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Following through on a promise made in May, the IRS this month issued long-awaited guidance on how investors should treat taxes on cryptocurrency.
Unfortunately, the new "guidance" clarified little. It ignored several key issues and left investors with more questions than answers.
The crypto community promptly scorched the IRS on Twitter and other social media, and rightly so.
This tweet from Jameson Lopp, the chief technology officer of crypto custody provider Casa, was the best I saw:
Citizens: "Please provide crypto guidance!"
Govt: "Grab the airdrop and smooth it out with a bunch of schleem. Then push it through the ledger, where the fork is rubbed against it."
Govt: "Your gross income is what's left after shaving away the klubus & grumbo."
— Jameson Lopp (@lopp) October 9, 2019
While the IRS has become more aggressive this year in pursuing investors that it suspects are underreporting capital gains from crypto trading, the agency last issued guidance on cryptocurrency taxes way back in 2014.
For years, the agency offered no further clarification, despite an obvious need. Then in May, the IRS raised expectations when it said it was working on an update to its cryptocurrency tax guidance.
What a tremendous disappointment.
I almost don't know where to start…
The IRS Needs to Go to School on Crypto
Rather than give a comprehensive overview of how it wants investors to treat crypto gains, the new IRS guidance focuses on one particular type of event: hard forks.
Worse yet, it's obvious that the IRS is not clear on how hard forks work, since it includes a discussion of "airdrops following a hard fork." An airdrop is a separate type of crypto event.
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A quick definition: A hard fork of a cryptocurrency is a change in the underlying software that results in the creation of a new and separate cryptocurrency. Typically, a person will receive as many of the newly created coins as they owned of the original coin.
These new coins can have value if they start trading on exchanges. And that value is in addition to the value of the original cryptocurrency – hence the interest of the IRS in hard forks.
The problem here is that even in the case of a hard fork, the IRS only discusses what happens when the taxpayer holds their crypto at an exchange. Most exchanges credit the new coins to the customer's account at some point. But depending on the circumstances of the hard fork, each exchange may handle this differently.
The IRS views an exchange crediting the newly created coins to a customer account as an "airdrop," which it is not. An airdrop is when the developers who control a cryptocurrency distribute coins for free (the methods for doing this vary, but a hard fork is not one of them) in the hope of increasing the coin's popularity.
The IRS concludes that the newly created coins are taxable when the customer has "dominion and control" over them. In other words, when the exchange credits them to the customer's account.
Left unanswered were questions about determining the fair value of the coin, since coins created from hard forks tend to spike in value at first and then decline. That would leave many investors paying tax on that higher value, even though the asset they hold is worth far less.
The IRS also doesn't mention anything about the obligations of people who keep their crypto in their own wallets. If you control your own keys, you need to take some steps to obtain any crypto to which you are entitled via a hard fork. No one will "airdrop" them to you.
The IRS also fails to address what happens with hard forks that create new spin-off coins but receive little attention. People could technically own a crypto they have no idea exists. Do they still owe tax?
I was also dismayed that the IRS totally ignored two major cryptocurrency tax issues…
Two Unanswered Questions Regarding Taxes on Cryptocurrency
About the Author
Dave has been a journalist for more than 35 years, including 18 spent at The Baltimore Sun. He has worked as a writer, editor, and page designer at different times in his career. He's interviewed a number of well-known personalities - ranging from punk rock icon Joey Ramone to Apple Inc. co-founder Steve Wozniak.
Over the course of his journalistic career, Dave has covered many diverse subjects. Since arriving at Money Morning in 2011, he has focused primarily on technology. He's an expert on both Apple and cryptocurrencies. He started writing about Apple for The Sun in the mid-1990s, and had an Apple blog on The Sun's web site from 2007-2009. Dave's been writing about Bitcoin since 2011 - long before most people had even heard of it. He even mined it for a short time.
Dave has a BA in English and Mass Communications from Loyola University Maryland.