✍️ Author: Davit Cho, Global Asset Strategist & Crypto Law Expert
π Verification: IRS Notice 2024-56, Notice 2024-57, Final Regulations TD 9961
π Published: January 11, 2026
π§ Contact: davitchh@proton.me
Form 1099-DA Penalty Relief 2026 — What the IRS Won't Tell You
The IRS buried penalty relief provisions deep in Notice 2024-56. Most taxpayers will never find them. Here's how to use them before April 15.
Figure 1: The IRS's new Form 1099-DA launches in 2026 with built-in penalty relief provisions that most crypto investors don't know exist—creating a narrow window for compliance without punishment.
π‘ Key Takeaways (30-Sec Summary)
- Penalty Relief Window: IRS waives penalties for 2025 transactions if brokers show "good faith" compliance efforts.
- FIFO Delay: Mandatory FIFO cost basis method postponed until 2026—you can still choose your accounting method for 2025.
- Backup Withholding Deferred: 24% backup withholding on crypto sales extended through 2026 under Notice 2025-07.
January 2026 marks a seismic shift in crypto taxation. For the first time, every major exchange must report your transactions directly to the IRS on Form 1099-DA. No more flying under the radar. No more "forgot to report" excuses. The era of crypto tax opacity is officially over.
But buried in the 300+ pages of IRS guidance lies something most taxpayers will never discover: comprehensive penalty relief provisions. The IRS knows this transition is messy. They know brokers aren't ready. They know cost basis tracking is a nightmare. So they built escape hatches—temporary relief that protects compliant taxpayers from punishment during this chaotic first year.
The problem? The IRS isn't advertising these provisions. They're buried in Notice 2024-56, Notice 2024-57, and scattered across multiple technical guidance documents. If you don't know where to look, you'll never find them. This article extracts every penalty relief provision, explains exactly how to qualify, and gives you the compliance roadmap to navigate 2026 tax season without fear.
In my view, this is the most important crypto tax article you'll read this year. Not because the rules are complex—they are—but because the relief provisions expire. Miss the window, and you're subject to full penalties. Use them correctly, and you buy yourself time to get compliant without financial punishment.
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π Strategic Blueprint
- π 1. What Is Form 1099-DA? The Basics Explained
- π‘️ 2. Notice 2024-56: The Hidden Penalty Relief Provisions
- π 3. FIFO Delay: Why Your Cost Basis Method Still Matters
- π° 4. Backup Withholding Deferral Through 2026
- π’ 5. Broker Reporting Requirements: What Exchanges Must Send
- ⚠️ 6. Common Mistakes That Void Your Penalty Relief
- ❓ 7. FAQ — 10 Critical Questions Answered
π 1. What Is Form 1099-DA? The Basics Explained
Form 1099-DA is the IRS's new standardized reporting form for digital asset transactions. Starting with tax year 2025 (filed in 2026), every crypto broker, exchange, and custodian must report your sales, exchanges, and dispositions directly to the IRS. This is the crypto equivalent of the 1099-B form that stock brokers have used for decades.
The form captures critical transaction data: the date of sale, gross proceeds, cost basis (starting 2026), and whether the gain or loss is short-term or long-term. For 2025 transactions reported in early 2026, brokers are only required to report gross proceeds. Full cost basis reporting kicks in for transactions occurring on or after January 1, 2026.
This represents a fundamental shift in IRS enforcement capability. Previously, the agency relied on voluntary compliance and occasional subpoenas to exchanges. Now, they receive automatic transaction data matching capabilities. If your tax return doesn't match your 1099-DA, expect a CP2000 notice—or worse, an audit flag.
