United States IRS Releases Questionable Tax Guidelines for Cryptocurrencies

The United States Internal Revenue Service (IRS) has announced its first guidelines in five year for tax reporting regarding cryptocurrency airdrops and hard forks.

The guidance notice published on October 9th addresses common questions of taxpayers as well as practitioners. For instance, common issues such as the tax liabilities created by cryptocurrency forks, the acceptable methods for valuing cryptocurrency received as income, as well as how to calculate taxable gains when selling cryptocurrencies.

Upon the release of the guidance notice, IRS Commissioner Chuck Rettig has stated:

“The new guidance will help taxpayers and tax professionals better understand how longstanding tax principles apply in this rapidly changing environment. We want to help taxpayers understand the reporting requirements as well as take steps to ensure fair enforcement of the tax laws for those who don’t follow the rules.”

The IRS requires taxpayers to track their crypto transactions to prove how much they bought, so they can determine how much they owe when they sell. In addition to that, an investor must also record transfers of coins between two wallets in order to prove to the IRS that the transaction is tax-free.

Furthermore, the new IRS document gives a thorough answer to a long -standing question, that of tax liabilities created by cryptocurrency forks. Accordingly, new cryptocurrencies created from a fork of an existing blockchain should be treated as “an ordinary income equal to the fair market value of the new cryptocurrency when it is received.”

That is to say tax liabilities will apply when the new cryptocurrencies are recorded on a blockchain or if the forked cryptocurrency is received by a holder. The cost basis for calculating tax liabilities in such cases is the coin’s “fair value” in the markets at the time it was received, regardless of whether it can be spent, exchanged, or transferred.

The document further explained that if a cryptocurrency went through a hard fork and a person didn’t receive any new digital currency, whether through an air drop – a distribution of crypto to multiple taxpayers’ ledger addresses – or some other method of transfer, then that person doesn’t have a taxable income.

Meanwhile, legal experts within the cryptocurrency industry have pinpointed two questionable aspects of the guidance.

The first one is IRS’ apparent confusion about the definitions for airdrops and hard forks. In its guidance, the IRS conflates both definitions and assumes that hard forks are achieved through airdrops or distribution by exchanges. The pluralism in definitions results in several possibilities.

Jerry Brito, executive director at Coin Center has stated:

“While the new guidance offers some much-needed clarity on certain questions related to calculating basis, gains, and losses, it seems confused about the nature of hard forks and airdrops.”

The second problem would be the confusion over the method of receiving cryptocurrency and its ownership. Non-custodial wallets, where crypto owners have access to private keys, can exercise discretion over receipt of forked cryptocurrencies. However, the IRS’ guidance assumes receiving crypto through third-party exchanges.

Lokay Cohen, the vice president of crypto tax calculation platform Bittax, stated that the recent guidance follows a congressional request to the IRS which sought clarity on tax reporting for digital currencies.

Earlier this year, the IRS sent thousands of letters to cryptocurrency investors to clarify crypto tax filing requirements. An estimated 10,000 crypto investors received post from the agency, asking some to amend their tax filings, while compelling others to pay back taxes and/or interest and penalties.