Anthony J. Carbone, David Strong, and Edward L. Froelich
U.S. Federal Tax and Blockchain + Smart Contracts
Last week the IRS issued a revenue ruling, FAQs, and a revision to draft Schedule 1 to Form 1040 regarding various aspects of virtual currency transactions. The guidance is in line with the Treasury 2019-2020 Priority Guidance Plan that also came out last week and listed as items general guidance on virtual currency and guidance specifically reporting on virtual currency transactions pursuant to Internal Revenue Code section 6045.
In Revenue Ruling 2019-24, the IRS considered two situations involving what is called a “hard fork,” which it defined as a protocol change on the distributed ledger supporting the legacy currency that results in a permanent diversion from the legacy or existing distributed ledger. In the first situation, the IRS considered whether a taxpayer has gross income as the result of a hard fork of a cryptocurrency the taxpayer owns if the taxpayer does not receive units of a new cryptocurrency. In the second, the IRS considered whether a taxpayer has gross income as the result of an airdrop of a new cryptocurrency following a hard fork if the taxpayer receives units of new cryptocurrency and the taxpayer has the ability to dispose of the new cryptocurrency immediately following the airdrop. Regarding the first situation, the IRS concluded that the hard fork event does not give rise to gross income to the taxpayer. Regarding the second, the IRS concluded that the taxpayer will have gross income to the extent of the fair market value of the new cryptocurrency determined at the time it is recorded on the distributed ledger. Because the taxpayer is receiving the new cryptocurrency due to the taxpayer’s pre-existing ownership of the legacy cryptocurrency, the taxpayer has no cost basis in the new currency. Because the fair market value of the new cryptocurrency is included in income, the taxpayer will acquire a cost basis equal to the fair market value. See FAQ 24.
The 43 FAQs address numerous questions relating to dispositions of virtual currency, including, for example, the determination of basis and holding periods, the use of virtual currency as compensation for an independent contractor or employee, and the donation of virtual currency.
The revision to draft Schedule 1 inserted the following question: “At any time during 2019, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?” This is followed by two boxes requesting a yes or no answer, similar to the longstanding question on income tax returns regarding the existence of foreign financial accounts with respect to which a taxpayer has a financial interest or signature authority. These questions serve as a reminder to taxpayers to fully consider the tax consequences of such assets, and as a potential enforcement tool for the IRS.
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