading application operators also provide other services that are
determined to be included in the definition of effectuating services.
DeFi trading applications provide a function that contributes to
carrying out DeFi sale transactions much like the functions provided by
established stock exchanges (such as the NYSE or the Nasdaq) contribute
to carrying out securities transactions in the securities industry.
These services are not analogous to functions performed by securities
brokers in the securities industry. It should be noted that DeFi
trading applications are unlike stock exchanges in that DeFi trading
applications permit any digital asset user to transact directly with
the application whereas stock exchanges prohibit retail investors from
trading directly on these exchanges and only permit persons that are
regulated members of the exchange (that is, broker-dealers) to trade on
these exchanges. Although Sec. 1.6045-1(b)(2)(ii) excludes stock
exchanges from being treated as brokers, that exclusion is conditioned
on those stock exchanges providing ``facilities in which others effect
sales.'' This condition--along with the underlying regulatory
requirements regarding membership in the exchanges--ensures that other
brokers that are closer to the customer can provide the necessary
reporting under section 6045. In contrast, operators of DeFi trading
applications, including DAOs and their governance token holders, do not
restrict access to the trading platform to regulated parties. The IRS
intends to evaluate the information reported by trading front-end
service providers and the extent to which changes in the industry
enable digital asset users to use DeFi trading applications without
using the services provided by trading front-end service providers. If
the IRS learns that a significant amount of DeFi trading does not give
rise to information reporting, the Treasury Department and the IRS may
reconsider the scope of the definition of broker with respect to DeFi
transactions.
In specific response to the comments, the Treasury Department and
the IRS have concluded that it is not necessary to determine at this
time whether and to what extent DeFi trading applications are truly
decentralized, the extent to which operators of DeFi trading
applications (including governance token holders) can make changes to
the underlying smart contracts and protocols to comply with broker
reporting or hire third party service providers to do so, or whether
operators of DeFi applications may not ever qualify as persons, within
the meaning of section 7701(a) because these final regulations have
determined that trading front-end service providers should be the only
DeFi participants that are treated as the brokers under section
6045(c)(1)(D) and required to file information returns under section
6045 with respect to DeFi sale transactions. For the same reason, it is
not necessary for the Treasury Department and the IRS to determine the
extent to which a DeFi trading protocol would be in a position to know
their customers' identities if the transaction makes use of technology
that does not reveal the customer's identity, such as zero-knowledge
proofs or similar technology.
One comment argued that the counterparty to a transaction carried
out using a DeFi trading application may be a liquidity pool and not
the person providing that liquidity (liquidity provider). Another
comment asserted that if liquidity providers are treated as engaging
directly in the activities of the DeFi trading application, they could
be brokers under the proposed regulations even though they would not
have any way to determine the identity of the customer. The Treasury
Department and the IRS considered these comments and have concluded
that it is also not necessary to determine at this time whether and to
what extent liquidity providers are the counterparties in these
transactions or can otherwise access information about the customer
because these final regulations have determined that trading front-end
service providers should be the only DeFi participants that are
required to file information returns under section 6045 with respect to
DeFi sale transactions.
Several comments argued that non-fungible token (NFT) marketplaces
are the same as DeFi trading protocols and other DeFi trading
applications. These comments stated that developers of NFT marketplaces
are incapable of knowing the transactions that are carried out by
customers that use their marketplaces and cannot update their software
to require customers to comply with the broker reporting requirements.
Because these final regulations have determined that trading front-end
service providers should be the only type of DeFi participant that is
required to file information returns under section 6045 with respect to
DeFi sale transactions under these final regulations, the Treasury
Department and the IRS have concluded that it is not necessary to
determine at this time whether and to what extent NFT marketplaces
operate like DeFi trading protocols. It should be noted, however, that
persons that provide customers with trading front-end services to
purchase or sell NFTs in exchange for other digital assets do provide
effectuating services and are digital asset middlemen and brokers under
these final regulations.
