Executive Summary
Following the implementation of the new IRS Form 1099-DA in 2025, centralized cryptocurrency exchanges will face an unprecedented shift in tax reporting requirements, expected to generate 8 billion new forms annually. Additionally, digital asset service providers must navigate an increasingly complex maze of evolving international tax compliance regulations. This article explores the changing regulatory landscape and examines the implementation challenges. It provides strategic guidance for digital asset service providers preparing for this transformation.
Introduction
From the issuance of multiple “John Doe” summons starting in 20161 seeking the identities of U.S. taxpayers who conducted transactions in cryptocurrency to today, compliance is no longer an afterthought for the crypto industry. After years of regulatory inaction, the crypto compliance environment is now experiencing seismic changes. With the adoption of Form 1099-DA in 2025, the current volume of 5 billion information returns that the IRS currently receives is predicted to balloon to include a staggering 8 billion 1099-DA forms annually resulting in the IRS receiving and processing 13B annual information returns overall2.
The Regulatory Tsunami Approaches
While the tax compliance environment for the crypto industry will change significantly over the next few years, the IRS has adopted a phased approach3. Beginning with reporting 2025 transaction reporting on new Form 1099-DA in 2025, exchanges that custody crypto assets for their customers must report gross proceeds from the sales they effectuate involving digital assets. To avoid penalties and withholding tax obligations, centralized exchanges must also match taxpayer identification (TIN) numbers to the IRS database of names and TINs, which means confirming that the TIN a business or individual provided matches the information on file for that taxpayer in the IRS database. For 2026 transactions, the environment shifts significantly, with the IRS requiring cost-basis tracking for every asset bought and sold on a custodial broker platform and reporting on Form 1099-DA in 2027.
“The government knows centralized exchanges can report gross proceeds– many of them were reporting gross proceeds on Form 1099-K until the new 1099-DA regulations were released. So that's why this year, for 2025, exchanges are required to report gross proceeds amounts, and they get another year to report the cost basis details for transactions in 2026,” says Wendy Walker, VP of Regulatory Affairs at Sovos.
Changes are also occurring outside the United States regarding the reporting and taxation of crypto transactions. For example, the Organisation for Economic and Cooperative Development (OECD) Crypto-Asset Reporting Framework (CARF) aims to make reporting crypto-asset-related transactions between tax authorities easy and transparent. The European Union (EU) member countries adopted DAC7 and DAC8 to support this effort, based on the OECD framework and designed to ensure regional exchanges' compliance.
Not to be outdone, individual states within the United States are developing their crypto tax reporting requirements. The IRS has added state income tax and withholding boxes on the new Form 1099-DA, which signals that the agency plans to share that state tax information with participating states in the Combined Federal State Filing (CF/SF) program. However, many states do not participate in the CF/SF; even when they do, they still require additional direct filing of information outside the federal program. This adoption by the states will inevitably lead to format variations and filing system disparities that may or may not disappear over time.
Core Implementation Challenges
Given the shifts taking place in the regulatory environment, exchanges face four primary challenges. The first is volume management. Crypto is bought and sold in fractional amounts –8+ decimal places – so the transaction volumes are exponential compared to traditional stock and bond trading. Exchanges handle billions of trades per month. Capturing and reporting these transactions will require additional data processing requirements and robust solutions to store and retrieve them as needed. “It is not unheard of to have an active trader on a platform be eligible to receive thousands of 1099-DA forms for each trade. The difference maker for many centralized exchanges is how they will normalize that transaction data and turn it into consumable tax information for their customers and for filing with the IRS and states.”
Verifying the identity of customers is also a pressing problem due to the inherent challenges of managing the collection and processing of Forms W-8 and W-9. The information provided by the payee on these complex tax forms is supposed to translate into information that gets reported on the 1099-DA by the centralized exchange. Additionally, the information on those forms dictates whether backup withholding tax is required, and these complexities must be factored into any new approach to tax compliance.
