**The Current State of the IRS Broker Rule**
In the final days of the Biden administration, the IRS finalized its controversial Broker Rule, which mandates that all cryptocurrency exchanges—whether custodial or non-custodial, and for both fiat-to-crypto and crypto-to-crypto transactions—implement Know-Your-Customer (KYC) measures for their users. This regulation clarifies that custody of funds is not a requirement for an entity to be classified as a broker by the IRS. Consequently, “DeFi front-end services” are now required to report trading activities to the IRS using the 1099 tax form.
The rule encompasses developers of user interfaces, including “screens, buttons, forms, and other visual elements” found in websites, mobile apps, and browser extensions that facilitate trading of digital assets in unhosted wallets. The IRS asserts that these developers exert a degree of “control” over the services they provide, even without taking custody of the coins or having the ability to influence the underlying protocols. This aligns with the guidance from the Financial Action Task Force (FATF), which categorizes developers of user interfaces as Virtual Asset Service Providers, subject to anti-money laundering and counter-terrorism financing regulations.
The broker rule defines control as the ability to modify or significantly impact the terms of service, collect fees from transaction flows—regardless of whether fees are actually collected—and the capacity to add instructions to query the distributed ledger to confirm order execution.
In response to what many view as an overreach—given that control over funds has traditionally been a prerequisite for financial service regulation according to FinCEN guidance—the cryptocurrency industry acted swiftly. The day after the rule’s publication, the Blockchain Association filed a lawsuit against the IRS and the Treasury Department, seeking to have the rule invalidated before it takes effect. The lawsuit claims that the rule is unconstitutional and contradicts existing federal laws.
Additionally, Senator Ted Cruz introduced a joint resolution to disapprove of the IRS rule, co-sponsored by Senators Cynthia Lummis, Bill Hagerty, Mike Lee, and Tim Scott, among others. Cruz stated, “This regulation undermines the purpose of DeFi technology: to enable individuals to freely buy, sell, and exchange digital assets.” Representative Corey also supported this resolution, emphasizing the need to protect the principles of decentralized finance.
