IRS Tries, Fails to Explain Your Crypto Tax Liabilities After a Hard Fork

by
Will Heasman
My articles My books
Follow on:

For the first time since 2014, the Internal Revenue Service (IRS) has issued guidelines for calculating tax liabilities on hard forks; but it seems to raise more questions than it answers.

The document attempts to explain how tax obligations arise from chain-splits; however, the IRS omitted guidance for those who do not wish to receive cryptocurrencies related to a hardfork.

What the Fork?

The IRS defines tax liabilities as arising as soon as the forked cryptocurrencies come into existence on the new chain. According to the guidelines, if a taxpayer has “dominion and control,” meaning the ability to transfer, sell, and exchange the cryptocurrency, then they owe the appropriate tax.

This creates a problem grey area. In effect, communities looking to fork a cryptocurrency can create a tax obligation, regardless of whether the holder of crypto on the old chain agrees, or indeed wishes to accept the new coins.

The only situation in which a taxpayer is not liable is if the receiving exchange address doesn’t provide hardfork support.

“a taxpayer does not have dominion and control if the address to which the cryptocurrency is airdropped is contained in a wallet managed through a cryptocurrency exchange and the cryptocurrency exchange does not support the newly-created cryptocurrency”

Ironically, this creates an opportunity for tax dodging, incentivizing holders to keep their crypto on exchanges, instead of controlling their own private keys.

The Crypto Community Strikes Back

Coin Center, a non-profit crypto research firm, dedicates itself to clarifying these kinds of policy issues. In response to the IRS, the firm analogized that the new guidance as tantamount to “owing income tax when someone buries a gold bar on your property and doesn’t tell you about it.”,

The research firm suggests that a tax liability should only occur if a user chooses to transact the new funds.

Crypto Twitter wasn’t short of responses, either. Cypherpunk, and bitcoin engineer, Jameson Lopp, aired his objections to the guidance, rasing some further questions.

These glaring omissions highlight some of the fundamental issues with the inappropriate crypto policy. For example, as Lopp notes, markets shortly after a hardfork aren’t priced in, as trading hasn’t commenced. This creates a strange loophole in which holdings will be taxed at zero immediately following the fork.

Marco Santori, chief legal officer at Blockchain, highlighted another problem – this time pertaining to semantics.

Indeed, the IRS completely confuses the two terms, wrongly assumes that crypto gets airdropped after a fork. While not the most pressing of the concerns, it does show a lack of understanding from the IRS’s side.

As for a resolution, its taken five years to get to this point, it’s unlikely that we’ll see any soon. Regardless, crypto aficionados may find some comfort in the fact that the IRS has finally provided some clarity.