Minters of collectible non-fungible tokens (NFTs) have taken a wide range of approaches. In addition to variations in the means of distribution, token standards, governing smart contracts and platforms on which initial sales or transfers are made, the terms, conditions and content licenses (or lack thereof) under which users take possession of an NFT often differ from project to project. The recent delisting by OpenSea of the original (or “v1”) version of the popular “CryptoPunks” NFT art collection in light of a takedown notice issued pursuant to the Digital Millennium Copyright Act (DMCA) by the collection’s creator, Larva Labs, and the ensuing DMCA counter-notification by v1 owners, illustrates some of the challenges that can result from the absence of clear written legal terms governing an NFT distribution.
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.