The Compliance Era: How Tax Regulation Is Reshaping Web3 | Patrick Camuso - Camuso CPA

I'm not from US so didn't know if it's tax season is now but apparently it is. So we're going to talk about compliance and tax regulation impacting crypto with Patrick. All right.

Thank you. So my name is Patrick Kamuso. Can you hear me? Okay.

Is that better? My name is Patrick Kamuso. I am the managing director of Kamuso CPA and what I want to talk about today is how tax regulation is reshaping web 3 and we're really entering a new era of digital assets which I call the compliance era. So for the past decade plus crypto transactions have existed with limited visibility for tax agencies and regulators and the market is maturing. You could even see that by some of the previous speakers and some of the things that they've discussed up here.

You know, the market is maturing and self-reported compliance and the level of non-compliance that exist from a tax perspective is not sustainable as we move forward. So, what we're going to see is the integration of digital assets and web 3 into existing reporting regimes. And what I want to focus on here today is form 1099DA, which some of you may have received those just this week. But I also want to point out that form 1099 day DA is not isolated. This is part of a broader trend of different regulatory focuses across stablecoin legislation, global coordination, as well as many different tax proposals that are going to reshape web 3.

So digital assets are taxed as property and this has serious implications to anybody that's transacting in them. Firstly, anytime you acquire a digital asset, you have to track the cost basis in that. You have to calculate this yourself. Similarly, when you dispose or sell of an asset, you have to track the proceeds associated with that sale. And then you have to match the cost basis based off of the correct tax slot to that transaction to calculate your capital gains.

What makes crypto unique to other assets is two factors. One, there's really no standardized reporting for digital assets before the 1099DA came out. So there's really no standardization of this reporting. The second is that blockchains are public immutable ledgers for the most part, but they don't record the relevant tax data that you need to report these transactions appropriately with the appropriate audit trails from tax classification to lot continuity to your identity and what jurisdiction you're operating in and the list goes on. This is all constructed through accounting processes and tax reporting offchain.

And what we're seeing again are very large non-compliance rates. The IRS has cited up to a 75% non-compliance rate. So the majority of these transactions up to this point are not being reported properly. And as the market becomes more and more irrelevant and continues to grow more, this just isn't sustainable and the level of non-compliance makes this third party reporting inevitable for digital assets. So we've reached the turn turning point as I mentioned.

Many of you may have received your 1099DA this week or you may be in the future. And what the 1099DA is is a new IRS information reporting form that requires digital asset brokers to report the transactions directly to the IRS. So for 2025, it's mainly going to be reporting report reporting proceeds data and then as we go into subsequent years for covered assets, it's going to also be reporting cost basis data. Although there may be gaps in this which we'll discuss, the big takeaway here is that the IRS now receives transaction data independent of what the taxpayers reporting. And they're going to be able to now match this independently source data to what the taxpayers reporting and put it into the tax systems, including the automated matching system, which will allow them to detect discrepancies much more quickly and much more systematically.

So, why is why is um I don't know what's wrong with that slide there. Sorry. Why is um what are some of the challenges with tax reporting for digital assets? You're dealing with three sets of records that all are not designed to reconcile properly. You start with your onchain transactions and your exchange records which are not standardized and then you have to calculate these in a tax software that has divergent treatment depending on the tax software you use, the protocols you're interacting with and what your overall activity looks like on chain.

And now these two systems have to now reconcile on your tax return to what's being reported on form 1099DA. So what I'm anticipating are, you know, some implementation challenges and one of the implementation challenges is the coverage gap because right now this current reporting regime only replies only applies to custodial environments. It doesn't cover Dexes and non-custodial environments. So there's going to be gaps where certain transactions can be e economically similar or even identical and one gets reported and one doesn't get reported based off of where the transaction takes place or or which assets are are traded and what type of transaction it is. Additionally, there's there's also the risk of basis fragmentation and a much harder reconciliation for taxpayers when they're moving from custodial environments to non-custodial environments because starting in 2025, we're on a wallet by wallet, account by account tracking for your cost basis.

So once you move from custodial or non-custodial or vice versa, that basis lineage breaks and it's going to be the burden is going to be placed on the taxpayer to reconcile that data and report it appropriately. And this gets magnified more with people that have maybe been in this space for the past 5 to 10 years. And I know this firsthand, a large amount of people have not gotten up to compliance, have not accurately calculated their basis for digital assets. This creates a longer tale challenge for you know in the future when you dispose of these legacy assets that may not have full basis details you're going to have compliance issues related to that and you as the taxpayer are going to have to reconcile that. So we're starting to see this third party information reporting come out but there still is not full coverage and there's a lot of variability in terms of how taxpayers and practitioners treat certain assets.