One comment raised a concern regarding the extent to which a DAO
would be treated as a person that regularly offers to redeem digital
assets that it created or issued if it redeems ``receipt tokens''
issued to help users track how much of a governance token has been
placed into a smart contract for voting purposes, which receipt tokens
have no value and serve only to allow the user to retrieve its
governance tokens. The Treasury Department and the IRS did not intend
for the redemption of receipt tokens used merely to keep track of
voting history to be treated as sales subject to reporting under these
regulations and will consider future guidance to clarify this
intention.
C. Settlement Layer Activities
Proposed Sec. 1.6045-1(a)(21)(iii)(A) would have provided that a
facilitative service does not include validating distributed ledger
transactions (whether through proof-of-work, proof-of-stake, or any
other similar consensus
[[Page 106951]]
mechanism) without providing other functions or services if provided by
a person solely engaged in the business of providing such validating
services.
Many of the comments agreed that validation services should be
excluded from the broker definition. Applying the DeFi technology stack
model discussed in Part I.B. of this Summary of Comments and
Explanation of Revisions to the effectuating services definition, the
Treasury Department and the IRS continue to maintain that it is
appropriate to exclude validation services from the definition of
effectuating services. The functions performed by DeFi participants at
the settlement layer, such as block building and validation services,
which are responsible for settling financial transactions on the
distributed ledger, contribute to the execution of digital asset
transactions much in the same way as clearing organizations, such as
The Depository Trust and Clearing Corporation (DTCC) and its
subsidiaries, contribute to the execution of securities transactions on
a securities exchange. Like clearing organizations in the securities
industry, participants at the settlement layer do not interact with the
ultimate customer and, as such, do not generally have access to the
information that would enable them to associate the customer's identity
with transactions settled by those participants. Indeed, in the
securities industry, this lack of proximity to the customer--along with
the fact that other participants are closer to the customer--supports
not treating clearing organizations as brokers. See Sec. 1.6045-
1(b)(2)(vii). Consistent with this understanding that participants at
the settlement layer do not interact with the ultimate customer,
several Senators expressed a concern with treating persons that perform
validation services as brokers in the deliberations leading up to the
passage of the Infrastructure Act. For example, Senator Portman said
during the colloquy, ``[w]e want to be sure that miners and stakers and
others who play a key role in validating transactions now or in the
future . . . will not be subject to the [broker reporting] rules for
those activities.''). 167 Cong. Rec. S6096 (daily ed. August 9, 2021).
Several comments focused on the ``without providing other functions
or services'' limitation to the carve-out for validation services. One
comment argued that when a validator performs other functions or
services, it does not enhance a validator's ability to know the
identities of the parties whose transactions it validated. Another
comment referenced the DeFi technology stack model to argue that the
regulations should more clearly exempt all settlement layer service
providers from the definition of broker. Numerous other comments
provided descriptions of additional functions that they said either
were a component of validation services or otherwise should be treated
similarly to validation services. Specifically, these comments urged
the Treasury Department and the IRS to exclude ordering services, block
arranging services, block-proposing services, communication node
operation services and other similar network services that operate on
the settlement layer. One comment suggested that persons that record
transactions on secondary networks that are built on top of (or beside)
a primary distributed ledger (layer 2 blockchains) using sequencer
software should be treated like validators for this purpose. Similarly,
another comment pointed out that to facilitate more transactions, some
distributed ledgers enable transactions to be aggregated on a layer 2
blockchain before being recorded as a single transaction on the primary
distributed ledger. In these cases, this comment asserted that persons
that validate transactions on this secondary network should be
excluded. Another comment suggested excluding validators that
participate in so-called liquid staking protocols. One comment argued
that unhosted wallet providers, DeFi protocols, and price discovery
services should be excluded as analogous to validators.
