Internal Revenue Service building
Internal Revenue Service building. The Balance

The United States Internal Revenue Service (IRS) presented a new guidance on calculating taxes owed on cryptocurrency holdings.

This is the first published update in five years, since their 2014 post which unfortunately left many open questions. It was actually back in May 2019, when Commissioner Charles Rettig shared that the IRS are working on a new guidance.

The new post was made public on Wednesday and discusses how to calculate taxable earnings when selling crypto, the acceptable ways for valuing cryptocurrency received as an income and tax liabilities created by cryptocurrency forks.

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The general counsel to Athena Blockchain and lawyer Drew Hinkes commented that “from the tax collector’s standpoint, this is the right answer,” although Certified Public Accountant Kirk Phillips expressed his confusion that the post is aimed only at forks.

Doubts about forks have been resolved

The new guidance finally answered the enduring doubts about forks. According to the IRS all cryptocurrencies coming from a fork of a blockchain should be dealt as “an ordinary income equal to the fair market value of the new cryptocurrency when it is received”.

This means that tax accountability occurs if a taxpayer administers new coins that are recorded on a blockchain and can spend them.

As the post explains:

“If your cryptocurrency went through a hard fork, but you did not receive any new cryptocurrency, whether through an airdrop (a distribution of cryptocurrency to multiple taxpayers’ distributed ledger addresses) or some other kind of transfer, you don’t have taxable income.”

Executive director at Coin Center, Jerry Brito, on the other hand thinks that the language used in the guidance might create even more confusion:

“While the new guidance offers some much-needed clarity on certain questions related to calculating basis, gains, and losses, it seems confused about the nature of hard forks and airdrops.”

Brito also added:

“One unfortunate consequence of this guidance is that third parties can now create tax reporting obligations for you by simply forking a network whose coins you own, or foisting on you an unwanted airdrop.”

Hinkes confirmed that once invididuals receive an asset, they would be assessed by the IRS, adding that:

“Receipt is defined by ‘dominion and control’ … so it’s ability to transfer, sell, exchange or dispose of the asset according to this guidance…The fear is that someone maliciously airdrops and tags you with a giant liability. But [this] fear is a bit oversold because you would only be liable for new income based on the fair market value of the asset when received, and most forks don’t start out with a high valuation.”

Kirk Phillips revealed some grey spots in the article – like if a person receives a token from an airdrop without knowing it. Over time the price of the token might change that much that the person would have to pay more income tax on the asset than the actual price of it when they try and sell it. He made it clear that:

“This can happen when coins hit a high water mark of price discovery right after the airdrop event and the heavy selling could sink the price to a level from which is never recovers.”

This leads to our next question.

How to calculate what you owe?

Another long-awaited answer is to the questions of how taxpayers can find out the amount that they would have to pay when they receive coins as income, for example from the sale of products or goods.

The base of the cost is calculated by the sum of all money spent to actually obtain the asset, “including fees, commissions and other acquisition costs in U.S. dollars”.

Another clarification the IRS made is how to work out the cost basis of tokens that are, for example, sold. This might come as an issue when a person buys cryptocurrency in a couple of transactions over multiple years.

So it is now clear that the value of assets bought is decided by the amount in U.S. dollars the exchange sold it. In such cases, the basis will include all fees, commissions and other costs of the purchase.

When cryptocurrency is purchased on a peer-to-peer exchange individuals should use a crypto price index to see the fair market value. As the IRS stated:

“A cryptocurrency or blockchain explorer that analyzes worldwide indices of a cryptocurrency and calculates the value of the cryptocurrency at an exact date and time.”

When selling, individuals should publish the following information:

“(1) the date and time each unit was acquired, (2) your basis and the fair market value of each unit at the time it was acquired, (3) the date and time each unit was sold, exchanged, or otherwise disposed of, and (4) the fair market value of each unit when sold, exchanged, or disposed of, and the amount of money or the value of property received for each unit.”

Still, the new guidance disappointed people who want to spend tokens on everyday products like food of even coffee as the IRS noted that they would not allow tax discharge for transactions below a fixed threshold.

According to the IRS, paying for services via cryptocurrency leads to capital gains/losses and should be calculated as “the difference between the fair market value of the services you received and your adjusted basis in the virtual currency exchanged”.

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