IRS Issues Guidance on Tax Treatment of Virtual CurrencyThe Internal Revenue Service (IRS) issued two new pieces of guidance on October 9, 2019 regarding tax treatment of transactions involving virtual currency.1 First, in Revenue Ruling 2019-24, the IRS outlines the tax treatment of a cryptocurrency “hard fork.” Second, the IRS issued a set of FAQs addressing taxpayers holding virtual currency as a capital asset. This new guidance expands upon previous IRS guidance and helps to better clarify taxpayers’ reporting obligations with respect to their virtual currency transactions.
The IRS has previously issued guidance applying principles of tax law to virtual currency transactions. In 2014, the IRS announced that virtual currency is to be considered property for federal tax law purposes and that the character of gain or loss that a taxpayer will realize upon the sale or exchange of virtual currency “generally depends upon whether the virtual currency is a capital asset in the hands of the taxpayer,” among other points of intersection between virtual currency transactions and tax considerations.2
Revenue Ruling 2019-24
In Revenue Ruling 2019-24, the IRS outlined the tax treatment of a cryptocurrency “hard fork” and the circumstances under which a hard fork will result in gross income to a taxpayer. According to the IRS, the question depends analytically upon whether an airdrop3 follows that hard fork.
Relevantly, under Section 61 of the Internal Revenue Code, gross income includes all gains or undeniable accessions to wealth, clearly realized, over which a taxpayer has complete dominion.4 Further, a taxpayer’s basis for determining gain or loss in connection with property received but not purchased is calculated “by reference to the amount included in gross income, which is the fair market value of the property when the property is received.”
In a hard fork, a cryptocurrency on a distributed ledger undergoes a change to its protocol “resulting in a permanent diversion from the legacy or existing distributed ledger.” This may lead to the creation of a new cryptocurrency, transactions of which would take place on a new distributed ledger, while transactions involving the prior, legacy cryptocurrency would be recorded on the legacy distributed ledger. In some instances, units of this new cryptocurrency may be distributed to the holders of the legacy cryptocurrency via an airdrop.
However, a hard fork does not necessarily result in an airdrop, and Revenue Ruling 2019-24 accordingly addresses the tax implications of both hard fork scenarios.
In the scenario where a hard fork does not result in a taxpayer receiving units of the new cryptocurrency via airdrop or other transfer, the taxpayer has not received gross income under Section 61 as a result of the hard fork. According to the IRS, this is because a taxpayer that does not receive units of a new cryptocurrency following a hard fork does not have an “accession to wealth” as a result of the hard fork.
By contrast, in the scenario where a taxpayer does receive units of the new cryptocurrency via airdrop or other transfer following a hard fork, the taxpayer does have an “accession to wealth” and, therefore, gross income under Section 61,5 so long as the taxpayer has dominion and dispositive control over the new cryptocurrency units. Moreover, the taxpayer’s basis in such cryptocurrency units will be equal to the fair market value on the date the taxpayer receives those units.6
The IRS also issued a series of 43 FAQs relating to the tax treatment of virtual currencies held as capital assets and the reporting obligations. The FAQs cover a range of topics, including how to determine short-term or long-term capital gain, how to calculate the fair market value of a virtual currency that does not have a published value, and how to treat virtual currencies either received as a bona fide gift or donated to charity.
The newly issued guidance “expand[s] on” and “supplements” the IRS’s earlier 2014 guidance, and emphasizes the extent to which traditional principles of tax law directly apply to the novel developments found in the fast-changing markets for virtual currencies. To this point, in announcing the new guidance, IRS commissioner Chuck Rettig stated that “the IRS is committed to helping taxpayers understand their tax obligations in this emerging area.” In addition, the IRS is soliciting public input on additional guidance about the tax considerations pertaining to the field of virtual currencies. The IRS is also seeking to address potential non-compliance with the reporting requirements for virtual currency transactions “through a variety of efforts, ranging from taxpayer education to audits to criminal investigations.”
1) Internal Revenue Service, “Virtual currency: IRS issues additional guidance on tax treatment and reminds taxpayers of reporting obligations” (Oct. 9, 2019).
2) Notice 2014-21.
3) An airdrop is a promotional method by which issuers of a cryptocurrency seek to spread awareness of a project and increase its ownership base by distributing units of its cryptocurrency, typically for free, to certain wallet holders in the blockchain community.
4) See Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955).
5) According to the IRS, this income would be ordinary in character, as it would not derive from the sale or exchange of a capital asset or otherwise fall under a special rule. See §§ 1222, 1231, 1234A.
6) The IRS notes that “cryptocurrency from an airdrop generally is received on the date and at the time it is recorded on the distributed ledger” but that “a taxpayer may constructively receive cryptocurrency prior to the airdrop being recorded on the distributed ledger” and, moreover, that “[a] taxpayer does not have receipt of cryptocurrency when the airdrop is recorded on the distributed ledger if the taxpayer is not able to exercise dominion and control over the cryptocurrency.”