New IRS guidance says Bitcoin forks and airdrops are taxable events

The guidance defines cryptocurrency as "a type of virtual currency that utilizes cryptography to secure transactions that are digitally recorded on a distributed ledger," and comes in the form of an FAQ and an associated Revenue Ruling.

The documents provide some guidance on tax obligations for hard forks and airdrops and advise taxpayers on how to determine cost basis and fair market value.

Though the guidance does include some positive news — crypto asset transfers are not considered tax events, and gifts of cryptocurrency are not subject to taxes — several commentators have questioned the guidance with concerns it could lead to unforeseen consequences.

Forks and airdrops

The main bone of contention is the treatment of hard forks, which are defined as "a protocol change resulting in a permanent diversion from the legacy or existing distributed ledger."

According to the new guidance, hard forks are a taxable event, meaning that taxpayers will need to pay out each time someone hard forks a cryptocurrency they hold — as long as they have "dominion and control" over the new cryptocurrency.

"A taxpayer does not have receipt of cryptocurrency when the airdrop is recorded on the distributed ledger if the taxpayer is not able to exercise dominion and control over the cryptocurrency," reads the guidance. "When the taxpayer later acquires the ability to transfer, sell, exchange, or otherwise dispose of the cryptocurrency, the taxpayer is treated as receiving the cryptocurrency at that time."

This would mean that US taxpayers holding Bitcoin in custodial accounts on exchanges like Coinbase would be obligated to pay tax on spin-off currencies which were automatically distributed to them, including the likes of Bitcoin SV and Bitcoin Gold.

Accountant Rebecca Samuels of Pythagus told Brave New Coin, "this puts a higher tax burden on crypto tax holders, even if the crypto depreciates considerably or even becomes worthless."

And, as crypto lawyers have pointed out on Twitter, even individuals with no desire to receive the cryptocurrency — and who never asked for it — would still be obligated to pay tax on it.

"The new IRS guidance is like owing income tax when someone buries a gold bar on your property and doesn’t tell you about it," tweeted Coincenter lawyer Peter Van Valkenburgh.

But not everyone is in agreement.

According to attorney Preston Byrne, "the idea that anyone indisputably possesses a coin on a fork for which they’ve never downloaded and run the client or attempted to control in any way is frankly absurd."

He adds that "stealth tax" liabilities won’t arise, because people can always reject unwanted property."

Cost basis and fair market value

When new cryptocurrencies are forked or airdropped to a taxpayer, they can be treated as “an ordinary income equal to the fair market value of the new cryptocurrency when it is received.”

This fair market value can be identified by using, in the words of the IRS, “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.”

Crypto bought on an exchange, on the other hand, can be valued by the purchase price in USD on that specific exchange.

The rules for determining cost basis, which is defined as the original value of an asset for tax purposes, remain unchanged.

Cost basis is defined by the guidance as "the amount you spent to acquire the virtual currency, including fees, commissions and other acquisition costs in U.S. dollars.”

As the IRS guidance is retroactive, these new guidelines are now applicable to past and future crypto transactions. American taxpayers will be reminded of their obligations each time they fill out a 1040 tax return form, which has been freshly updated to ask taxpayers if they have "acquired any financial interest in any virtual currency.”

As more US citizens start paying out taxes on their cryptocurrency, we could expect to see the uncertainties around the guidance be resolved, but only as tax attorneys drag the inevitable resulting cases through the courts.