As discussed in Part III.A.1. of this Summary of Comments and
Explanation of Revisions, the Treasury Department and the IRS have
determined that the only DeFi participant that should be treated in
these final regulations as providing effectuating services for purposes
of the reporting rules under section 6045 in a sale is the DeFi
participant that provides trading front-end services. Accordingly, an
exclusion for validation services--which are not trading front-end
services--is technically no longer necessary. Nevertheless, given the
strong concern expressed by members of Congress and others in the
industry that these ancillary services be excluded, the final
regulations retain this exclusion for validation services and expand it
to also include those services necessary to complete the validation. It
is intended that block building as well as the operation of
communication nodes would be included in the other services necessary
to complete the validation, and thus excluded from the definition of
effectuating services. Without expressing any view regarding the extent
to which the other services raised by the comments are analogous to
these validation services, the Treasury Department and the IRS have
determined that it is not appropriate to expand the exclusion from the
definition of effectuating services for validation services any
further. First, as noted, the exclusion is not necessary now that
trading front-end services are the only DeFi services that are treated
as effectuating services. As long as these other services do not fit
within the definition of trading front-end services, they will not be
treated as effectuating services under the final regulations. Second,
the list of services that are not trading front-end services is
potentially infinite and can change over time. It is not practical or
appropriate to draft a list of all the services within the DeFi
industry that do not fit within the definition of trading front-end
services.
Several comments argued that the proposed carve-out for validation
services is too narrow because it would be limited to persons
``solely'' engaged in the business of providing distributed ledger
validation services. These comments argued that the exclusion should
remain available even for persons who are engaged in more than one
trade or business or providing more than one type of service. Another
comment pointed out that, as drafted, the carve-out seemingly would not
apply to persons conducting validation services only as a hobby or
without a profit motive. One comment recommended that the exclusion
instead be based on the functions or services conducted with respect to
the transaction. Another comment requested additional examples to
clarify the circumstances in which validation services would be
considered facilitative services.
The Treasury Department and the IRS agree that the carve-out for
validation services should not be limited to persons that are
``solely'' engaged in the business of performing such services. Rather,
the intent of the carve-out was to exclude validators from reporting on
sales for which they provide validation services unless those
validators also performed other services with respect to those same
sales that would be treated as effectuating services. Accordingly,
final Sec. 1.6045-1(a)(21)(iii)(C)(1) provides that providing
distributed ledger transaction validation services (whether through
proof-of-work, proof-of-stake, or any other similar consensus
mechanism), including those services necessary to complete the
validation, are not an effectuating service under final Sec. 1.6045-
1(a)(21)(i). Additionally, an example is added at final Sec. 1.6045-
[[Page 106952]]
1(b)(24) to illustrate that the exclusion applies only to the
validation services provided. It does not apply when validators also
perform trading front-end services because those validators must report
sales carried out as a result of those trading front-end services.
Thus, if a validator, as part of its ordinary course of a trade or
business, provides trading front-end services with respect to a sale
for a customer and thereafter also validates that sale (likely without
even knowing that validated block included the customer's sale), the
validator would be required to report on the sale as a result of
providing the trading front-end services notwithstanding that the
validator also validated the sale.
IV. Multiple Broker Rule
The proposed regulations did not extend the multiple broker rule
under Sec. 1.6045-1(c)(3)(iii) of the pre-TD 10000 regulations to
digital asset brokers, but instead asked for comments regarding the
best way to apply a multiple broker rule. Comments overwhelmingly
requested that the final regulations implement a multiple broker rule
applicable to digital asset brokers to avoid burdensome and confusing
duplicative reporting. In response, TD 10000 added a multiple broker
rule under Sec. 1.6045-1(c)(3)(iii)(B) that applies if more than one
digital asset broker effects the same sale. Under that rule, the broker
crediting the gross proceeds to the customer's wallet address or
account (the crediting broker) must report the transaction to the IRS.
