The U.S. Internal Revenue Service (IRS) has issued long-awaited guidance on the tax treatment of cryptocurrencies. It is generally described by the crypto community as a mixed bag since some parts are useful while others have raised many more questions, particularly how cryptocurrencies from hard forks and airdrops are taxed.
Also read: 10 Tax Tools to Help Crypto Owners
New Crypto Tax Guidance
The IRS has finally issued the long-promised follow-up guidelines on the tax treatment of crypto assets. The agency’s new guidance, published Wednesday, includes Revenue Ruling 2019-24 and 43 frequently asked questions (FAQs).
“The new revenue ruling addresses common questions by taxpayers and tax practitioners regarding the tax treatment of a cryptocurrency hard fork,” the IRS explained, adding that the accompanied “set of FAQs address virtual currency transactions for those who hold virtual currency as a capital asset.” The new guidance supplements Notice 2014-21, issued in 2014, in which the agency “applied general principles of tax law to determine that virtual currency is property for federal tax purposes,” the IRS detailed.
Hard Forks and Airdrops
While the IRS has clarified some issues, there are many more questions the new guidelines have raised. One heavily-discussed area the new guidance tries to address is how hard forks are treated. The agency states that “If a hard fork is followed by an airdrop and you receive new cryptocurrency, you will have taxable income in the taxable year you receive that cryptocurrency,” adding:
When you receive cryptocurrency from an airdrop following a hard fork, you will have ordinary income equal to the fair market value of the new cryptocurrency when it is received … provided you have dominion and control over the cryptocurrency so that you can transfer, sell, exchange, or otherwise dispose of the cryptocurrency.
However, there is still the question of what constitutes receipt of that new coin. Peter Van Valkenburgh, director of research at Coin Center, commented: “That means that anyone who forks a blockchain can, without warning or notice, create new tax obligations for every holder of coins on the old chain. The same goes for airdrops. Any time someone airdrops a coin to an address over which you have dominion and control, they will create a tax reporting obligation on your part. This is a very bad result.” In other words, he noted that just having private keys to any cryptocurrency would trigger an income event if a third party forked its blockchain.
More Unanswered Questions
Following the publication of the new IRS guidance, many crypto enthusiasts flooded social media with feedback and more questions, particularly regarding hard forks and airdrops. Van Valkenburgh further pointed out the problem of how the IRS described the two events: “It suggests that some hard forks come with airdrops and some do not. However, airdrops and hard forks are distinct and unrelated terms that the IRS seems to be conflating.”
Marco Santori, Chief Legal Officer of Blockchain, shares a similar sentiment. “Sadly, it [the guidance] seems to confuse the two, assuming that airdrops and forks often occur at the same time or are otherwise functionally related,” he tweeted, highlighting a number of unanswered questions. For example, he pondered, “If there was hard fork at all relevant to ‘your’ crypto, then under what circumstances would you not ‘receive’ crypto?”
Santori also questioned the tax treatment of forks that occur when some custodians do not support the new chain. “The custodian’s customer does not know the keys. They owned the original coins but will not ‘receive’ the forked coins until or unless the custodian supports the new chain,” he wrote:
The bleak reality is likely that IRS drafted this guidance with a purely custodial mindset. It assumes that we all have accounts with custodians that hold our crypto for us.
Casa CTO Jameson Lopp also commented in response to the new guidance. “Today’s IRS guidance is a hot mess,” he tweeted before raising several points of concern, such as “What if you have keys but no software from which to spend the asset?” Lopp additionally asked: “What if you never sell or transfer the asset and it drops 90% in value?” and “What’s the value if the asset isn’t even trading at the time of fork?”
As for soft forks, the IRS confirmed that they “will not result in any income” to taxpayers since no new cryptocurrency is received.
Vamshi Vangapally, cofounder of cryptocurrency software provider Bear.tax, shared some thoughts with news.Bitcoin.com. From a tax preparation point of view, he emphasized that “No income needs to be reported in case you don’t receive a new coin after [a] hard fork.” The cofounder continued: “The value of a new coin (if received) will be the FMV [fair market value] at the time of the issue … If the coin you own has no published value, then value = value of goods/services exchanged.” News.Bitcoin.com recently provided a list of 10 useful tax tools to help crypto owners with tax filing.
Accounting Methods and Other Important Points
Sean Stein Smith, a professor at the City University of New York’s Lehman College who serves on the Advisory Board of the Wall Street Blockchain Alliance, explained what the guidance says about accounting methods for cryptocurrencies. For taxpayers who “have information linked to the date and time that the specific unit was acquired, the cost basis and fair market value of that unit at the time of acquisition, the time and date information of when this specific unit was sold, and the fair market value of the specific unit when it was sold,” they can “account for these transactions under a specific identification method,” he described. “Otherwise, the FIFO [first-in, first-out] method of accounting should be used.”
David Kemmerer, CEO of tax reporting software Cryptotrader.tax, concurs. “Previous to this guidance, it wasn’t clear whether specific identification would be allowed at all due to the transferable nature of digital assets,” he opined, elaborating:
We now see that FIFO should be the standard costing method used if you are unable to specifically identify where your cryptocurrencies are at all times. This doesn’t come as a surprise as a similar approach is taken with other forms of property like stocks.
Exchanging Crypto for Other Property
The new guidance also addresses using and making payments with cryptocurrency. Using cryptocurrency held as a capital asset to pay for goods and services or exchange for other property, including other cryptocurrencies, will result in a capital gain or loss. “If you transfer property that is not a capital asset in exchange for virtual currency, you will recognize an ordinary gain or loss,” the IRS clarified.
Vangapally emphasized that the new guidelines put “More emphasis on fair market value (FMV) based on the timestamp of the transactions,” adding:
Paid in crypto is considered income and should be reported as income by FMV of crypto on that date … Paying for services or goods using crypto results in a capital gain or loss.
The IRS explained that the cost basis “is the amount you spent to acquire the virtual currency, including fees, commissions and other acquisition costs in U.S. dollars.” Vangapally added that for crypto gifts, “To calculate gain, the purchase price of a gifted coin is [the] donor’s basis plus gift tax. If it’s a loss, the purchase price will be lesser of the donor’s basis or the fair market value.”
IRS Reminds Crypto Users to Pay Taxes
With the publication of the new guidance, the IRS is soliciting public input on additional guidance in this area as well as reminding crypto users of their tax obligations.
The tax agency claims that it is “aware that some taxpayers with virtual currency transactions may have failed to report income and pay the resulting tax or did not report their transactions properly,” adding that it is “actively addressing potential non-compliance in this area through a variety of efforts, ranging from taxpayer education to audits to criminal investigations.”
The tax agency has been ramping up efforts to remind crypto users to pay their taxes, such as sending letters to more than 10,000 taxpayers in July “who may have reported transactions involving virtual currency incorrectly or not at all,” the IRS reiterated. “Taxpayers who did not report transactions involving virtual currency or who reported them incorrectly may, when appropriate, be liable for tax, penalties and interest. In some cases, taxpayers could be subject to criminal prosecution.”
What do you think of the new IRS crypto guidance? Let us know in the comments section below.
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