BCOTAX
July 2019
*Disclaimer: This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice.
In light of the recent announcement in the form of a letter from the Internal Revenue Service (IRS) Commissioner that the IRS will soon be publishing guidance on the “tax consequences of virtual currency transactions”, many are pondering when and how much. Although the exact date is uncertain, some predict that the new guidance will be published before the extended deadline for individual returns (October 15, 2019) and pass-through businesses (September 15, 2019). As for how much guidance will be published, we should expect it to be more than the comically vague guidance that was initially issued in 2014. What we learned from this notice was that in a nutshell, virtual currency is treated as property for tax purposes and is to be recorded as the fair market value of the virtual currency at the date of receipt.
Although the IRS, as explained in the letter (see above), recognizes the ever-developing crypto world, the question remains whether they will be able to keep up with choosing the tax treatments of the various types of transactions and other crypto phenomena. What we can do, however, is predict what those tax treatments might be and plan accordingly.
Forks, airdrops, and staking
The nature of forks in the crypto world, which whether it be hard or soft, can be defined in layman’s terms as software updates. Tax-wise, a soft fork is more straightforward as any change made is ‘backward compatible’ and thus could be compared to any other type of software update one might make on their computer, rendering it a non-taxable event. A hard fork, however, may be more complicated as the “chain will split, resulting in two separate currencies”. In essence, the investor will receive a new cryptocurrency as a result of holding another cryptocurrency. Last year the American Bar Association (ABA): Section of Taxation sent comments to the IRS on the proposed tax treatment of hard forks. In this document, they advise that investors who owned coin that was subject to a hard fork “would be treated as having realized the forked coin resulting from the hard fork in a taxable event” and “the deemed value of the forked coin at the time of the realization event would be zero, which would also be the taxpayer’s basis in the forked coin”. It would be at the time of disposing that forked coin that the investor would be taxed on the proceeds of the transaction.
In regard to airdrops, a similar tax treatment to what the ABA suggested for forks might be used – or maybe not. From a company’s perspective, airdrops, being free coins sent to an investor’s wallet, could be considered a promotional good and thus one may argue listing any costs incurred in giving the coin as a promotion expense will fall in-line with business expenses, and are thus tax-deductible as long as giving that coin to customers can be argued as ordinary and necessary. With the increasing frequency of airdrops occurring and expected in the crypto world, ‘ordinary’ and ‘necessary’ fits the description. From an investor’s perspective, some think that airdrops may also fall in the category of the treasure trove and thus be seen as gross income. The IRS explains that gross income is “all income from whatever source derived”, and is “realized in any form, whether in money, property, or services”. The IRS views treasure troves – or ‘found’ property – as a part of gross income.
Proof of staking allows an individual to validate new transactions for coins, which much equate to the number of coins of the same cryptocurrency that they have staked. They key factor in this activity is that the individual must “complete an act of staking to receive the reward”. The American Institute of CPAs (AICPA) also provided comments to the IRS with suggestions on forks, airdrops, staking, and other crypto transactions. In regard to staking, due to this action taken by the investor to stake coins, the AICPA believes that it should be treated as ordinary income from services just like the treatment of virtual currency mining.
Although there are multiple opinions about how every type of crypto transaction is treated, it wouldn’t be surprising if the IRS followed the advice listed by the ABA and AICPA. They likely won’t get every answer right in what guidance the IRS will eventually publish, but at least they’ll get it close.