The IRS released long-awaited tax guidance on hard forks for crypto assets today. But the mechanics of the technology that underpins cryptocurrency means that the agency’s attempt to clarify matters has elicited more questions than answers.
The IRS guidance states that a hard fork is a taxable event, 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. A hard fork is not taxable, however, if a fork takes place but crypto wallets for holders of the original cryptocurrency are not credited with new coins, according to the IRS.
Legal experts within the cryptocurrency industry have focused on two problematic aspects of the guidance.
The first one is the federal agency’s 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 conflation in definitions results in several possibilities.
Why would forked coins get airdropped post-fork?
If they were, who would do the airdropping?
Why would they be airdropped to an "account" owned or controlled by the recipient?
What could the airdrop have to do with the fork?
— Marco Santori (@msantoriESQ) October 9, 2019
The conceptual differences between both terms are important within the context of taxation because a crypto wallet owner may be forced to accept a taxable event outside their control, per the current IRS guidance.
“Anytime someone airdrops a coin to an address over which you have dominion and control, they will create a tax-reporting obligation on your part,” wrote Coin Center, a Washington D.C. - based crypto advocacy firm, in its assessment. For example, an airdrop distribution of tokens for wallets on a platform results in a taxable event for all wallets on that platform, regardless of whether the airdropped coin is used or not.
The second problem, which is related to the first, is confusion over the manner 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. But the agency’s guidance presumes receiving crypto through third-party exchanges.
To that extent, the guidance seems to be primarily directed at custodial cryptocurrency exchanges in which ownership of the actual crypto rests with the exchange, according to Marco Santori, president and chief legal officer at Blockchain, a software platform for digital assets.
The agency’s assumptions may have far-reaching consequences for the crypto ecosystem’s evolution. One of them might be an incentive for taxpayers to hold their coins at exchanges. This is because an exchange’s decision to not support a hard fork could result in fewer tax obligations.
In that sense, the guidance leaves room for further revisions in the future. Don’t hold your breath for it, though. The agency took five years to make revisions to its first guidance.