Information Reporting on Digital Assets Steps Into the Spotlight
The looming prospect of compliance with the reporting requirements in section 6050I has been a problem for the digital asset industry since the passage of the Infrastructure Investment and Jobs Act (P.L. 117-58) last November. The requirements pose procedural obstacles and privacy concerns for taxpayers, but the government has an interest in ensuring compliance with the tax laws.
The revised version of section 6050I requires taxpayers engaged in a trade or business to file an information return when they receive $10,000 or more in digital assets in one transaction or two or more related transactions in the course of that trade or business. The information required is the name, address, and tax identification number of the person from whom the assets were received; the amount of the assets; and the date and nature of the transaction. The provision was originally designed for cash transactions.
The brief push for legislative repeal of the crypto-related portions of the infrastructure bill last year never stood a great chance. The new proposal by Sens. Cynthia Lummis, R-Wyo., and Kirsten E. Gillibrand, D-N.Y., includes an instruction to the IRS to write guidance implementing the changes to section 6050I. (Prior analysis: Tax Notes Federal, June 20, 2022, p. 1834.) The Responsible Financial Innovation Act is crypto- and taxpayer-friendly on the whole, suggesting that at least two senators who are interested enough in ensuring that the digital asset industry has a favorable regulatory environment in the United States to sponsor comprehensive legislation aren’t looking to repeal the expansion of section 6050I.
That appears to be something of a trend. The Keep Innovation in America Act (H.R. 6006), introduced in November 2021, would have only delayed implementation of the section 6050I reporting requirements until 2026. But it would have required the IRS and Treasury to study the effects of including digital assets in the scope of the reporting regime, including the effects on “the privacy and liberty rights and interests of taxpayers and other persons affected.” Such a comprehensive study of the cryptocurrency industry and possible legislative design ramifications is a good idea.
Also last November, Sen. Ted Cruz, R-Texas, introduced S. 3206, which would have repealed the information reporting requirement, along with the change to the definition of broker in section 6045. He explained that he wanted Congress to study the digital asset industry more carefully before legislating because “when it comes to legislating in an area where most Members of this body have very little familiarity of the details, it is highly perilous.” Cruz pointed to the technical difficulty that digital asset industry participants may have in getting the information required under section 6050I, and suggested that aggressive enforcement could decimate the digital asset industry, in a Joint Economic Committee hearing on November 17.
A recent case highlights the pressing need for Congress to be more circumspect in its attempts to regulate both the digital asset industry and the digital privacy of Americans more generally. Coin Center, along with Dan Carman, Raymond Walsh, and Quiet Industries Corp., filed a suit on June 10 to stop enforcement of the infrastructure bill’s expansion of section 6050I’s reporting requirement for digital assets, arguing that it is facially unconstitutional under the First, Fourth, and Fifth amendments.
In Carman v. Yellen, No. 5:22-cv-00149-KKC (E.D. Ky. 2022), the plaintiffs allege that the requirement “would force the disclosure of sensitive information in violation of their reasonable expectations of privacy and their property rights.” The complaint also says that it would threaten to expose the plaintiffs’ protected associations and thereby chill their expressive activities.
As an example of the breadth of information that the reporting requirements could reveal, the complaint notes that “from one [section] 6050I report in 2024, the government could discover that a person donated to a local mosque in 2016, paid for a son’s sobriety treatment in 2018, contributed to an unpopular political cause in 2020, and hired a marriage counselor in 2022.” Absent the information reporting, the government typically needs a warrant for a cryptocurrency address to make those types of connections. “Extending [section] 6050I to digital assets would not meaningfully assist the IRS’s administration of the income tax,” the complaint argues.
At the November 2021 JEC hearing, Peter Van Valkenburgh of Coin Center explained that although the Bank Secrecy Act passed constitutional muster because the third parties who bear the reporting requirements hold private information that has been voluntarily given to them for a legitimate business purpose, there’s no third party in the section 6050I context. Accordingly, he said the third-party doctrine cannot render a warrant unnecessary for the collection of information such as Social Security numbers. That argument is reflected in the Carman complaint. “One of the central stated goals of cryptocurrency is to allow transactions without the intermediary institutions that implicate the third-party doctrine, such as banks and telephone companies,” the complaint says.
