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software code are not carrying out broker than paid to the protocol itself. Thus, it the broker definition referenced decen-
activities.” may be difficult for Treasury to make the tralized exchanges and peer-to-peer mar-
case that a DEX is receiving consider- ketplaces. For its part, Treasury does not
Decentralized finance protocols ation, which is another requirement for seem to have ruled out DeFi reporting,
The traditional cost basis reporting broker status. stating in its recent letter that it would
framework relies on persons with knowl- On a more practical level, it is not “consider the extent to which other par-
edge of the cost basis and gross proceeds clear how requiring DEXs to provide ties in the digital asset market, such as
of transactions to report cost basis and cost basis information to users could centralized exchanges and those often
gross proceeds information to their cus- be implemented or enforced. Again, described as decentralized exchanges
tomers and to other brokers in the event there typically are no real people who and peer-to-peer exchanges, should be
of a transfer. One of the more unusual own a DEX who could be encouraged treated as brokers. …”
aspects of the cryptoasset market is its to comply by the threat of penalties for
decentralized network and smart con- noncompliance. It is also noted that, al- Diabolical details
tract capabilities. These have allowed the though changes can be made to a DEX, Although there are some encouraging
creation of a burgeoning “decentralized it typically requires the holders of gov- signs from Treasury, there still exists con-
finance” (DeFi) ecosystem, where parties ernance tokens to agree to the change. siderable uncertainty as to the nature and
transact peer-to-peer using “decentral- It may be difficult to secure sufficient scope of the cost basis reporting rules
ized exchanges” (DEXs). Unlike the tra- support to implement a cost basis report- as they apply to digital assets. The devil
ditional stock and securities exchanges, ing infrastructure into a DEX, given the will be in the details, and, hopefully, the
in a digital asset transaction carried out importance of anonymity to many users. forthcoming guidance will take a mea-
on a DEX, software code — not a person One could imagine, however, a sured approach and consider the unique
or legal entity — stands between the scenario in which Treasury and other nature of the digital asset markets.
parties to the transaction. Although this regulators could create a framework of Provisions of the Infrastructure Act will
software was developed by people, it is adverse tax consequences for payments require brokers to monitor cost basis for
usually decentralized and is not “owned” made through a DEX so as to (1) induce digital assets acquired on or after Jan. 1,
in the traditional sense. DEX token holders to adopt reporting 2023, and report for tax year 2023 at the
The definition mentioned above of a procedures when there are significant beginning of 2024. Given the extremely
digital assets broker as “any person who U.S. participants; or (2) incentivize a short time frame for implementation,
(for consideration) is responsible for U.S. participant to seek out DEXs that Treasury should also consider delaying
regularly providing any service effectuat- provide reporting. In other information the implementation of digital asset cost
ing transfers of digital assets on behalf of reporting areas, for example, an absence basis reporting, particularly for market
another person” creates significant tech- of information could lead to presumption participants that might have reasonably
nical hurdles to requiring DEXs to pro- rules that require withholding or taxation expected they would not be subject to
vide cost basis reporting information. As at the highest applicable rate. the requirements.
defined, a broker is a “person.” The term Notwithstanding the significant From Pete Ritter, J.D., LL.M., San
“person” is broadly defined for purposes roadblocks to DeFi reporting on both Francisco; Joshua Tompkins, CPA,
of the Code by Sec. 7701(a)(1) to include a technical and practical level, it is not Minneapolis; and Hubert Raglan, LL.B.,
an individual, trust, estate, partnership, yet clear that DeFi will be exempted. LL.M., Detroit
association, company, or corporation. Admittedly, a cost basis reporting regime
However, even that expansive definition that excludes DeFi transactions would
does not include software. Assuming a exclude a sizable portion of cryptoasset State & Local Taxes
DEX is not classified as a business entity transaction volume and might fall short
(e.g., a partnership), it is not clear that of the improved tax compliance that Tennessee taxation of
DeFi protocols, as nonpersons, could be Congress envisioned. Also, it should passthrough entities
required to report transactions under the be noted that DeFi was not specifically Tennessee’s entity classification rules
new statutory framework. addressed as an area that should be ex- only partially conform to the federal
It also bears noting that DeFi pro- cluded from reporting in previous public entity classification rules. An insufficient
tocols typically do not charge any fees statements by members of Congress, and understanding of the rules, like a little
to users — the fees that are charged are in an early draft of the Infrastructure Act knowledge, can be dangerous to taxpay-
either paid to liquidity providers or net- digital assets reporting amendments that ers when determining which entity
work fees paid to miners/stakers, rather was circulated to industry participants, has a filing responsibility in Tennessee.

www.thetaxadviser.com June 2022 21