The Infrastructure Investment and Jobs Act (IIJA) of 2021 mandated this reporting requirement, giving the IRS four years to develop the form and regulations. The final rules, published in Treasury Decision 9961, establish the framework that every crypto investor must now navigate.
| Tax Year | Reporting Requirement | What Brokers Report |
|---|---|---|
| 2025 (Filed 2026) | Gross Proceeds Only | Sale date, proceeds amount |
| 2026 (Filed 2027) | Gross Proceeds + Cost Basis | Full transaction details, gain/loss calculation |
| 2027+ (Filed 2028+) | Complete Reporting | All data including wallet transfers |
π‘️ 2. Notice 2024-56: The Hidden Penalty Relief Provisions
Notice 2024-56 is where the IRS buried the gold. This technical guidance document, released alongside the final regulations, contains comprehensive penalty relief provisions that most taxpayers and even many tax professionals don't know exist. Understanding these provisions could save you thousands in penalties during this transition year.
The core relief provision states that for transactions occurring in calendar year 2025 (reported in 2026), the IRS will not impose penalties for failure to file or furnish Forms 1099-DA if the broker can demonstrate "good faith efforts" to comply with the new requirements. This means brokers get a pass on technical errors, late filings, and incomplete data—as long as they tried.
But here's what matters for taxpayers: this broker-level relief flows downstream. If your exchange sends you an incorrect or incomplete 1099-DA, you can rely on that form in good faith without penalty exposure. The IRS explicitly states that taxpayers who receive forms with errors are not penalized for reporting based on the information provided—provided they didn't know the information was incorrect.
The relief also extends to backup withholding failures. Normally, brokers must withhold 24% on payments to customers who fail to provide valid TINs. Notice 2024-57 defers this requirement through 2026, giving both brokers and taxpayers additional runway to sort out compliance issues without immediate financial penalties.
π Market Reality Check
The practical reality is that most exchanges are scrambling. Coinbase, Kraken, and Gemini have publicly acknowledged challenges in implementing the new reporting requirements. Cost basis tracking for assets transferred between wallets remains technically difficult. The IRS knows this—which is why they built in these relief provisions. Smart taxpayers use this window to get compliant, document their good faith efforts, and avoid the penalty hammer that will fall harder in 2027.
| Relief Provision | What It Covers | Expiration |
|---|---|---|
| Broker Filing Penalty Waiver | Late/incorrect 1099-DA filings | Tax Year 2025 only |
| Good Faith Reliance | Taxpayer reliance on broker forms | Tax Year 2025 only |
| Backup Withholding Deferral | 24% withholding requirement | Through December 31, 2026 |
| FIFO Method Delay | Mandatory cost basis method | Until January 1, 2026 |
π 3. FIFO Delay: Why Your Cost Basis Method Still Matters
Figure 2: The IRS's phased implementation timeline for 1099-DA reporting requirements, showing the critical transition from gross proceeds-only reporting (2025) to full cost basis disclosure (2026+).
One of the most significant relief provisions concerns cost basis accounting methods. Under the final regulations, brokers would be required to use the First-In-First-Out (FIFO) method for calculating cost basis starting in 2025. FIFO assumes you sell your oldest coins first—which often results in higher taxable gains for long-term holders who bought at lower prices.
The IRS delayed mandatory FIFO implementation until January 1, 2026, giving taxpayers one additional year to use their preferred accounting method. This is massive for tax optimization. If you've been using Specific Identification (selecting which lots to sell) or HIFO (Highest-In-First-Out) to minimize gains, you can continue through the end of 2025.
For the 2025 tax year, this means you still have flexibility. If you sold Bitcoin at $95,000 and have lots purchased at $60,000 (2024) and $20,000 (2021), you can specifically identify the $60,000 lot to minimize your gain. Under mandatory FIFO, you'd be forced to use the $20,000 lot first—creating a much larger taxable event.