The Carman plaintiffs’ first argument is that the reporting requirement constitutes an unreasonable search in violation of the Fourth Amendment. “Digital asset users have developed and adopted a technology designed to preserve personal agency and protect enhanced privacy in transactions, which entitles them to an enhanced expectation of privacy,” the complaint states. The response to the complaint will likely address the legitimacy of the government’s interest in getting the information it seeks about transactions in digital assets. There should be some mechanism to allow the government to enforce the tax and other laws. How to do that when there’s no obvious intermediary from whom to require information reporting on specific transactions is a broader debate that was exemplified last year in the expansive proposal for financial account information reporting.
The Carman complaint cites opinions concerning the privacy implications of various laws, including an opinion from Supreme Court Justice Lewis F. Powell Jr. in 1974 that explains, “Financial transactions can reveal much about a person’s activities, associations and beliefs. At some point, governmental intrusion upon these areas would implicate legitimate expectations of privacy.” The problem is that the justices and judges who wanted to recognize that line weren’t writing the majority opinions.
First Amendment Claim
The Carman complaint highlights one of the central privacy issues of the digital age in its First Amendment claim based on freedom of association. The plaintiffs might have difficulty succeeding with this argument in court, because their claim that “the inviolability of privacy in associations means that Americans presumptively enjoy a right against reporting mandates” is hard to square with the other reporting requirements in the tax code. They might stand a better chance of finding a sympathetic ear in Congress with their other argument that “truly private associations have become the last refuge of Americans fearful of the consequences of engaging in public life.”
Part of the challenge here is that financial activities, even in decentralized forms, aren’t exclusively expressive. Sometimes financial choices are just that — business transactions that have no particular First Amendment implications. Many of them, if exposed, wouldn’t reveal expressive associations so much as everyday financial decisions. That could implicate privacy concerns generally, but whether you ordered a book from a huge online retailer or a small local shop doesn’t necessarily implicate freedom of association.
The argument is that by forcing disclosure of transactions that aren’t necessarily expressive, the government could use the information gleaned from them to uncover expressive transactions as well. Once the government knows how to identify an individual on the public ledger from disclosure of a large transaction, it can find all the smaller transactions too. The trade or business limitation is insufficient because many contributions to advocacy groups would fall within the course of a trade or business, the complaint notes.
The ability to easily produce a full picture of the financial choices of taxpayers because of advances in technology can’t be ignored when considering the impact of seemingly limited reporting regimes. That should now be a universal consideration in the development of reporting requirements, although Congress doesn’t seem to be up to speed with the relevant technology.
Space for Congress to Act
By highlighting critical modern privacy issues, the complaint provides an opening for their further consideration in the development of reporting regimes. Congress should do its share here, rather than leaving the questions entirely to the courts. Still, this case will be important to watch because it could offer insight into how the courts might view a proposal like the one from the Biden administration last year to require broad financial account reporting. The contexts are different — digital assets versus bank accounts — but the arguments about transactional privacy have enough similarities that they could be a preview should that type of proposal be revived.
The Carman complaint notes that “the third-party doctrine is restricted to the sharing of information that provides a ‘limited’ view of a person’s affairs, not a detailed mosaic.” In the financial account reporting regime, the $600 threshold for gross inflows and outflows, or even a slightly higher one, would likely have created a situation in which the “limited” collection of individual information, when aggregated across all accounts and individuals, would have offered a detailed picture.
The plaintiffs have a worthy and serious point about Congress’s near-total disregard for individual privacy, but that failure isn’t new, and it isn’t limited to digital assets. Protection of digital privacy in the United States is almost entirely absent, leaving those concerns to be addressed by what amounts to a privacy-exploding scheme based on a facade of consent. But the appropriate venue for this broader debate is the legislature.