U.S. IRS publishes new crypto tax guidelines for forks, income, and gains

U.S. IRS publishes new crypto tax guidelines for forks, income, and gains

The Internal Revenue Service (IRS), the tax collection agency in the United States, is three months into its crackdown on taxpayers that may have forgotten to report their crypto related transactions back in April. Up to now, they have furnished an assortment of educational materials and telephone “hot-line” support, but, in their infinite wisdom, the agency has finally, after five years, published new tax guidelines for how to treat various transactions that involve cryptocurrencies.

According to tax professionals, the guidelines create about as many questions as they do answers regarding hard forks, income received, and taxable gains. For example, tokens received via a hard fork are immediately taxable as ordinary income. In another common transaction, if you exchange one token, say Bitcoin, for another, say Ether, the transaction may not qualify as a “non-taxable exchange”. Laws were changed in 2018 to limit these provisions to only exchanges of real estate.

Back in late July, the IRS mailed letters to 10,000 taxpayers that it suspected might have a tax issue related to cryptos. The agency had already approached crypto exchanges to gather information on these potential targets. The letters were a “soft” approach, in that no assessments were proposed. The wording questioned the taxpayer by inquiring if he might not be aware, or may not have reported, or may have reported incorrectly items related to cryptocurrencies. The taxpayer was given time to respond, along with a modicum of educational information on the topic. They seem to have put the cart before the horse, in that they waited three months to release specific guidance on the topic.

According to Coindesk:

As expected, the guidance notice released Wednesday addresses: the tax liabilities created by cryptocurrency forks; the acceptable methods for valuing cryptocurrency received as income; and how to calculate taxable gains when selling cryptocurrencies.

Certified Public Accountant Kirk Phillips was surprised that the document provided guidance in the context of a hard fork, but very little else.

Hard Forks

As the crypto world matures, the need for hard forks has tended to expand, as a token’s competing factions disagree on how a particular protocol should evolve. The basic thesis of the new guidelines is that when a new cryptocurrency is created via a hard fork of an existing blockchain, the new tokens are “ordinary income equal to the fair market value of the new cryptocurrency when it is received”.

The document goes on to clarify that:

If your cryptocurrency went through a hard fork, but you did not receive any new cryptocurrency, whether through an airdrop (a distribution of cryptocurrency to multiple taxpayers’ distributed ledger addresses) or some other kind of transfer, you don’t have taxable income.

Receipt is the deciding factor, but an independent third-party could create a tax liability for you. Drew Hinkes, a lawyer with Carlton Fields and the general counsel to Athena Blockchain, explains:

Receipt is defined by ‘dominion and control’ … so it’s ability to transfer, sell, exchange or dispose of the asset according to this guidance. The fear is that someone maliciously airdrops and tags you with a giant liability. But [this] fear is a bit oversold because you would only be liable for new income based on the fair market value of the asset when received, and most forks don’t start out with a high valuation.

Fair Market Value of Coins Received as Income

Tax professionals have been waiting for clarification on how to determine the cost basis of a token when it is received in a hard fork, as a mining reward, as compensation for general services, or in a simple transfer or sale on an exchange. The IRS now defines the “cost basis” of the cryptos received as “all the money spent to acquire the crypto, including fees, commissions and other acquisition costs in U.S. dollars.”

It gets a little trickier when you exchange one token for another on a DEX (Decentralized Exchange). You must determine U.S. Dollar equivalents by using “a cryptocurrency or blockchain explorer that analyzes worldwide indices of a cryptocurrency and calculates the value of the cryptocurrency at an exact date and time”.

Calculating Taxable Gains When Selling Cryptocurrencies

When selling your coins, you must be specific about their address, but if you are only selling a portion of your holdings from a single address, then “FIFO” rules apply, i.e., First-In-First-Out means the cost basis of earlier acquired coins applies first. You must be able to provide the following information:

  1. “The date and time each unit was acquired;
  2. Your basis and the fair market value of each unit at the time it was acquired;
  3. The date and time each unit was sold, exchanged, or otherwise disposed of, and
  4. The fair market value of each unit when sold, exchanged, or disposed of, and the amount of money or the value of property received for each unit.”

There are more specifics in the IRS document, and this brief summary does not constitute tax advice. Always consult the IRS or your personal tax professional, if you have a question. There is one other unfortunate drawback that these new rules imply. If you bought a Starbucks coffee with Bitcoin, you might have created a taxable event at the same time – odd, but true. The IRS did not exempt small-valued transactions.

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