This is going to further compound the problem when you're talking about your basis calculations as well as your proceeds calculations. Think bridges, wrapped assets, staking, even even pricing that gets applied to certain transactions especially in thinly traded markets. Even you know new new forms of transactions and assets like we're seeing prediction market contracts. These can all have divergent treatment among taxpayers and practitioners. And then the differences in methodology are going to potentially lead to compliance issues as this starts to come out in third party reporting.

So this is not isolated just to the United States. So form 1099DA is US focused. But we also have the crypto asset reporting framework referred to as KARF which is going to be imp implemented internationally across many many tax jurisdictions. And that framework's outside of the scope of this conversation here. But the big takeaway is is that these transactions are becoming visible to tax authorities across the world.

And those tax authorities are also going to be through these through these processes systematically sharing that information with each other. So there's going to be much more visibility overall into these cryptocurrency transactions. So what does this mean for you as a builder and as a founder? So your protocol design has always impacted accounting compliance and tax reporting, but your users are likely to be much more focused on this as we move forward. And you know how you design your protocols.

There's downstream tax classification, compliance, basis tracking considerations to this. And the builders that can design predictable transactions that reduce compliance risk and build their protocols in a way where it's compliance aware can start to gain a competitive advantage where they may choose to use your protocol over another protocol. For you as a founder and you as an individual taxpayer, your transaction footprint is going to be increasingly sitting in these environments that are going to be reported on by third parties. And any issues with your cost basis tracking, with your methodologies that you're applying to calculate your cost basis, to calculate your proceeds, tax positions you're taking with certain assets. These are going to become increasingly visible.

Your documentation and methodology have always mattered, but they're going to be put under a magnifying glass now as these inconsistencies are able to become more externally visible through this third party reporting. So, what is the next phase to this? It's unlikely that this is going to stop at the 1099D. As I mentioned, there's already a lot of potential compliance friction and reconciliation friction based off of where reporting is going to be covered and where it's not going to be covered. And as we start to see this play out this year and in subsequent years, that compliance friction is going to be felt industrywide, I believe.

And when you know we start to feel that compliance friction and we start to deal with the cost associated with that the way markets usually respond is to redesign the systems. So this type of friction is reduced and the way that this can be done here is through integrated onchain reporting systems to where these transactions that are happening on chain. The tax relevant data that is necessary for tax reporting will be captured at the protocol or at the transaction level on the blockchain and potentially stream directly to tax tax agencies for tax reporting. And this can start to reduce the variability in tax outcomes for different taxpayers who may be reporting differently or may not be reporting at all. So there's going to be a lot of friction as we move through the compliance era and this is really just the start of it.

The layer one friction I already touched on a bit. We're going to see enforcement capacity scale through form 1099DA and automated matching and the broker reporting. And you know taxpayers are going to have to really focus on have they calculated their cost basis with the right methodologies? Are there proceeds in information that they've calculated? Is that matching up to form 1099DA?

And to the degree that there's discrepancies, have you documented why there's these discrepancies and able to defend them in an audit? And are you applying the correct methodologies to even calculating this? Because there's a lot of divergence just in terms of wallet bywallet tracking and other considerations that largely impact basis. But there's the second layer as well to where when we start looking at the potential for onchain reporting systems, you know, this is going to be a deeply debated topic. It already has been in the past to a certain degree, but questions start to arise.

How far should tax reporting extend into decentralized environments? What role should onchain identity play in these transactions onchain and in the tax reporting associated with it? and how are we going to reduce blind spots in reporting onchain transactions without completely stifling innovation or sacrificing privacy on chain. So these are going to be questions that are extremely important and there's a third layer to this reshaping of web 3 from a tax perspective and that's the policy layer. So you know there's many different legislative proposals in various stages right now related to taxation of digital assets and this layer can determine a lot of the structural boundaries that are going to dictate how how this industry forms for the next decade.

So questions around when and how will staking be taxed when will wrapping transactions will those be taxed? Should wash sales apply to digital assets? the list of questions go on and these are conversations that are being discussed right now and attempting to be solved from a policy level and it's going to deeply impact the industry. So to wrap this up overall digital assets are becoming a market that is too big to ignore. It's systematically relevant to the financial system and to the industry in general.

And that type of market maturity starts to drive integrated reporting to reduce these compliance issues. And as we start to see this get rolled out, compliance is going to reshape the market design and also the behavior of the of all the market participants. So the decisions made now are going to define how web 3 global financial systems integrate into the global financial system. It's going to decide how web 3 integrates into the global financial system. And you know builders that understand this and can design for compliance and can also protect their companies and their own bottom lines are the ones that are going to be successful in the digital asset compliance era.

So, I appreciate everybody listening and um you know, I'll be here in the back for a little bit if anyone wants to uh discuss this in more detail.