Hard forks, hard tax: IRS issues guidance on unplanned crypto forks
The IRS has recently released guidance stating that the receipt of cryptocurrency from a hard fork or airdrop is taxable upon receipt.
A fork is a split of a blockchain into two separate blockchains that generally happens due to a disagreement among miners. An airdrop, on the other hand, is a distribution of new tokens by developers, often for free or for performing a small task.
Tax attorneys, accountants and cryptocurrency investors have been asking for this guidance for years. After high profile hard forks that left individuals with not only the cryptocurrency they held before the fork, but also with the new cryptocurrency created from the fork, many argued that the new currency should not be taxable in the year received. Rather, they argued, it should be taxable when sold or traded, less an allocated portion of the tax basis of their original investment (based on the relative fair market value of the old and new currency, on the date received). In other words, the profit (or loss) at disposition should be taxable. Others argued the basis should be zero, with no tax owed until the date the forked cryptocurrency was disposed.
Not only did the IRS refuse to adopt the approaches advocated by cryptocurrency holders, it adopted one that makes the unplanned receipt of cryptocurrency a taxable event. The IRS did provide for some exceptions, including where new cryptocurrency is not airdropped and the taxpayer cannot control it. The plain purpose of the IRS ruling, however, is to make clear that mere receipt is taxable.
The revenue ruling
In Revenue Ruling 2019-24, the IRS discusses both cryptocurrency forks and airdrops. While forks and airdrops are two separate technical mechanisms, the IRS ruling fails to understand the differences between the two. (The receipt of a new cryptocurrency from a hard fork is not an airdrop.)
Nonetheless, the revenue ruling makes two points clear: Forked/airdropped cryptocurrencies are to be included in a taxpayer’s ordinary income; and that ordinary income should be valued and taxed on the date the taxpayer has “constructive receipt” of the forked/airdropped cryptocurrency.
This tax treatment indicates that the IRS will treat the forked and airdropped cryptocurrency as new wealth to the taxpayer, resulting in additional income taxes, taxed at ordinary income rates. The timing of these factors is based on the concept of “constructive receipt.” Income is constructively received when an amount is credited to a taxpayer’s account or made available to the taxpayer without restriction. Possession is not required. Income is not constructively received if the taxpayer’s control of its receipt is subject to substantial restrictions or limitations. This is relevant in certain cases where an individual maintains an account at an exchange, but the exchange does not support the new forked/airdropped cryptocurrency at the time of the fork/airdrop.
Cryptocurrency forks can be very common. For example, take Bitcoin, the most well-known cryptocurrency. It has been forked numerous times, creating Bitcoin Private, Bitcoin God, Bitcoin Core, Bitcoin Atom, Super Bitcoin, Bitcoin Diamond, Bitcoin Gold, and Bitcoin Cash. While this could create an accounting headache for taxpayers owning cryptocurrency, the issue is not material in most cases. Supply and demand dictate the price of cryptocurrencies, so forked-and-airdropped cryptocurrencies often have little to no value. Each of the previously listed forked iterations of Bitcoin has a value of under $10 per unit, with the notable exception of Bitcoin Cash.
The two forks most material to taxpayers are the Bitcoin/Bitcoin Cash fork, which occurred on Aug. 1, 2017, and the Bitcoin Cash/Bitcoin SV fork, which occurred on Nov. 15, 2018. Taxpayers involved in those hard forks should assess the effect of the IRS ruling on their potential tax liabilities and consider whether amended returns need to be filed.
Taxpayers involved in other hard forks who received cryptocurrency by airdrop (or by other means that provided access and control) should also assess the value of the cryptocurrency received and the income tax effects.
Mark DiMichael, a partner in the valuation and forensic services department of Citrin Cooperman, specializes in litigation support and valuation services. His areas of expertise include divorce litigation, economic damages analysis, fraud investigation, cryptocurrency, white collar criminal defense, and business appraisals.
Daniel J. Healy is a partner in Anderson Kill's Washington, D.C. office. He started his career with Anderson Kill and then served over five years as a Trial Attorney with the U.S. Department of Justice, Tax Division. He appeared as lead trial counsel in federal and state courts across the country, received numerous Outstanding Attorney awards and served as the E-Discovery Coordinator for the Tax Division.