Starting January 1, 2026, this flexibility disappears for broker-reported transactions. Brokers must default to FIFO unless you provide specific identification instructions before the sale. The practical implication: if tax optimization matters to you, get your cost basis records organized now, and provide specific lot instructions to your exchange before executing trades in 2026.
| Method | How It Works | Tax Impact | 2025 Status |
|---|---|---|---|
| FIFO | Sell oldest coins first | Often higher gains | Optional (mandatory 2026+) |
| LIFO | Sell newest coins first | Often lower gains | Available for 2025 |
| HIFO | Sell highest cost first | Minimizes current gains | Available for 2025 |
| Specific ID | Choose specific lots | Maximum control | Available (requires documentation) |
π° 4. Backup Withholding Deferral Through 2026
Backup withholding is one of the most punishing IRS enforcement mechanisms—and crypto investors nearly faced it in 2025. Under normal rules, if you fail to provide a valid Taxpayer Identification Number (TIN) to your broker, they must withhold 24% of your gross proceeds and remit it directly to the IRS. For a $100,000 Bitcoin sale, that's $24,000 withheld immediately.
Notice 2025-07 extended the deferral of backup withholding obligations for digital asset sales through calendar year 2026. This means exchanges don't have to withhold that 24%—even if your TIN is missing or mismatched—giving both brokers and customers time to resolve identification issues without immediate cash flow consequences.
This relief is particularly important for international users of U.S. exchanges, customers who opened accounts years ago with incomplete information, and anyone who has changed their legal name or TIN since account creation. Without this deferral, millions of crypto users would face unexpected withholding on every sale.
The catch: this is a deferral, not an elimination. Starting January 1, 2027, backup withholding applies in full force. If your exchange is flagging TIN issues now, resolve them before the end of 2026. Once withholding kicks in, getting that money back requires filing a tax return and waiting months for a refund—cash flow you may need.
| Timeline | Backup Withholding Status | Action Required |
|---|---|---|
| 2025 | Deferred | None immediate |
| 2026 | Deferred (Final Year) | Verify TIN with all exchanges |
| 2027+ | Fully Enforced (24%) | Withholding on non-compliant accounts |
π’ 5. Broker Reporting Requirements: What Exchanges Must Send
Figure 3: Comparison of broker reporting obligations under the new 1099-DA regime—showing the phased implementation from gross proceeds only (2025) to full cost basis and gain/loss reporting (2026+).
Not all crypto platforms are created equal under the new rules. The IRS definition of "broker" determines who must file 1099-DA forms. Centralized exchanges like Coinbase, Kraken, Gemini, and Binance.US clearly qualify. They custody your assets, process your trades, and know your identity—making them natural reporting entities.
Decentralized exchanges (DEXs) and DeFi protocols occupy a grayer zone. The final regulations include provisions for "DeFi brokers"—front-end interfaces that facilitate trades—but enforcement mechanisms remain unclear. For 2025-2026, most DEX activity will likely escape 1099-DA reporting, though taxpayers remain responsible for self-reporting regardless of whether they receive forms.
What brokers must report for 2025 transactions (your first 1099-DA arriving in early 2026): gross proceeds from each sale or exchange. This includes crypto-to-crypto trades—swapping ETH for BTC is a taxable event reported on the form. Brokers are not required to report cost basis for 2025, though many will include it voluntarily if available.
Starting with 2026 transactions (reported in 2027), brokers must include cost basis for "covered securities"—assets acquired on or after January 1, 2023, on that same platform. Assets transferred in from external wallets or purchased before 2023 may show "N/A" for basis, leaving taxpayers responsible for tracking and reporting their own cost basis.
| Platform Type | 1099-DA Required? | Notes |
|---|---|---|
| Centralized Exchanges (CEX) | Yes | Coinbase, Kraken, Gemini, etc. |
| Custodial Wallets | Yes | If they facilitate sales |
| DEX Front-Ends | TBD (2027+) | Regulations pending enforcement |
| Self-Custody Wallets | No | No broker relationship |
| P2P Transactions | No | Self-reporting required |
⚠️ 6. Common Mistakes That Void Your Penalty Relief
Penalty relief isn't automatic. The IRS grants it based on "good faith" compliance—which means you can lose protection through carelessness, negligence, or willful disregard. Understanding what voids your relief is just as important as knowing it exists.
