Tax Insights

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Cryptocurrency update: New IRS guidance and requirements

In their continuing quest to get their arms around the many intricacies of cryptocurrency, the IRS has recently issued new guidance regarding the taxation of certain crypto transactions. They also added a new question regarding ownership of virtual assets to the 2019 Form 1040, Schedule 1 (still in draft form as of this writing.)

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Let’s start with the easy part – the new question on Schedule 1. Similar to the foreign bank account question on Schedule B, this question is essentially designed to inform the IRS whether or not a taxpayer is involved with cryptocurrency. Specifically, the question asks, “At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” The answer is a simple yes or no, and taxpayers required to file Schedule 1 in order to report various types of other income will be required to answer the question. Taxpayers not otherwise required to file Schedule 1 and who have not transacted with any virtual currencies, will not be required to file Schedule 1 for the sole purpose of answering this new question.

Now for the more complicated stuff. But first, if you’re a cryptocurrency rookie and want a brief primer before diving even further in, please check out my article on cryptocurrency taxation basics. The most recent guidance issued by the IRS is Revenue Ruling 2019-24, which addresses topics of the taxability of hard-forks and airdrops. If you’re still reading, you’re probably thinking, “What the heck is a hard-fork or an airdrop? Isn’t that something I can do on my iPhone?” Well yes, an airdrop is something you can do on your iPhone. But that’s not what the IRS is concerned about.

Hard-forks and airdrops are interrelated but are not quite one and the same. Without getting too far into the weeds, a hard-fork is essentially the creation of a new type of cryptocurrency via the splitting of a previously existing blockchain. Most famously, Bitcoin experienced a hard-fork of its underlying blockchain in August 2017, resulting in the creation of “Bitcoin Cash,” an entirely new cryptocurrency at the time. As a result of this hard-fork, current owners of Bitcoin received an equal amount of Bitcoin Cash. It can almost be thought of as a stock-split, or more accurately a spinoff. And just like a stock, the new currency has a value, determined by current market demand and ever-changing.

Now that we’ve covered the basic concept of hard-forks, what is an airdrop? An airdrop is simply the method of delivering the new units of cryptocurrency to the owners, or “shareholders” to continue the stock spinoff analogy. A hard-fork always creates a new currency but is not always followed by an airdrop. This is key when determining the taxability of hard-fork transactions.

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According to Revenue Ruling 2019-24, the quick answer is that if a taxpayer receives units of virtual currency via airdrop as a result of a hard-fork, it is considered an accession of wealth and is therefore taxable as ordinary income at the fair market value of the currency at the time received. Note that this income is considered ordinary income, not capital gain, regardless of how long the taxpayer has held the underlying asset prior to the hard-fork. As with everything in tax, however, there is always an exception. Oftentimes in the case of hard-fork transactions, it can take a while for the online crypto exchanges to catch-up to the new currency and begin supporting its transactions. In such a scenario, the IRS has ruled that taxpayers receiving an airdrop of virtual currency to an online exchange which does not yet support the new currency do not have accession to wealth due to lack of “dominion and control,” and thus do not have a taxable event. There is no free lunch though – once the taxpayer’s exchange does support the new currency, the taxpayer will be required to report ordinary income of the new currency at that time, and at the fair market value of the asset on the date control is established.

Cool stuff, right? Stay tuned for further virtual currency updates as they arise. Whether you’ve been dabbling in Bitcoin for a little bit of portfolio diversification, or are a full-time trader or miner, consider reaching out to your trusted tax advisor to make sure your filing requirements are covered. Crypto may have been anonymous and untraceable a few years ago, but the Wild West days are over, and Uncle Sam has caught on fast.

 

Austin Bradley, CPA