TAXLITIGATOR – Tax Controversy (Civil & Criminal) Report

In a recent Tax Notes article by Mary Katherine Browne (published December 31, 2024), the spotlight is on the cryptocurrency industry’s legal challenge to the IRS’s newly finalized decentralized finance (DeFi) broker reporting regulations. The article, titled “Crypto Industry Seeks to Strike Down DeFi Reporting Regs,” delves into the case of Blockchain Association v. IRS, where three DeFi advocacy groups allege that the regulations constitute an unlawful overreach by the government.

The final regulations, issued on December 27, 2024, expand the definition of a broker under Section 6045 to include front-end service providers in DeFi transactions. Critics argue that this interpretation imposes burdensome compliance obligations that are incompatible with blockchain technology’s decentralized nature.

Among the legal experts quoted in the article, Philipp Behrendt of Hochman Salkin Toscher Perez P.C. offered a critical perspective on the regulations’ implications. Behrendt described the IRS’s decision to classify front-end services as brokers as “surprising and bold,” noting that it deviates from traditional brokerage concepts.

“By attempting to impose a centralized reporting framework on inherently decentralized systems, the regulation undermines the core innovation of DeFi: the elimination of intermediaries,” Behrendt explained. He further warned that the rule threatens the viability of U.S.-based DeFi platforms, potentially forcing them offshore or out of business altogether.

Behrendt also pointed out the privacy concerns raised by the new rules. “Connecting personal identities to transactions on the blockchain, which are pseudonymous, would reveal vast troves of personal information to the world, including whom people bought digital assets from and sold them to,” he said.

The Tax Notes article highlights how the lawsuit challenges the regulations on several grounds, including statutory overreach and violations of the Fourth and Fifth Amendments. Behrendt emphasized that the recent Supreme Court decision in Loper Bright Enterprises Inc. v. Raimondo bolsters the plaintiffs’ case, as it curtails deference to regulatory interpretations of ambiguous statutes.

Behrendt finds it somewhat surprising that the lawsuit acknowledges that cryptocurrencies such as Bitcoin are “digital representations of value.” “This is somewhat surprising, given that the statutory language defining ‘digital assets’ as representations of value is not entirely clear. Cryptocurrencies, particularly non-stablecoins, usually do not represent anything; they have intrinsic value but do not inherently ‘represent’ value,” Behrendt said.

As legal battles shape the future of DeFi and digital asset regulation in the United States, the field of digital asset taxation is set to undergo further transformation under the new administration and ongoing legal challenges.

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For more information, please contact Philipp Behrendt at behrendt@taxlitigator.com