December 2019 Foodman CPAs & Advisors and JD Supra

On 10/9/19, IRS issued Rev. Rul. 2019-24 addressing the issues of a Taxpayer having gross income under § 61 of the Internal Revenue Code as a result of a hard fork of a cryptocurrency that the Taxpayer owns if the Taxpayer DOES NOT RECEIVE units of a new cryptocurrency….…  AND…… of a Taxpayer having gross income under § 61 as a result of an AIRDROP of a new cryptocurrency following a hard fork if the Taxpayer RECEIVES units of new cryptocurrency.  IRS wants to make sure that Taxpayers understand their reporting obligations if they engage in transactions involving virtual currency.   IRS is aware that some Taxpayers with virtual currency transactions may have failed to report income and pay the resulting tax or not report transactions properly.  As a result, IRS mailed over 10,000 “educational” letters in July 2019, to Taxpayers who may have reported transactions involving virtual currency incorrectly or not at all.  Those Taxpayers could be liable for tax, penalties and interest or be subject to criminal prosecution in some cases. 

Revenue Ruling 2019-24 provides definitions and addresses Hard Fork and Airdrop Issues

Hard fork: is unique to distributed ledger technology and occurs when a cryptocurrency on a distributed ledger undergoes a protocol change resulting in a permanent diversion from the legacy or existing distributed ledger. A hard fork may result in the creation of a new cryptocurrency on a new distributed ledger in addition to the legacy cryptocurrency on the legacy distributed ledger. Following a hard fork, transactions involving the new cryptocurrency are recorded on the new distributed ledger and transactions involving the legacy cryptocurrency continue to be recorded on the legacy distributed ledger.
Airdrop: is a means of distributing units of a cryptocurrency to the distributed ledger addresses of multiple taxpayers. A hard fork followed by an airdrop results in the distribution of units of the new cryptocurrency to addresses containing the legacy cryptocurrency. A hard fork is not always followed by an airdrop.
Cryptocurrency from an airdrop is generally is received on the date and at the time it is recorded on the distributed ledger.
A taxpayer may receive cryptocurrency prior to the airdrop being recorded on the distributed ledger.
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.

A taxpayer does not have dominion and control if the address to which the cryptocurrency is airdropped is contained in a wallet managed through a cryptocurrency exchange and the cryptocurrency exchange does not support the newly-created cryptocurrency such that the airdropped cryptocurrency is not immediately credited to the taxpayer’s account at the cryptocurrency exchange
If 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.

Taxpayer Tax Impact from Revenue Ruling 2019-24 on Holdings

  • A taxpayer does not have gross income under § 61 as a result of a hard fork of a cryptocurrency the taxpayer owns if the taxpayer does not receive units of a new cryptocurrency.
  • A taxpayer has gross income, ordinary in character, under § 61 as a result of an airdrop of a new cryptocurrency following a hard fork if the taxpayer receives units of new cryptocurrency.

Section 61 of the Internal Revenue Code

Section 61 defines gross income as all income from whatever source derived, including (but not limited to) the following items:

(1) Compensation for services, including fees, commissions, fringe benefits, and similar items;

 (2) Gross income derived from business;

(3) Gains derived from dealings in property;

(4) Interest;

(5) Rents;

(6) Royalties;

(7) Dividends;

(8) Alimony and separate maintenance payments;

(9) Annuities;

(10) Income from life insurance and endowment contracts;

(11) Pensions;

(12) Income from discharge of indebtedness;

(13) Distributive share of partnership gross income;

(14) Income in respect of a decedent; and

(15) Income from an interest in an estate or trust

You have a Choice.  Make it!

Section 61 of the Internal Revenue Code is clear in that gains from dealings in property are included in gross income.  The IRS defined cryptocurrency (or virtual currency) as “property”  in its original guidance 2014-21: “ For federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency”.  It is now evident that the IRS is addressing virtual currency non-compliance and is willing to engage in audits and criminal investigations if necessary.  Taxpayers that have not reported their virtual currency activity should consult with a specialized tax advisor.