This blog post summarizes recent federal bills that have been introduced (but not yet passed), proposals by the Biden Administration, and guidance issued by the Internal Revenue Service with respect to the taxation of digital assets.
On March 28, 2022, the Biden Administration proposed certain very limited changes to the taxation of cryptocurrency transactions. The proposals do not change the current treatment of cryptocurrency as property for federal income tax purposes, and do not address any of the fundamental tax issues that cryptocurrency raise.
IRS Commissioner Charles Rettig, testifying before Congress in April 2021, estimated the gap between taxes owed and taxes collected in the United States to be close to $1 trillion. While there is some debate as to how much lax reporting on cryptocurrency transactions contributes to this so-called “tax gap,” with a market capitalization hovering at the time of writing around $2 trillion, cryptocurrency investments have increasingly become an object of regulatory scrutiny.
Virtual currency disclosure on Form 1040
Beginning with Notice 2014-21, the IRS has consistently taken the view that cryptocurrencies are property for U.S. federal income tax purposes. Absent any specific statutory or regulatory exception, U.S. individual taxpayers are generally required to report gains realized on the sale of property (including cryptocurrency) and pay tax on these gains. To remind taxpayers of this requirement, Form 1040 now specifically asks taxpayers whether they have received, sold, exchanged or otherwise disposed of any financial interest in any virtual currency. (The instructions define “virtual currency” for this purpose as a digital representation of value other than a representation of a “real” (i.e., fiat) currency that functions as a unit of account, a store of value, or a medium of exchange. Cryptocurrencies are included in this definition). The question on Form 1040 requires an affirmative answer of “yes” or “no” from all taxpayers.
A version of the virtual currency question was included on Schedule 1 of Form 1040 when it was introduced in 2019 but, beginning with the 2020 tax year, the question has had a more prominent position on page 1 (and, at that time, asked: “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”). The wording of the question has been modified for the 2021 tax year to remove the word “send” and replace “otherwise acquire” with “otherwise disposed of,” consistent with the IRS’s focus on identifying taxable events involving cryptocurrency. Generally any transaction involving cryptocurrency during the tax year will require a taxpayer to answer “yes” to this question, with the exception of purchases of virtual currency with real currency (with no further activity).
On May 5, 2021, another federal district court, this time for the Northern District of California, permitted the IRS to proceed with a John Doe summons very similar to the one served on Circle last month (the subject of a recent post). This time, the Summons seeks information on…
The U.S. Internal Revenue Service (IRS) quietly added two new questions and answers regarding virtual currency donations to its answers to Frequently Asked Questions on Virtual Currency Transactions (FAQs) on December 26, 2019. The two new answers address the responsibilities of charitable organizations when accepting donations of virtual currency, including…
In October of 2019, the U.S. Internal Revenue Service issued the first new guidance on the taxation of cryptocurrency transactions in over five years (the “Guidance”). The Guidance comprising a revenue ruling (Rev. Rul. 2019-24) and answers to frequently asked questions on the taxation of cryptocurrency transactions published on the IRS’s website.
This post discusses recent news reports of statements by officials with the IRS and the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) concerning issues not explicitly addressed in the Guidance.
Please refer to our earlier post for complete coverage of the Guidance.
- Tax treatment of promotional airdrops remains uncertain
Revenue Ruling 2019-24 indicated that cryptocurrency received in a hard fork would be taxable to the owner at the moment the new units of cryptocurrency issued in connection with the hard fork are “received” by the holder of the legacy cryptocurrency, which is generally the moment the units of the new cryptocurrency are “airdropped” to the legacy holder’s wallet, provided the holder is able to exercise “dominion and control” over the units at that time.
Because the facts of the ruling involved a hard fork (i.e., a change in the protocol of a cryptocurrency’s blockchain causing the creation of a new blockchain and, therefore, a new cryptocurrency), it was not clear whether the same rule would apply to airdrops of cryptocurrency received in other contexts. Airdrops may occur for promotional or marketing purposes by blockchain-focused startups in order to generate interest in the startup in connection with an upcoming ICO or to encourage mass adoption of the cryptocurrency. The coins may be distributed for free to holders of existing cryptocurrencies (such as Bitcoin or Ethereum), or may be “earned” by posting to social media or referring the cryptocurrency to other users.
