Casner & Edwards

Client Alert: IRS Provides First Guidelines for Cryptocurrency Tax Treatment Since 2014

By: Katie L.S. Von Kohorn

Rev. Rul. 2019-24

On October 9, 2019, the Internal Revenue Service (IRS) issued new guidance on the tax treatment of virtual currency, including cryptocurrency. Revenue Ruling 2019-24 focuses on the tax treatment of a cryptocurrency “hard fork,” while a new “frequently asked questions” (FAQs) publication includes guidance on basis, gain/loss, and fair market value.

Up to now, the IRS’ only guidance on cryptocurrency had been issued in 2014, and took the position that cryptocurrencies are not fiat currencies, like US dollars, but rather “capital assets,” like stocks, meaning that capital gains rules apply to any gains or losses in the value of cryptocurrency held by US taxpayers.

This Revenue Ruling provides answers to two questions:

  1. Does a taxpayer have gross income as a result of a “hard fork” of a cryptocurrency the taxpayer owns, if the taxpayer does not receive units of a new cryptocurrency?; and
  2. Does a taxpayer have gross income as a result of an “airdrop” of a new cryptocurrency after a hard fork, if the taxpayer receives units of new cryptocurrency?

Taking a step back, a “hard fork” in a cryptocurrency occurs when a blockchain ledger, which is used to record transactions in a cryptocurrency, undergoes a protocol change and “forks,” or splits, into two, such that a new cryptocurrency is created. Following the hard fork, transactions in the new cryptocurrency are recorded on a new ledger, while the previous ledger continues to be used to record transactions in the old cryptocurrency. For example, on August 1, 2017, the ledger for Bitcoin underwent a hard fork, and every owner of 1 Bitcoin received 1 Bitcoin Cash as a result of the hard fork, resulting in separate ledgers for Bitcoin and Bitcoin Cash.

An “airdrop” is a method of distributing units of a cryptocurrency to the distributed ledger addresses of multiple taxpayers. If a hard fork is followed by an airdrop, units of the new cryptocurrency are distributed to addresses containing the legacy (former) cryptocurrency, as in the case of Bitcoin Cash, above. However, hard forks are not always followed by airdrops, and taxpayers may not actually or constructively receive cryptocurrency when an airdrop is recorded on the distributed ledger.

The Revenue Ruling makes clear that (1) the taxpayer does not have income as a result of the hard fork if the taxpayer does not receive units of the new cryptocurrency, and (2) the taxpayer does have gross ordinary income if, as the result of an airdrop following a hard fork, the taxpayer receives units of a new cryptocurrency. The taxpayer will have gross income at the time he or she “acquires the ability to transfer, sell, exchange, or otherwise dispose of the cryptocurrency.”

This guidance may create unintended tax problems for holders of cryptocurrency. For instance, anyone who creates a hard fork in a blockchain can now, without notice, create new tax obligations for every holder of coins on the legacy blockchain. Similarly, if a third party airdrops a coin to an address over which a taxpayer has “dominion and control,” that taxpayer now has a potentially unwanted tax reporting obligation. Taxpayers may worry about hackers maliciously airdropping unwanted coins in order to create reporting obligations, or receiving a new cryptocurrency from an airdrop without realizing it or requesting it. For example, earlier in 2019, cryptocurrency exchange Coinbase distributed a new currency, Bitcoin SV, to all of its customers who owned Bitcoin; those individuals received taxable income as a result. Depending on how the new currency’s value fluctuates, this may result in taxpayers having to pay income tax on an asset that was worth more when they received it than when they sell the asset.

The IRS provides more details about basis and income in the FAQs. As established in 2014, capital gains rules apply to any gains or losses on the sale or transfer of virtual currency. However, if you transfer virtual currency from a wallet, address, or account that belongs to you, to another wallet, address, or account that also belongs to you, then the transfer is a non-taxable event, even if you receive an information return (like a Form 1099) from a cryptocurrency exchange as a result of the transfer. You may also choose which units of cryptocurrency are deemed to be sold, exchanged, or disposed of if you can specifically identify which unit or units of virtual currency are involved in the transaction and substantiate your basis in those units (so you may, for example, choose LIFO or FIFO; if no specific method is chosen, the IRS’ default is FIFO).

If you receive cryptocurrency in exchange for performing services, whether or not you perform the services as an employee, you will be deemed to have received taxable income. Cryptocurrency received by an independent contractor for performing services constitutes self-employment income and is subject to the self-employment tax. The amount of income is based on the value of the cryptocurrency at the time of receipt in US dollars. However, if “that cryptocurrency is not traded on any cryptocurrency exchange and does not have a published value, then the fair market value of the cryptocurrency received is equal to the fair market value of the property or services exchanged for the cryptocurrency when the transaction occurs.”  Please note that the IRS does not provide any guidance in the FAQs on how to determine fair market value in this situation.

Taxpayers may also donate cryptocurrency to a charitable organization and may take a charitable deduction equal to the fair market value of the cryptocurrency on the date of donation (provided that the taxpayer held the cryptocurrency for more than one (1) year).

Most importantly, the FAQs make clear that taxpayers are required to maintain detailed records to establish positions taken on tax returns. Unfortunately, this can be difficult when dealing with cryptocurrency, particularly given the prevalence of fraudulent exchanges in this area (such as Quadriga, Bitgrail, etc.). Taxpayers will need to document all of their receipts, sales, exchanges, or other dispositions of cryptocurrency and its fair market value in US dollars at the time of each transaction.

Please feel free to contact the members of the Tax and Private Client Group at Casner & Edwards with any questions on this IRS guidance.

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