Image by USAF illustration/Sr. Airman Courtney Witt / CC BY 2.0
The IRS has issued some long-awaited tax guidance on virtual currencies. The new guidance comes on the back of the agency’s recent efforts to educate taxpayers on their tax-reporting obligations arising from the receipt, use, and disposition of crypto.
This crypto tax guidance also comes with the first official ruling from the IRS regarding cryptocurrencies. Note that a revenue ruling constitutes an official interpretation by the IRS, a document that every taxpayer can refer to.
In summary, this is what the IRS released:
- A revenue ruling that answers two key questions
- A list of FAQs and answers that build on the first guidance given in 2014
You can learn a lot from the document and by going through the FAQs to understand exactly what the agency says about basis, fair market value, capital gains/losses, crypto gifts and donations, and overall tax reporting requirements.
In general, here is what will likely stand out.
- Crypto tax liabilities resulting from hard forks and airdrops
- Crypto events taxable as income, gain/loss
- How to record and value crypto-related income
Hard forks and airdrops gain some clarity
In its revenue ruling, the IRS outlined the tax treatment of cryptocurrencies and what taxpayers should expect as a result of a hard fork or airdrop.
Here the IRS addresses two questions:
- Does a taxpayer have gross income under § 61 of the Internal Revenue Code (Code) as a result of a hard fork of a cryptocurrency the taxpayer owns if the taxpayer does not receive units of a new cryptocurrency?
- Does a taxpayer have gross income under § 61 as a result of an airdrop of a new cryptocurrency following a hard fork if the taxpayer receives units of new cryptocurrency?
Regarding the first question, the IRS maintains that a taxpayer would not generate a gross income if they do not receive new coins resulting from the hard fork. In the second instance, a taxpayer indeed has a gross income because they receive new cryptocurrencies from the airdrop that comes as a result of the hard fork.
What the IRS means is:
If you hold a cryptocurrency and the ledger splits but you do not receive any new wealth, then you haven’t added any income that needs to be taxed. However, if you add to your wealth by way of new coins, then that is income that constitutes a taxable event.
For you to be taxed on the new coins, you need to have received the coins in your possession. For ex. If the coins are being held by your exchange and have not been credited to your account yet then theres no income.
This also raises questions around how unwelcome hard forks could result in tax obligations even if you have no intentions of using them.
Not a whole lot has changed in terms of what is taxable
The IRS built on previous guidance by confirming that convertible virtual currency is a capital asset. It essentially affirmed the fact that capital gains laws apply to taxable events resulting from certain crypto transactions.
You incur capital gains or losses when you sell or dispose of your crypto holdings in any way. These details outlined in Schedule D.
Crypto received for services is considered income. If it comes from an independent contractor, then it’s taxed under the self-employment tax, while if the crypto is received as payment for compensation, it falls under federal income tax.
There is no taxable event when you transfer cryptocurrencies to a different wallet, address, or account that belongs to you.
If you use crypto to pay for goods, you attract a capital gain or loss. This is true regardless of the amount involved in U.S dollars.
Account for and value income from crypto
The IRS guidance also clarified the issue of how we calculate and arrive at a cost basis and fair market value when reporting crypto income, gain, and loss.
If you have bought cryptocurrency, then your calculated cost basis is the total value or amount spent on that crypto. Here, the taxpayer is being asked to note all the fees and other charges that go into buying the asset and then denominating that in U.S. dollars.
The same principle applies when determining the cost basis and fair market value of sales or other taxable events. Taxpayers can now use the value of an item, as sold to them on the exchange, including any fees or commissions involved.
If it’s not an exchange, let’s say a peer-to-peer platform instead, then the IRS allows taxpayers to use the values calculated by a blockchain explorer.
This guidance reveals that a taxpayer must have the correct records to show exact dates and times of purchase and sale. Details on fair market value and cost basis, as well as the value of the sale, are also very important to hold onto.
The Bottom Line
Interpreting IRS guidance is only one part of figuring out crypto taxes and answering your tax questions. While experts are always at hand to give a simplified version, the majority of what needs to happen falls on you as an individual taxpayer – take the initiative and make sure you’re doing everything right. If you still need clarity on regulations around crypto taxes don’t hesitate in consulting a crypto tax accountant.
Community contribution by Robin Singh, the co-founder and CEO of Koinly.io – a cryptocurrency tax solution that solves capital gains reporting for crypto investors by automatically generating tax reports like Form 8949.