IRS issues new digital asset tax rules; industry groups sue

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The United States Internal Revenue Service (IRS) issued regulations requiring brokers to report digital asset transactions while expanding the definition of broker to include platforms such as decentralized exchanges (DEXs). Several industry lobbying groups filed a suit against the IRS and Treasury Department in response.

On December 27, the IRS—the Department of the U.S. Treasury responsible for tax collection and regulation—released new reporting rules classifying certain decentralized finance (DeFi) platforms as brokers and requiring them to disclose information about taxpayers involved in digital asset transactions. The brokers must also report their gross proceeds from digital asset sales. 

Once the rules take effect in 2027, decentralized finance (DeFi) platforms, such as decentralized exchanges (DEX), could be treated as brokers if they facilitate the exchange or sale of digital assets—whether through smart contracts or other means—and exercise sufficient control or influence on the transaction process.

“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,” the IRS document stated.

The agency estimated that between 650 and 875 DeFi brokers and up to 2.6 million taxpayers will be affected by the new regulations.

“Information reporting by DeFi brokers under section 6045 will lead to higher levels of taxpayer compliance because the income earned by taxpayers engaging digital assets transactions without a custodial broker will be made more transparent to both the IRS and taxpayers,” the IRS argued.

The new rules will take effect in 2027, but brokers—including those DeFi entities that newly fall under that category thanks to the amended rules—will need to begin collecting and reporting the necessary data for digital asset transactions starting in 2026.

Digital asset middlemen

Before the amendments to the tax rules, the definition of a “broker” included a dealer, a barter exchange, and a person who regularly acted as a “middleman” concerning property or services.

Specifically, “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.

Due to the questionable status of digital assets in the U.S., this definition left room for certain DeFi platforms to skirt the obligations associated with being classified as brokers, namely disclosing gross proceeds from asset sales, including information regarding taxpayers involved in the transactions.

The prospect of this latter point caused the most consternation in the often anonymous or pseudonymous digital asset industry, with requirements for personal information leading some to claim the information mandated by brokers would be difficult, or in some cases impossible, to collect.

However, the new tax rules removed any potential ambiguity around who in the digital asset space is a broker by the clause to the definition: “any person who is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.”

Any person or entity whose activities meet this description would henceforth be classified as a “digital asset middleman,” with the document going into further detail as to how one may fall into this new broker category.

According to the IRS, a digital asset middleman “provides a facilitative service,” in which the broker acts either as an agent or a counterparty in a digital asset sale. This includes 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.

This may seem to encompass a broad range of DeFi platforms, but the final regulation also stated that “the only DeFi participants that are treated as brokers […] are trading front-end service providers.”

In other words, the DeFi platform that will fall within the new definition of broker—and thus will be subject to the associated reporting requirement—are “front-end service providers” that facilitate transactions involving digital assets for customers, such as DEX platforms.

The IRS argued that this would “result in trading front-end service providers being able to provide to their customers the same useful information regarding gross proceeds as custodial brokers.” 

Backlash and lawsuit

Predictably, the new tax rules didn’t go down well with everyone in the digital asset industry. On the same day the new rules were published, the DeFi Education Fund, the Blockchain Association, and the Texas Blockchain Council—three blockchain technology advocacy and lobbying organizations—filed a joint lawsuit against the IRS and the Department of the Treasury.

“During the rule’s comment period, the public warned the IRS and Treasury that moving forward with the rule would cripple the digital asset industry. But the government ignored this feedback, leaving the digital asset sector with a rule that puts unlawful compliance burdens on software developers who build so-called “trading front-end services.” This midnight rule will stifle innovation and burden American entrepreneurs—if it stands,” the Blockchain Association argued in a press release announcing the suit.

Filed on December 27 with the U.S. District Court for the Northern District of Texas, the suit challenged the IRS and Treasury Department’s final “broker” rulemaking on the basis that it “exceeds the agencies’ statutory authority, violates the Administrative Procedure Act (“APA”), and is unconstitutional.”

“The IRS and Treasury have gone beyond their statutory authority in expanding the definition of “broker” to include providers of DeFi trading front-ends even though they do not effectuate transactions,” said Marisa Coppel, Head of Legal at the Blockchain Association.

“Not only is this an infringement on the privacy rights of individuals using decentralized technology, it would push this entire, burgeoning technology offshore.” 

However, in response to similar feedback and criticism provided during the consultation period for the new rules, the IRS insisted that the regulation “merely treats” DeFi like any other industry, claiming the rules have applied to brokers for over 40 years.

The agency added: “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.”

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