This is a guest post from Andrea Pretorian
For the first time since 2014, the IRS released two new pieces of guidance—Revenue Ruling 2019-24 and frequently asked questions (FAQs)—on October 9, 2019, indicating how taxpayers should proceed when it comes to reporting and paying taxes on virtual currency.
Fundamentally decentralized, cryptocurrency has no single official body directly responsible for regulating it—and so frequently it ends up standing at the intersection between fiat money and assets. In the United States, the IRS is the single biggest establishment player that “touches” crypto with rules, since failure to comply can lead to penalties or even incarceration.
Releases like this one from the IRS can have a significant impact on the decisions that cryptocurrency holders will make in handling their property. This week’s release has generated a lot of buzz.
What was new in this release?
The IRS primarily addressed the case of hard forks, where a new branch appears in the blockchain protocol and does not recognize old blocks and transactions. Hard forks most commonly arise when a new spin-off cryptocurrency comes about (e.g. Bitcoin Cash from Bitcoin), or when Ethereum created a hard fork to reverse the DAO hack.
The release indicates that once the new fork appears, the taxpayer has a new tax obligation tied to the new fork. The taxpayer has to have “dominion and control” over the currency, meaning they have to be able to transact with it, which is technically true regardless of whether the taxpayer stores this cryptocurrency in an exchange or in a private wallet.
This release also addressed airdrops, and specifically noted that not all hard forks should be considered as airdrops. Essentially, it is only when a hard fork results in new currency that this should be reported as gross income; and per the IRS’ release, this can occur via airdrop and result in a new tax liability.
The new IRS release generates a new set of questions.
One-size-fits-all rules are a challenge within the widely varied world of crypto. This release by the IRS has generated even more questions about how to handle various situations that may arise, even within the context of a hard fork. The biggest questions center around how to treat the “old” currency:
- How do you determine value of the old and new coins?
- What if the coin is in a private wallet?
If the coin is in an exchange and not a wallet, the exchange will declare the new and old coins and note whether new assets—and therefore new tax obligations, as clarified under this release—were created.
But if the coin is held in a private wallet, demonstrating this can get tricky. While Q27 of the release tries to answer the question of how individuals can determine a cryptocurrency’s fair market value if there is no published one, this can get tricky since cryptocurrency doesn’t carry intrinsic value.
People frequently turn to wallets with private keys for increased security, and so they will not welcome added layers of complication to wallet ownership.
While public buzz notes that the IRS recognizes actions taken in good-faith, this does not necessarily assuage the fears of a public seeking clarity and security that they will not be penalized, particularly if any further changes arise in the future.
How has the release been received?
The release’s reception could perhaps best be summarized by the CCN headline, “IRS Tries, Fails to Explain Your Crypto Tax Liabilities After a Hard Fork.” Twitter was set ablaze with reactions to this ruling from everyone in the cryptocurrency and blockchain community, who were overall disappointed with the release.
One recurring sticking point has to do with the way the release handles airdrops, and how value is taxed even before the value is truly recognized—such as by a sale. ConsenSys’ legal expert Matt Corva likened it to oil: “If I discover oil is on my property, I don’t recognize income (thereby forcing me to set up a mining operation to extract it to offset my tax burden).” Instead, he recommends the same for both oil and crypto airdrops: “no tax until manipulated.”
Another contention with this release has to do with how this tax guidance could be used as a weapon by one exchange against another. If an exchange were to hard fork a cryptocurrency and then use a bit of capital to inflate the “fair market value,” this would create a new, unforeseen tax liability for those holding the original cryptocurrency—including other exchanges.
According to Cointelegraph and Blockonomi, this particular release came as a result of the Congressional Blockchain Caucus’ request for clarity on how to report cryptocurrencies for tax purposes. It will be interesting to see what further clarifications, if any, will be requested over time.
The IRS is maintaining high visibility in their attempts to educate the public, having even sent out letters to taxpayers who may have filed incorrectly. As a result, the IRS might have a stronger case for the prosecution of noncompliant taxpayers.
Author Bio: Andrea Pretorian is Content Manager over at BitIRA, leaders in digital IRA set-up and management