Mistake #1: Ignoring the Digital Asset Question. Form 1040 now includes a mandatory checkbox asking whether you received, sold, exchanged, or disposed of digital assets. Checking "No" when the answer is "Yes" is considered a false statement under penalty of perjury. Even if you qualify for penalty relief on reporting errors, lying on your return voids all protections.
Mistake #2: Failing to Report Known Income. If you received staking rewards, airdrops, or mining income that you know is taxable, not reporting it isn't covered by the 1099-DA penalty relief provisions. Relief applies to form filing issues—not to taxpayers who simply don't report income they know they owe.
Mistake #3: Intentionally Providing False Basis. When your exchange can't calculate cost basis (common for transferred-in assets), you must provide it yourself. Fabricating a higher basis to reduce gains is tax fraud—not a good faith error covered by relief provisions. Keep documentation: purchase records, blockchain timestamps, exchange statements.
Mistake #4: Missing Form 8949 Entirely. The 1099-DA flows to Form 8949 (Sales and Other Dispositions of Capital Assets). Even if your broker's form has errors, you must still file Form 8949 with your return. Penalty relief doesn't excuse you from filing—it protects you from penalties when you file with good faith reliance on broker data.
❓ 7. FAQ — 10 Critical Questions Answered
Q1: When will I receive my first Form 1099-DA?
Brokers must furnish 1099-DA forms by February 15, 2026, for tax year 2025 transactions. However, under transitional relief, forms may arrive later—some taxpayers might receive them after the April 15 filing deadline, requiring amended returns.
Q2: What if my 1099-DA has errors?
Report based on what you believe is correct, attach an explanation statement, and keep documentation of your actual basis. You qualify for good faith reliance protection if you used the broker's data reasonably and corrected obvious errors.
Q3: Does penalty relief apply to taxpayers or just brokers?
Both. Brokers get relief from filing penalties; taxpayers get relief from accuracy penalties when they rely in good faith on broker-provided information. The provisions work in tandem.
Q4: Is DeFi activity reported on 1099-DA?
Not yet for most protocols. The IRS has proposed regulations for DeFi brokers, but enforcement is delayed. You must still self-report DeFi income regardless of whether you receive a form.
Q5: Can I still use HIFO or Specific ID for 2025 transactions?
Yes. Mandatory FIFO doesn't begin until January 1, 2026. For 2025 transactions, you can use any consistent, reasonable method with proper documentation.
Q6: What is backup withholding and does it apply to me?
Backup withholding requires brokers to withhold 24% from sales if you haven't provided a valid TIN. It's deferred through 2026 for crypto—but verify your exchange accounts have correct tax IDs before 2027.
Q7: Do I need to report crypto-to-crypto trades?
Yes. Swapping BTC for ETH is a taxable event. Your 1099-DA will report the gross proceeds from each trade. You must calculate and report the gain or loss on Form 8949.
Q8: What if I transferred crypto between wallets?
Transfers between your own wallets are not taxable events. However, brokers may report them as potential dispositions. Keep records showing the transfer was to yourself—same cost basis carries over.
Q9: How long does penalty relief last?
Filing penalty relief applies to tax year 2025 only. Backup withholding deferral extends through 2026. Starting 2027, full enforcement begins with no transitional relief.
Q10: Should I file an extension to wait for late 1099-DAs?
Consider it if you expect multiple late forms. An extension gives you until October 15 to file—but pay estimated taxes by April 15 to avoid interest. File Form 4868 for an automatic 6-month extension.
⚠️ Legal Disclaimer
This article is for informational purposes only and does not constitute legal, tax, or investment advice. Tax laws are complex and change frequently. Consult a qualified tax professional for advice specific to your situation. LegalMoneyTalk is not a law firm or CPA practice.
Image Disclosure: Images are AI-generated for illustrative purposes and do not represent actual IRS forms or official government documents.
