Cryptocurrency Tax Update: Irs Offers New Cryptic Guidance
| Publication year | 2020 |
| Author | By Ken Harvey & Kali McGuire |
By Ken Harvey & Kali McGuire1
On October 9, 2019, the Internal Revenue Service ("IRS") released long-anticipated cryptocurrency transaction characterization and reporting guidance in the form of Revenue Ruling 2019-24 ("the Revenue Ruling") and a 43-item "Q&A" style guide ("the Q&A")2 The guidance arrives concurrently with many crypto investors receiving letters from the IRS requesting information related to their crypto transactions. The IRS guidance may prove useful for taxpayers who seek confirmation about the validity of prior reporting positions and guidance about documenting anticipated crypto transactions. Many unanswered questions nevertheless still remain.
Taxpayers had previously relied on five-year-old Notice 2014-21 ("the Notice")3 for basic characterization guidance for cryptocurrency transactions. The Notice asserted the IRS's position that cryptocurrency was considered to be "property" in the hands of the taxpayer and would receive treatment as a capital asset for U.S. tax purposes. Accordingly, as a capital asset, crypto would not be treated as a form of fiat currency or money. The Notice, while fairly basic, was the only authority or guidance available to taxpayers and tax advisors for five years until the release of the Revenue Ruling and the Q&A. The Revenue Ruling builds on the basic concepts provided in the Notice by providing guidance on "hard forks," "air drops," and additional technical matters, such as valuation and tax basis.
The Revenue Ruling defines a "hard fork" as a split in cryptocurrency existing in the distributed ledger as a result of a protocol change.4 In other words, a hard fork is a change in the blockchain due to the creation of a new, distinct, and separate cryptocurrency. Often a hard fork is accompanied by what the IRS refers to as an "airdrop." Essentially, an airdrop is the creation of new units of the new cryptocurrency created by the hard fork, and the distribution of these units to taxpayers who also hold the original cryptocurrency, usually in a pro-rata fashion. Not every hard fork, however, is accompanied by an air drop.5
Under the Revenue Ruling, a holder of cryptocurrency recognizes taxable income from a hard fork and/or an airdrop if the taxpayer has "dominion and control" over the new units of cryptocurrency. To illustrate the principle of dominion and control, the Revenue Ruling provides two fact patterns resulting in two different conclusions. In the first example, a hard fork occurs, but the subject taxpayer does not receive any of the new cryptocurrency (i.e., no airdrop). The Revenue Ruling concludes that the taxpayer does not realize taxable income under section 61 because there is no "accession to wealth."6
In the second example, the taxpayer does receive new and assessable crypto assets as a result of a hard fork. The taxpayer realizes income under section 61 because there is an accession to wealth; the taxpayer receives a valuable asset that presumably has a saleable value. As the Revenue Ruling explains, the ability of the taxpayer to dispose or transfer the new asset resulting from an airdrop provides the taxpayer with dominion and control over the new cryptocurrency, and therefore the taxpayer recognizes ordinary income in that year. The basis of the airdropped coin is the fair market value of the airdropped coin the moment it is recorded on the distributed ledger.7
The question of "dominion and control" therefore determines whether the taxpayer derives income from an airdrop. Under the Revenue Ruling, a taxpayer will not have dominion and control over cryptocurrency where the exchange holding the taxpayer's wallet does not support the new cryptocurrency resulting from the airdrop.8 While a taxpayer may not have dominion and control over airdropped cryptocurrency not supported by their exchange, the Revenue Ruling provides that a taxpayer has constructive receipt over cryptocurrency...
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