The SEC is pursuing an aggressive enforcement stance to bring the crypto industry under its regulatory purview. This strategy has sparked controversy and fostered confusion among industry players. The SEC has done a tremendous amount in their ongoing efforts to protect investors and enforce our securities laws. The IRS culture is almost entirely one of accommodation and cooperation, emphasizing guidance. Marcin Kowalczyk, a blockchain regulatory analyst based in Poland, said that the SEC has much to learn from the IRS’s approach. Such lessons might pioneer innovation while simultaneously holding the crypto wild west accountable to regulatory guardrails.

The SEC's primary tool has been litigation. The agency’s moved from warnings and phishing scams to actual lawsuits against crypto companies, exchanges, and individuals. Their aim is to illuminate the regulatory path forward and establish key precedents. This approach has led to years-long legal disputes, putting many players in a state of limbo. It’s no surprise that companies such as Coinbase, Ripple, and Celsius have all dedicated millions of dollars to legal fees. They are resolute in trying to understand and iron out the convoluted regulatory landscape. This reactive approach, albeit ambitious, has arguably hampered innovation and pushed some companies out of the country.

The IRS says it is committed to providing taxpayers with clear guidance. This is to help them fulfill their new obligations under tax laws concerning digital assets. The IRS provides specific guidance on the tax treatment, record-keeping needs, and reporting requirements. It accomplishes this through issuing public notices, revenue procedures, and chief counsel advice. This proactive approach empowers individuals and businesses to understand their responsibilities and avoid unintentional non-compliance. Through an emphasis on data sharing and collaboration, the IRS creates a more mutually beneficial partnership between the tax collecting agency and those in the crypto industry.

Those diverging approaches are a product of the underlying imperatives of each agency’s mandate. The SEC's primary focus is on securities laws and investor protection, while the IRS is primarily concerned with tax compliance and revenue collection. The SEC’s enforcement-first strategy has already drawn fire for creating a climate of fear and ambiguity. This overly cautious approach would hamstring the crypto industry’s potential for growth and innovation.

Contrasting Regulatory Philosophies: SEC vs. IRS

Yet the SEC remains committed to a vigorous enforcement-first approach. They adopt this approach primarily to dissuade perpetrators from committing fraud and other nefarious acts within the crypto marketplace. The first strategy is the most popular, and it’s about catching companies that you think have violated securities laws. This means cracking down on those that provide unregistered securities or misleading information. Yet, despite the SEC’s great intentions, its approaches have faced criticism for being too aggressive and lacking sufficient clarity.

The IRS has taken a much more flexible view. Understanding the novelty and complexity of digital assets, the agency prioritized guidance and support for taxpayers. We release guides breaking out how to properly calculate and report taxes on crypto transactions. In addition, we offer support for all taxpayers who have questions or issues. By emphasizing understanding and partnership, the IRS hopes to promote voluntary compliance and reduce the chances of accidental mistakes.

One major difference between the two agencies in their approach to transportation innovation is the way they engage with industry. The SEC has not shown much willingness to adapt their frequently oppositional approach to the crypto industry. On the other hand, the IRS has taken extensive steps to proactively seek input from stakeholders. You’ll conduct listening sessions with business stakeholders. … You further will help organize conferences and workshops and prepare requests for public comment on proposed agency regulations. The IRS has been actively engaging with the industry to discuss the challenges and opportunities that crypto businesses are navigating. This connection helps the agency create better and more workable regulatory solutions.

IRS Guidance: A Model for Crypto Regulation?

So far, these key pieces of guidance have come from the IRS. These initiatives are excellent examples of its commitment to provide guidance and assistance to taxpayers who engage in the crypto economy. These examples provide a roadmap for how the SEC could adopt a more collaborative approach to regulating the crypto industry.

