On October 9, 2019, the U.S. Internal Revenue Service (IRS)
released frequently asked questions on virtual currency
transactions (FAQ) and Revenue
Ruling 2019-24 (Revenue Ruling). The long-anticipated guidance on
virtual currency transactions primarily builds on previous guidance the IRS
provided in Notice 2014-21.
Summary
The FAQ generally expands on the guidance and examples
provided in Notice 2014-21 and applies the same general tax principles to
additional situations such as
(i) payments for services using virtual currency,
(ii) exchanges of virtual currency for property
(including other virtual currency),
(iii) (iii)
gifts and charitable donations of virtual currency and
(iv) (iv) sales of multiple units of one kind of
virtual currency acquired at different times.
Additionally, the FAQ gives
examples on how to determine the fair market value of a cryptocurrency received
on an exchange or otherwise (e.g., as part of a transaction that is either
recorded or not recorded on a distributed ledger, a peer-to-peer transaction or
the receipt of cryptocurrency with unpublished value). Both the FAQ and the
Revenue Ruling address the tax treatment of two specific types of transactions,
·
the occurrence of a “hard fork” (i.e., when a
cryptocurrency undergoes a change that may result in the creation of a new
cryptocurrency in addition to the legacy cryptocurrency) and
·
an “airdrop” (i.e., when a taxpayer receives new
units of cryptocurrency following a hard fork).
·
The Revenue Ruling and the FAQ make clear that a
taxpayer is taxed only if the taxpayer receives a new virtual currency, which
requires that the taxpayer be able to exercise complete dominion and control
over the new virtual currency. Thus, the tax treatment of virtual currencies is
consistent with the tax treatment of other properties.
Frequently Asked Questions on Virtual Currency Transactions
Similar to Notice 2014-21, the FAQ applies only to virtual
currency that has an equivalent value in real currency or acts as a substitute
for real currency (convertible virtual currency). The FAQ covers all
types of convertible virtual currency, regardless of the label applied, under
the tax definition of a virtual currency, such as digital currency and
cryptocurrency (i.e., a type of virtual currency that uses cryptography to
secure transactions that are digitally recorded on a distributed ledger, such
as a blockchain). The FAQ reaffirms Notice 2014-21 in providing that virtual
currency is treated as property for U.S. federal income tax purposes and
general tax principles applicable to property transactions apply to virtual
currency transactions.
For example, when a taxpayer receives a virtual currency in
exchange for services, whether or not through an exchange platform, the
taxpayer is required to include the fair market value of the virtual currency
in gross income as measured in U.S. dollars at the time of receipt. If a
taxpayer acquires virtual currency on an exchange, the taxpayer’s basis in the
virtual currency will be equal to the amount spent to acquire the virtual
currency (including fees, commissions and other acquisition costs) as measured
in U.S. dollars at the time of acquisition. The taxpayer’s holding period
starts on the day after the virtual currency is received or acquired. If a
taxpayer holds virtual currency as a capital asset, upon the sale of the
virtual currency, the taxpayer will recognize capital gain or loss that will be
either long-term or short-term depending on the taxpayer’s holding period.
Fair Market Value of Cryptocurrency For cryptocurrency
received in a transaction facilitated by an exchange, the fair market value of
the cryptocurrency is the amount recorded by the exchange for that transaction
in U.S. dollars; if the transaction is not recorded, the fair market value is
the amount the cryptocurrency was trading for on the exchange in U.S. dollars
at the time the transaction would have been recorded. For cryptocurrency
received in a transaction not facilitated by an exchange (e.g., a peer-to-peer
transaction), a taxpayer may rely on cryptocurrency or blockchain explorers or
other published evidence that establishes the cryptocurrency’s fair market
value. For cryptocurrency that does not have a published value, its fair market
value is the fair market value of the property or services exchanged for it.
Payments for Services Using Virtual Currency The FAQ
confirms that payments for services with virtual currency, whether to an
employee or to an independent contractor, will be taxed as ordinary income to
the service provider in the amount of the fair market value of the virtual
currency as measured in U.S. dollars at the time it is received. Based on the
FAQ and Revenue Ruling, the time of receipt will be the time when the taxpayer
is able to exercise complete dominion and control over the virtual currency.
For example, in a transaction recorded on a distributed ledger, a taxpayer is
considered to have dominion and control over the virtual currency on the date and
at the time the taxpayer has the ability to transfer, sell, exchange or
otherwise dispose of such virtual currency. If an independent contractor
receives virtual currency for performing services, such virtual currency will
be treated as self-employment income.
Similarly, if an employer uses virtual currency as
remuneration for services, it will constitute wages for employment tax
purposes. If the service recipient held the virtual currency as a capital
asset, the service recipient will also recognize a capital gain or loss on the
exchange in the amount equal to the fair market value of the services received
over the service recipient’s adjusted basis in the virtual currency (i.e., the
adjusted basis equals the service recipient’s cost basis as increased by certain
expenditures and decreased by certain deductions or credits in U.S. dollars).
Taxpayers who expect to use virtual currency in compensating
their employees and independent service providers should carefully assess (a)
their own potential tax liabilities on any gains associated with the use of
virtual currency, (b) their employment tax obligations and (c) related
withholding and information reporting obligations.
Exchanges of Virtual Currency for Property (Including Other
Virtual Currency)
The FAQ includes multiple scenarios involving the
exchange of virtual currency for property or vice versa. A taxpayer will
recognize gain or loss upon the exchange of virtual currency for other property
(which includes other virtual currency) in the amount equal to the fair market
value of the property received over the taxpayer’s adjusted basis in the
virtual currency exchanged. The nature of the recognized gain or loss will
depend on whether the taxpayer held the virtual currency as a capital asset.