The other broker can generally avoid reporting if it obtains proper
documentation from the crediting broker that the crediting broker is a
U.S. digital asset broker. The preamble to TD 10000 also indicated that
the Treasury Department and the IRS are continuing to study the
question of how a multiple broker rule would apply to the non-custodial
(DeFi) digital asset industry.
Many comments pointed out that a customer engaging in any DeFi
transaction may use the services of many DeFi participants, including
interface providers, wallet software providers, and DeFi protocols. To
the extent the final regulations deem all of these DeFi participants to
be brokers, their overlapping reporting obligations would create
duplicate reporting and unnecessary compliance costs. Because these
final regulations treat only trading front-end service providers as a
broker and because only one front-end service provider translates the
customer's trade order details into coded trade order instructions,
there should generally be only one DeFi participant that is a broker
under section 6045(c)(1)(D) in a DeFi transaction. The Treasury
Department and the IRS are not aware of multiple broker fact patterns
in which more than two types of brokers could be involved in a DeFi
sale. If such a case did exist, however, the existing multiple broker
rule in Sec. 1.6045-1(c)(3)(iii)(B) would apply to ensure that only
one of the two brokers report on the transaction. Further, the Treasury
Department and the IRS intend to issue a notice of proposed rulemaking
that will propose examples illustrating how the existing multiple
broker rule would apply to transactions like this that are effected by
both a front-end service provider and a custodial broker to obtain
comments from the public regarding the application of the existing
multiple broker rule in Sec. 1.6045-1(c)(3)(iii)(B) to such
transactions.
V. Comments Based on Constitutional Concerns
A. Major Questions Doctrine
Several comments alleged that the proposed regulations, if
finalized, would raise major questions doctrine concerns under West
Virginia v. EPA, 597 U.S. 697 (2022).\25\ One comment alleged that the
IRS ``literally has no power to act . . . unless and until Congress
confers power upon it,'' La. Pub. Serv. Comm'n v. FCC, 476 U.S. 355,
374 (1986), and that Congress's use of the term ``broker'' did not
authorize the IRS to impose onerous requirements on every person
tangentially involved in cryptocurrency or other digital assets. The
comment claimed that the proposed regulations, if finalized, would
eliminate DeFi transactions and fundamentally transform non-custodial
wallet services and that Congress withheld that authority from the
Treasury Department and the IRS even though Congress amended section
6045 to allow for broker reporting on digital asset transactions.
Another comment claimed that the Treasury Department and the IRS should
be especially careful not to encroach on Congress's policymaking power
in light of the ongoing congressional debate about how digital assets
should be treated and regulated and the economic importance of the
digital asset industry. The comment alleged that amended section 6045
does not provide any clear congressional authorization that could give
the IRS the right to dictate important policy decisions about digital
assets.
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\25\ The major question doctrine is a canon of construction that
bars agencies from resolving questions of ``vast economic and
political significant'' without clear statutory authorization.
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The Treasury Department and the IRS do not agree that these final
regulations are prohibited by the major questions doctrine. The major
questions doctrine is only implicated when an agency claims an
extraordinary grant of regulatory authority based on ``modest words,''
``vague terms,'' or ``subtle devices,'' and the ``history and the
breadth'' of the agency's asserted power provide a reason to hesitate
before concluding that Congress meant to confer such authority. West
Virginia v. EPA, 597 U.S. at 721 and 723.
Section 80603 of the Infrastructure Act made several changes to the
broker reporting provisions under section 6045 to clarify the rules
regarding how certain digital asset transactions should be reported by
brokers. These clarifications are not mere ``modest words,'' ``vague
terms,'' or ``subtle devices.'' Section 6045(c)(1)(D) provides that a
broker includes ``any person who (for consideration) is responsible for
regularly providing any service effectuating transfers of digital
assets on behalf of another person.'' As discussed in Part II. of this
Summary of Comments and Explanation of Revisions, this statutory
language extends to treating DeFi industry participants as brokers.
Further
[…truncated; see source link]Indexed from Federal Register on December 30, 2024.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.