The IRS Just Issued Its First Cryptocurrency Tax Guidance in 5 Years
The U.S. Internal Revenue Service (IRS) has published its first guidance in five years for calculating taxes owed on cryptocurrency holdings.
Industry members have been eagerly awaiting the update since May 2019, when IRS Commissioner Charles Rettig said the agency was working on providing fresh guidance. The agency’s 2014 guidance left many questions unanswered, and the
crypto market has grown more complex in the years since.
As expected, the guidance notice released Wednesday addresses: the tax liabilities created by cryptocurrency forks; the acceptable methods for valuing cryptocurrency received as income; and how to calculate taxable gains when selling cryptocurrencies.
Drew Hinkes, a lawyer with Carlton Fields and the general counsel to Athena
Blockchain, told CoinDesk that “from the tax collector’s standpoint, this is the right answer,” though Certified Public Accountant Kirk Phillips said he was surprised that the guidance basically only addressed forks.
Resolving a long-standing question, the guidance says new cryptocurrencies created from a fork of an existing blockchain should be treated as “an ordinary income equal to the fair market value of the new cryptocurrency when it is received.”
In other words, tax liabilities will apply when the new cryptocurrencies are recorded on a blockchain – if a taxpayer actually has control over the coins and can spend them.
The document reads:
“If your cryptocurrency went through a hard fork, but you did not receive any new cryptocurrency, whether through an airdrop (a distribution of cryptocurrency to multiple taxpayers’ distributed ledger addresses) or some other kind of transfer, you don’t have taxable income.”
James Mastracchio, a partner at Eversheds Sutherland, told CoinDesk that this applies when there is a distinctly different cryptocurrency as a result of the hard fork.
The IRS language might create more confusion, said Jerry Brito, executive director at Coin Center.
“While the new guidance offers some much-needed clarity on certain questions related to calculating basis, gains, and losses, it seems confused about the nature of hard forks and airdrops,” Brito told CoinDesk, adding:
“One unfortunate consequence of this guidance is that third parties can now create tax reporting obligations for you by simply forking a network whose coins you own, or foisting on you an unwanted airdrop.”
Individuals would be assessed income when they receive the asset, Hinkes said.
“Receipt is defined by ‘dominion and control’ … so it’s ability to transfer, sell,
exchange or dispose of the asset according to this guidance,” he said. “The fear is that someone maliciously airdrops and tags you with a giant liability. But [this] fear is a bit oversold because you would only be liable for new income based on the fair market value of the asset when received, and most forks don’t start out with a high valuation.”
Phillips said it was possible that an individual with an
ethereum wallet, for example, could receive an ERC-20 token from an airdrop without realizing it. Depending on how the token’s value fluctuates, this may result in them having to pay income tax on an asset that was worth more when they received it than when they sell the asset.
“This can happen when coins hit a high water mark of price discovery right after the airdrop event and the heavy selling could sink the price to a level from which is never recovers,” he said.
The issue has grown more salient in recent years, as fights over protocol changes caused rifts in various crypto communities, leading to splinter currencies like ethereum classic and bitcoin
Holders of the original bitcoin and ethereum could automatically claim a like amount of the new coins, raising the question of whether and under what conditions they would owe taxes on the windfall.
Now crypto holders and their accountants have a roadmap.