The U.S. Internal Revenue Service (“IRS”) released Revenue Ruling 2019-24 on October 9, 2019 providing guidance on the U.S. income tax treatment of hard forks and airdrops of cryptocurrency. Revenue Rulings are an official interpretation of the U.S. tax laws by the IRS and intended to guide taxpayers in addressing their income reporting and tax obligations. This Revenue Ruling supplements the first and only cryptocurrency-related guidance issued by the IRS in 2014.
The IRS described a hard fork as a protocol change resulting in a permanent diversion of a cryptocurrency’s distributed ledger. The IRS described an airdrop as a means of distributing units of a cryptocurrency to the distributed ledger addresses of multiple users. According to the IRS, 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. A hard fork that results in an airdrop occurs when units of the new cryptocurrency are distributed among users of the legacy cryptocurrency. The IRS noted that a hard fork may not always result in an airdrop. The Revenue Ruling acknowledges that even if a hard fork results in issuance of units of a new cryptocurrency, a taxpayer may not have “dominion and control” over those units if they are airdropped in a wallet managed through a cryptocurrency exchange and the cryptocurrency exchange that does not support the newly-created cryptocurrency. However, if the exchange later supports the newly created cryptocurrency, the taxpayer is considered as receiving the cryptocurrency at that time.
The Revenue Ruling endeavored to answer the following questions:
- Does a U.S. taxpayer have income as a result of a hard fork of a cryptocurrency if the taxpayer does not receive units of a new cryptocurrency?
- Does a U.S. taxpayer have income as a result of an airdrop of a new cryptocurrency following a hard fork if the taxpayer receives units of a new cryptocurrency?
The IRS concluded that the taxpayer does not have income in the first scenario. However, the taxpayer has ordinary income in the second scenario equal to the fair market value of the new units at the time of receipt.
This guidance raises additional questions about the nuances of airdrops generally, cryptocurrency held via a custodial wallet provider or exchange versus directly by a taxpayer, among others.
For example, the answers in the Revenue Ruling do not deal explicitly with airdrops of cryptocurrency occurring without a hard fork. Presumably, the guidance is intended to mean that such an airdrop results in income to the taxpayer equal to the fair market value of the new cryptocurrency. However, these types of airdrops often occur without the taxpayer wanting or knowing that the airdrop occurred. Furthermore, the initial value of newly airdropped cryptocurrency (whether it follows a hard fork or not) may be initially high but thereafter fall, in which case the recipient could recognize taxable income at the time of receipt and a capital loss when he or she sells the same cryptocurrency to pay the tax liability.
Additionally, custodial wallets and exchanges do not always support new cryptocurrency at the time of an airdrop. In which case, is the airdropped cryptocurrency non-taxable until the custodial wallet or exchange supports the new cryptocurrency and makes it available to the taxpayer? Or is the custodial wallet or exchange considered to control and own the new airdropped cryptocurrency and, therefore, have taxable income at the time of the airdrop?