In October 2019, the IRS issued Revenue Ruling 2019-24, providing much-needed guidance on the treatment of specific taxable events associated with cryptocurrencies. The virtual world, akin to a complex web, presents challenges for those investigating transactions within it. Cryptocurrencies have become a focal point for revenue departments globally. Some jurisdictions have established regulations, while others continue to study their intricacies. This is true not only for tax departments but also for central banks worldwide.
Today, we’ll explore two cryptocurrency transactional events that may or may not generate a taxable event: hard forks and airdrops. Cryptocurrency transactions are usually recorded digitally in a distributed ledger (blockchain). Units may be coins or tokens, and there is no central data administration function. Blockchain technology records and synchronizes transactions in multiple locations simultaneously.
Hard Forks
A hard fork occurs when a cryptocurrency undergoes a protocol change, resulting in a permanent divergence from the existing ledger. This creates a new cryptocurrency on a new ledger. Transactions with the new crypto are recorded on the new ledger, while transactions involving the older crypto continue to be recorded on the old ledger.
Airdrops
An airdrop is a method of distributing units of a cryptocurrency to the ledgers of multiple individuals.
Understanding the Tax Implications
When a hard fork results in the creation of a new cryptocurrency, the new currency must be distributed to the individual’s ledger address so they have control over it and can use it. Let’s assume the taxpayer has a Crypto K account with 50 units. A hard fork occurs, creating a new currency, Crypto S. Two possible events may take place:
- Post-Hard Fork without Airdrop:
- A new currency, Crypto S, is created but is not airdropped or transferred to the owner’s ledger address/account.
- Tax Implications: Since the taxpayer does not receive dominion over the new currency, they do not have accession to wealth. Therefore, this does not qualify as gross income under Sec 61 of the IRC.
- Post-Hard Fork with Airdrop:
- 25 units of the new currency, Crypto S, are distributed/airdropped into the owner’s ledger address, giving the owner the ability to use the currency.
- Tax Implications: The airdrop ensures that the new currency is in the distributed ledger address of the taxpayer, granting them complete dominion over the currency. Originally, the taxpayer held 50 units of Crypto K, and post-hard fork, they also have control over 25 units of Crypto S. In this case, the value of the new currency (25 units of Crypto S) credited to the taxpayer’s ledger post-hard fork is considered gross income.
Understanding the tax implications of cryptocurrency transactions is essential for CPAs and accountants. Revenue Ruling 2019-24 clarifies that not all cryptocurrency transactions result in taxable events. For a transaction to be taxable, the taxpayer must have complete dominion over the newly created cryptocurrency. Staying informed about these developments will help ensure compliance and accurate reporting for clients involved in the virtual world.