  • Tax treatment of virtual currency transactions (Notice 2014-21): This notice provides guidance on the tax treatment of virtual currency, such as Bitcoin, for federal income tax purposes. It clarifies that virtual currency is treated as property, and that general tax principles applicable to property transactions apply to transactions using virtual currency.
  • Reporting requirements for digital asset transactions (Final Regulations 2024-07-09): The US Department of the Treasury and IRS issued final regulations providing guidance on tax reporting requirements applicable to certain decentralized finance (DeFi) platforms operating as “brokers” of digital assets.
  • Guidance on allocating basis in digital assets to wallets or accounts (Revenue Procedure 2024-28): This revenue procedure provides guidance on how to allocate basis in digital assets to wallets or accounts. It allows taxpayers to choose between two options: Specific Unit Allocation and Global Allocation, providing flexibility in accounting methods and reducing the administrative burden of meeting safe-harbor requirements.
  • Notice 2023-27: The IRS treated certain NFTs as collectibles, indicating collaboration with the crypto industry to understand and address tax implications of digital assets.
  • Chief Counsel Advice (CCA) 202302011 PDF: The IRS provided guidance on the applicability of IRC section 165 to cryptocurrency that has declined in value, showing collaboration with the crypto industry on tax-related issues.

Each of these examples illustrates how the IRS is really on the side of taxpayers. Their recommendations provide pragmatic and easily understandable guidance on challenging new questions related to digital assets. By taking the approach laid out above, the SEC could encourage more compliance and innovation in the crypto industry.

Safe Harbors and Voluntary Disclosure: Tools for Collaboration

The SEC can also drive innovation and guarantee compliance, by following the same kind of strategies used by the IRS and Treasury. For instance, they can take action by creating voluntary disclosure programs and safe harbor provisions. Such tools could offer an avenue for crypto companies to atone for past indiscretions and usher in a new era of compliance with changing regulatory expectations.

Voluntary Disclosure Agreement (VDA) Program

Through this program crypto companies would be incentivized to self-disclose any history of non-compliance with securities laws in return for lower penalties or other beneficial treatment. Here’s how it could work:

  1. Define the scope of the program: The SEC could specify which types of non-compliance are eligible for the program, such as failure to register a crypto token or non-compliance with reporting requirements.
  2. Set clear guidelines for participation: The SEC could establish clear guidelines for companies that want to participate in the program, including the information that must be disclosed and the process for submitting a disclosure.
  3. Offer incentives for participation: The SEC could offer incentives for companies that participate in the program, such as reduced penalties, avoidance of enforcement actions, or other benefits.
  4. Administer the program: The SEC could administer the program through its existing enforcement or compliance functions, or it could create a new office or department to oversee the program.

Safe Harbor Provisions

Specific safe harbor provisions should be articulated to offer transition relief to crypto innovators, helping them adjust to new regulatory requirements in a safe and reasonable timeframe. Revenue Procedure 2024-28 increases flexibility and consistency with accounting method rulings. It decreases the impact of administrative burden and implements temporary relief from FIFO accounting requirements.

  • Transition relief: Safe harbor provisions, such as those outlined in Revenue Procedure 2024-28, provide transition relief to crypto innovators, allowing them to adapt to new regulatory requirements, like tracking crypto cost basis on a wallet-by-wallet (or exchange-by-exchange) basis.
  • Flexibility in accounting methods: The safe harbor provision allows taxpayers to choose between two options: Specific Unit Allocation and Global Allocation, providing flexibility in accounting methods and reducing the administrative burden of meeting safe-harbor requirements.
  • Temporary relief from FIFO accounting: The relief postpones the requirement that mandated crypto exchanges default to first-in, first-out (FIFO) accounting methods for capital gains calculations, giving innovators time to adjust to new regulations.
  • Simplified record-keeping: By taking specific actions, such as moving all digital assets into one account or selling all digital assets held by a custodian, innovators can simplify the process of meeting safe-harbor requirements and reduce record-keeping burdens.
  • Protection from penalties: Safe harbor provisions can protect crypto innovators from penalties and fines associated with non-compliance, providing a level of certainty and stability in an evolving regulatory landscape.

By diving headlong into these collaborative tools, the SEC can become more efficient, effective protectors of investors. Simultaneously, they can promote positive innovation among the crypto sector.

This enforcement-heavy approach has undermined innovation and created uncertainty in the crypto industry, resulting in a negative impact on the SEC’s key mission to protect investors. By drawing inspiration from the IRS's collaborative and guidance-focused methods, the SEC could foster a more constructive relationship with the industry, encouraging compliance while promoting responsible innovation. With clear guidelines and effective voluntary disclosure programs, we can reinvigorate the crypto ecosystem. Supplementing these provisions with safe harbor provisions will go even further to promote sustainability and growth.

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