An attorney in the IRS Office of the Associate Chief Counsel clarified in recent comments that promotional airdrops are not within the scope of Revenue Ruling 2019-24, but also noted that the IRS had not yet reached a decision on the tax treatment of these airdrops
- Valuation and receipt issues for airdropped coins
If coins of a new cryptocurrency are “received” for tax purposes, the owner of the cryptocurrency is required to include in its taxable income the fair market value—generally, the trading price—of the cryptocurrency at the moment of its receipt. An attorney for the IRS speaking before a recent conference of the American Institute of CPAs (AICPA) in Washington, D.C., suggested that a limited market for new coins may affect their valuation and that a zero valuation may be appropriate for a cryptocurrency that cannot be disposed of at all.
The same attorney also noted that, depending on the specific facts, a taxpayer may be treated as actually or constructively receiving coins of the new cryptocurrency distributed in a hard fork even if it is necessary for the taxpayer to download new software or undertake some other ministerial-type action to accept (or later to transfer) the cryptocurrency. Taxpayers cannot avoid or delay a taxable event simply by declining to accept the airdropped coins.
The first official guidance on the taxation of cryptocurrency transactions in more than five years has been issued.
The guidance includes both a Revenue Ruling (Rev. Rul. 2019-24, 2019-44 I.R.B. 1) and answers to Frequently Asked Questions on Virtual Currency Transactions (the “FAQs,” together with Revenue Ruling 2019-24, the “Guidance”) was issued on October 9, 2019 by the U.S. Internal Revenue Service (the “IRS”). The Guidance provides much sought information concerning the tax consequences of cryptocurrency “hard forks” as well as acceptable methods of determining tax basis for cryptocurrency transactions. The Guidance also reasserts the IRS’s position, announced in Notice 2014-21, 2014-16 I.R.B. 938, that cryptocurrency is “property” for U.S. federal income tax purposes and provides information on how the rules generally applicable to transactions in property apply in the cryptocurrency context. However, important questions remain unanswered. It remains to be seen whether more definitive regulatory or administrative guidance is forthcoming.
The Guidance comes amidst an ongoing campaign by the IRS to increase taxpayer compliance with tax and information reporting obligations in connection with cryptocurrency transactions. In 2017, a U.S. district court ordered a prominent cryptocurrency exchange platform to turn over information pertaining to thousands of account holders and millions of transactions to the IRS as part of its investigation into suspected widespread underreporting of income related to cryptocurrency transactions. Earlier this year, the IRS sent more than 10,000 “educational letters” to taxpayers identified as having virtual currency accounts, alerting them to their tax and information reporting obligations and, in certain cases, instructing them to respond with appropriate information or face possible examination. Schedule 1 of the draft Form 1040 for 2019, released by the IRS shortly after publishing the Guidance, would require taxpayers to indicate whether they received, sold, sent, exchanged, or otherwise acquired virtual currency at any time during 2019.
Taxpayers who own or transact in cryptocurrency or other virtual currency should consider carefully any tax and information reporting obligations they might have. Please contact the authors of this post or your usual Proskauer tax contact to discuss any aspect of the Guidance. Read the following post for background and a detailed discussion of the Guidance.
Except where the context indicates otherwise, the tax consequences discussed in this post generally apply to transactions involving cryptocurrency held by a taxpayer as a capital asset. This post does not consider tax consequences other than U.S. federal income tax consequences.
On December 20, 2018, a bipartisan pair of Congressmen, Warren Davidson (R-OH) and Darren Soto (D-FL), introduced bill H.R. 7356 to enact the Token Taxonomy Act (the “Act”). The Act proposes several amendments to federal securities and tax laws that are intended to clarify how cryptoassets should be treated thereunder. Below, we discuss the key provisions of the Act and their potential implications for cryptoasset market participants. Emphasis is placed on “potential” because, as we will discuss, the Act will likely require certain revisions, as well as substantial political support, before becoming effective law.