Although not required until 2026, cost-basis tracking presents another pressing problem. Exchanges will need systems that can ingest transaction details, create tax lots within a ledger for each trader, and track the dates assets were purchased and sold to determine the associated cost-basis and, ultimately, calculate correct gains and losses for tax purposes. This process is complicated by cross-platform transfers, historical data requirements, and the challenges of managing and reporting transactions across multiple jurisdictions. “I could buy Bitcoin today. I could buy more Bitcoin in a week. I could buy ETH in two weeks. If I do all three of those things, whatever centralized exchange I'm buying on is required to keep tax lots of the details – they are required to track how much I bought the Bitcoin and ETH for on each respective day and the dates I bought them, and how much and what type of crypto assets I bought,” says Walker. “If I transfer the ETH to another platform and then ultimately sell it, that new exchange has no idea what I purchased it for or when I purchased it – so they would not have the information they need to accurately determine cost basis and calculate gains and losses for that subsequent sale.”
Finally, the operational impact cannot be overlooked. Tax reporting in this new age will require additional resources, process creation and optimization, and stakeholder coordination, which can stretch an exchange’s resources and provide an unwelcome distraction from the primary focus of providing a marketplace for crypto transactions.
Technology as the Compliance Cornerstone
While the changes in the regulatory environment in the United States and abroad present significant challenges, the right technology solutions can drastically reduce the impact. End-to-end solutions can integrate data from disparate systems, improve data flow management, and aid in process automation, which can do much to minimize the impact of onerous tax reporting requirements. Scalability, API capabilities, and robust security standards are also critical to reducing the regulatory burden and must form the core of any platform.
Some exchanges may find themselves considering whether to build versus buying tax solutions. Building an in-house solution will significantly increase the demand for internal resources in tax, technology, operations, and customer service. The IRS and state filing requirements will continue to evolve significantly over the next several years imposing significant costs to organizations to research and keep up with the changing requirements in various jurisdictions. These changes will require organizations that build their own solutions to develop ongoing technology projects to deploy constant product changes and manage the annual testing processes with the IRS and states to be able to file.
Strategic Recommendations
So, how should exchanges prepare for the upcoming tax compliance environment? Immediate actions include identifying key organizational stakeholders who must participate in tax compliance and adopting dedicated technology to facilitate the most onerous parts of the reporting and withholding processes. A technology assessment of existing solutions and their ability to support future tax reporting and withholding compliance is also critical.
Should these assessments uncover gaps, developing technology partner selection criteria, their experience, technical capabilities, and support services is next. This is followed by an implementation strategy, including a phased approach, efforts to mitigate risk, and corresponding success metrics.
Conclusion
As the crypto industry is undergoing a transformation in how it records and reports transactions for tax-related purposes, getting it right quickly is of the utmost importance. For those who do, a competitive advantage is likely to emerge. With changes currently taking place in the United States at both the state and federal levels and set to expand into Europe soon, being prepared and having the right technology partner will prove to be critical.
1 Court Authorizes Service of John Doe Summons Seeking the Identities of U.S. Taxpayers Who Have Used Virtual Currency, https://www.justice.gov/opa/pr/court-authorizes-service-john-doe-summons-seeking-identities-us-taxpayers-who-have-used
2 IRS Prepping for at Least 8 Billion Crypto Information Returns, https://www.taxnotes.com/featured-news/irs-prepping-least-8-billion-crypto-information-returns/2023/10/25/7hhdp
3 Treasury, IRS issue final regulations requiring broker reporting of sales and exchanges of digital assets that are subject to tax under current law, additional guidance to provide penalty relief, address information reporting and other technical issues; https://www.irs.gov/newsroom/treasury-irs-issue-final-regulations-requiring-broker-reporting-of-sales-and-exchanges-of-digital-assets-that-are-subject-to-tax-under-current-law-additional-guidance-to-provide-penalty-relief-address
