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Cryptocurrency Guidance, Virtual Currency FAQs Released

The IRS has released cryptocurrency guidance and frequently asked questions (FAQs) on virtual currency. Under the cryptocurrency guidance:

  • a taxpayer does not have gross income from a “hard fork” of the taxpayer’s cryptocurrency if the taxpayer does not receive units of a new cryptocurrency and
  • a taxpayer has ordinary income as a result of an “airdrop” of a new cryptocurrency following a hard fork if the taxpayer receives units of the new cryptocurrency.

The IRS also has the FAQs posted on its website.

Virtual Currency and Cryptocurrency

Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and a store of value other than a representation of the U.S. dollar or a foreign currency.

Cryptocurrency is a type of virtual currency that uses cryptography to secure transactions that are digitally recorded on a distributed ledger, such as a blockchain. Distributed ledger technology uses independent digital systems to record, share, and synchronize transactions, the details of which are recorded in multiple places at the same time with no central data store or administration functionality.

Hard Forks and Air Drops

A hard fork 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.

An 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. Note, however, that a hard fork is not always followed by an airdrop.

Cryptocurrency from an airdrop generally is received on the date and at the time it is recorded on the distributed ledger. However, while a taxpayer may constructively receive cryptocurrency prior to the airdrop being recorded, the taxpayer has not officially received the cryptocurrency when the airdrop is recorded if the taxpayer is not able to exercise dominion and control over the cryptocurrency.

Gross Income

If the taxpayer did not receive units of new cryptocurrency from a hard fork, the taxpayer does not have an accession to wealth and does not have gross income as a result of the hard fork.

If the taxpayer receives units of new cryptocurrency from an airdrop following a hard fork, the taxpayer received a new asset. Therefore, the taxpayer has an accession to wealth and has ordinary income in the year in which the taxpayer receives the new cryptocurrency. The taxpayer includes the fair market value of the new cryptocurrency in gross income. The taxpayer’s basis in the new cryptocurrency is the amount of income recognized.

Schedule 1, Form 1040 for 2019

A draft of the 2019 Form 1040, Schedule 1, “Additional Income and Adjustments to Income,” includes a question which asks: “At any time during 2019, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?” If an individual has engaged in any virtual currency transaction in 2019, he or she must check the “Yes” box next to the question.

If taxpayers have disposed of any virtual currency held as a capital asset, they must use Form 8949 to figure the capital gain or loss and report it on Schedule D (Form 1040 or Form 1040-SR). If taxpayers have received any virtual currency as compensation for services, or disposed of any virtual currency held for sale to customers in a trade or business, they must report the income as they would report other income of the same type.

For more information about this article, please contact our tax professionals at taxalerts@windes.com or toll free at 844.4WINDES (844.494.6337).

 

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