The IRS has issued its first cryptocurrency taxation guidance in 5 years, and it is turning out to be quite controversial. Charles Rettig, the IRS Commissioner, announced the recent update in May of this year, but only on October 9th were details released. Three of the main topics addressed in the guidance documentation are tax liabilities as a result of cryptocurrency forks, methods of valuing cryptocurrency as income, and how to calculate the taxable gains that result from selling cryptocurrency.
Hard Forks and Airdrops
For crypto-holders, the most contentious of these policies is the decision to create a taxable event when a hard fork occurs. If there is a new cryptocurrency recorded on the blockchain of a cryptocurrency an investor already holds, that cryptocurrency must be treated as income at the fair market value of the cryptocurrency when received.
The policy is worded as shown below:
“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.”
This creates many different issues in the cryptocurrency community, as hard forks and airdrops may occur without consent from the holding party. The idea of a third-party being able to trigger a tax liability seems very illogical. However, this fear may be a bit overblown, since most forks don’t start out with high valuations and often take time to find a stable price on the market.
A different perspective is that users could receive an air drop that occurs at a high price and then crashes to nothing. This is most likely to occur with ERC-20 wallet holders who might not even be aware that they hold certain cryptocurrencies.
The main thing crypto-holders are thinking about is how this would affect the taxation of Ethereum Classic and Bitcoin Cash, both of which were created as hard forks from the more prominent Ethereum and Bitcoin blockchains. These holders are now responsible for determining how much taxes they owe on the windfall from these hard forks.
Policy Is Years Behind
There are some more helpful policies included in this guidance, like the first-in, first-out method of accounting for multiple transactions, but the guidance is still way behind.
An overarching issue here is that the cryptocurrency market is growing increasingly complex. Futures are now available, forks have occurred, and there are alternative ways for companies to finance their operations. Regulators don’t seem to have kept up, and sudden implementation of tax guidance like what was recently released tends to create a gap in taxes payable for crypto holders.
To experience an unexpected tax liability is a huge hassle, and the fact that no further clarification has been given since 2014 is likely infuriating for market participants. Other examples of exasperating policies are that there is no threshold for taxable transactions. That would make every minor purchase using cryptocurrency a taxable event. This almost fully invalidates the use of Bitcoin as a medium of transfer in the US, and serves as further proof that the US is not a cryptocurrency-friendly country.