New Revenue Rule on Crypto

Disclaimer

The new rule (Rev. Rule 2019-24) can be found here.  It has not yet been published in an Internal Revenue Bulletin, but presumably will be soon.  There has also been an update to the IRS's FAQs on Crypto located here.

The point of the new Rev. Rule is to address what happens when you receive a new series of tokens in connection with a hard fork (you have taxable ordinary income once you can trade the tokens received).

However, there are a number of other statements in the ruling that were interesting.

  • First, there had been some ambiguity before as to whether you had taxable income if the protocol changed in a material way, but you simply kept the same number of tokens.  This Rev. Rule now clearly says that such a change is not a taxable event -- apparently even if the network changes dramatically, say from an ERC-20 network to something else.  I believe that conclusion supports the suggestion elsewhere in this blog that Crypto Sponsors should create a genesis block to hold the "founders' share" as early as possible even if the protocol is still in development and likely to undergo significant changes (because those changes won't be treated as taxable events).

  • Second, it was previously unclear when you had to recognize taxable income if you were credited with tokens, but the tokens were locked up.  The Rev. Rule appears to say that if you receive tokens other than in connection with the performance of services and use the "cash method of accounting," you have income only once the Token is tradable -- which not only implies that all lock ups or smart contract restrictions have expired, but also that the crypto currency exchange that manages the wallet holding the tokens supports trading in those tokens.  The Rev. Rule specifically says:

"For example, 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 such that the airdropped cryptocurrency is not immediately credited to the taxpayer’s account at the cryptocurrency exchange. If the taxpayer later acquires the ability to transfer, sell, exchange, or otherwise dispose of the cryptocurrency, the taxpayer is treated as receiving the cryptocurrency at that time."  

Its not clear if that conclusion applies to tokens received as dividends on corporate equity, or upon an exchange of tokens for other tokens, but the same logic should apply (the IRS's publication on sales or exchanges, (544) specifically says, "You do not constructively receive money or unlike property if your control of receiving it is subject to substantial limitations or restrictions. However, you constructively receive money or unlike property when the limitations or restrictions lapse, expire, or are waived."
  • Finally, it's worth pointing out that income from a hard fork is ordinary income.  That conclusion would suggest that  income from staking and income from an inflationary issuance is also ordinary.  Not only is ordinary income taxed at higher rates than capital gains income, but it is more likely to be treated as UBTI (bad for tax exempt holders) or as "Effectively Connected Income" (bad for foreign holders with US activities).  There are lots of other factors that must be present to cause such adverse treatment, but the risk is higher for ordinary income than it is for capital gain income.  The ruling does not specifically address these issues, but it will likely be a factor in the relevant determination.

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