The taxpayer’s basis in the property received will equal the fair market value
of such property at the time of exchange.
Gifts and Charitable Donations
of Virtual Currency
Bona fide gifts of virtual currency are generally not
income to the recipient until the recipient sells or otherwise disposes of the
virtual currency. Upon a sale, the recipient’s basis in the gift depends on
whether the recipient has gain or loss. If the recipient has gain, the
recipient’s basis is equal to the donor’s basis plus any gift tax the donor paid.
If the recipient has loss, the recipient’s basis is the lower of either the
donor’s basis or the fair market value of the virtual currency at the time of
the initial gift. Gift recipients must substantiate the donor’s basis; without
evidence, a recipient’s basis is zero. Recipients’ holding period of virtual
currency includes the holding period of the donor, unless the recipient cannot
substantiate the donor’s holding period, in which case the holding period
begins the day after receipt of the gift.
Charitable contributions of virtual currencies generally do
not result in the recognition of gain or loss on the virtual currency for the
donor (as opposed to a service recipient who pays an employee or independent
contractor in virtual currency as discussed above). For charitable
contributions of virtual currency where the donor held the virtual currency for
more than a year at the time of donation, the donor’s deduction is the fair
market value of the virtual currency; for donations where the donor held the
virtual currency for a year or less, the donor’s deduction is the lesser of the
donor’s basis and the fair market value of the virtual currency at the time of
donation. Prospective donors now have clarity on the favorable nonrecognition
rule for charitable donations.
Sales of Multiple Units of One Kind of Virtual Currency
Acquired at Different Times
In virtual currency transactions, taxpayers
who own multiple units of one kind of virtual currency purchased at different
times and with different basis amounts may specifically identify which units
are a part of the transaction as long as they can substantiate for each unit
(1) the date and time
of acquisition,
(2) the basis and fair market value of the virtual currency
at acquisition,
(3) the date and time
of sale and
(4) the fair market value of each unit when sold and the
value of money or property received in exchange.
Without substantiation, units are deemed to have been sold
in chronological order beginning with the earliest unit acquired (i.e., on a
FIFO or first in, first out basis). Taxpayers should maintain streamlined
records in respect of their virtual currencies to avoid being forced into the
default FIFO rules.
Hard Fork, Airdrop and Revenue Ruling 2019-24
Revenue Ruling 2019-24 addresses whether a taxpayer has
gross income under Section 61 of the Internal Revenue Code of 1986 (the
Code)2 as a result of two types of transactions: the occurrence of
- a hard fork (i.e., when a cryptocurrency undergoes
a change that may result in the creation of a new cryptocurrency in addition to
the legacy cryptocurrency) and - an airdrop (i.e., when a taxpayer receives new
units of cryptocurrency following a hard fork).
The Revenue Ruling addresses only transactions involving a
cryptocurrency, a type of virtual currency that uses cryptography to secure
transactions that are digitally recorded on a distributed ledger. The IRS ruled
on two separate fact patterns and both conclusions hinged on whether the
taxpayer in the particular case “received” the newly created cryptocurrency for
U.S. federal income tax purposes. The IRS explained that although the receipt
of cryptocurrency from an airdrop generally occurs when it is recorded on the
new distributed ledger, “receipt” for U.S. federal income tax purposes does not
occur unless the taxpayer is able to exercise complete dominion and control
over the new cryptocurrency. For example, the IRS stated that a taxpayer does
not have dominion and control if the address to which the new cryptocurrency is
airdropped is in a wallet managed through a cryptocurrency exchange that does
not support the newly created cryptocurrency. In that example, the IRS stated
that the taxpayer is treated as receiving the new cryptocurrency for U.S.
federal income tax purposes only when the taxpayer acquires the ability to
transfer, sell, exchange or otherwise dispose of the new cryptocurrency.
In the first fact pattern, a taxpayer owned a cryptocurrency
that experienced a hard fork, resulting in the creation of a new cryptocurrency
that was not airdropped or otherwise transferred to the taxpayer’s account. In
this case, the IRS ruled that because the taxpayer did not receive the new
cryptocurrency and did not have accession to wealth, the taxpayer did not have
gross income as a result of the hard fork. In the second fact pattern, a
taxpayer owned a cryptocurrency that experienced a hard fork, resulting in the
creation of a new cryptocurrency, but this time the new cryptocurrency was
airdropped to the taxpayer’s distributed ledger address and the taxpayer had the
immediate ability to dispose of the new cryptocurrency. In this case, the IRS
ruled that the taxpayer had an undeniable accession to wealth, clearly
realized, and the taxpayer had complete dominion and control over the new
cryptocurrency at the time of the airdrop.
Therefore, the IRS ruled that the taxpayer had ordinary
income in the amount of the fair market value of the new cryptocurrency
measured at the time the airdrop was recorded on the taxpayer’s distributed
ledger. The FAQ provides additional guidance on the treatment of hard forks.
The fair market value of the new cryptocurrency realized as a result of a hard
fork is measured at the time of receipt, which is typically when the
transaction is recorded on the distributed ledger, provided the taxpayer has
complete dominion and control over the new cryptocurrency. The taxpayer’s basis
in the new cryptocurrency will equal the amount included in income for tax
purposes, which is the fair market value of the new cryptocurrency at the time
of receipt.
These circumstances
surrounding a hard fork should be distinguished from the occurrence of a “soft
fork” when a legacy cryptocurrency undergoes a change, but the change does not
result in the creation of a new cryptocurrency. In those situations, the taxpayer
will not have a taxable recognition event because the taxpayer will not receive
any new cryptocurrency as a result of the soft fork.
IRS Revenue Ruling here – https://www.irs.gov/pub/irs-drop/rr-19-24.pdf
