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.

Comments

Post a Comment

Popular posts from this blog

Should I sell my Tokens and realize a loss before year end?

Disclaimer     I have now been asked almost a dozen times about the "Wash Sale Rules" and whether token holders should sell and repurchase tokens before year end. The Wash Sale rules (IRC Section 1091) provide that if you sell a security at a loss and repurchase a substantially identical security within 30 days, your loss will be disallowed (and added to your tax basis in the purchased security). People have been hearing that the Wash Sale rule doesn't apply to tokens because the IRS has not designated tokens as securities.  (Remember that the characterization of tokens as securities by the SEC or as something else by the CFTC is not relevant for tax law purposes.  Tokens may be securities for some purposes and not for others.) If that's true, you could sell your BTC today and buy back BTC an hour later and trigger a loss that you can use to offset capital gain (or up to $3,000 of ordinary income) from some other source. That's a very reasonable argument
Read more

1. So you want to do an ICO

Disclaimer The number of token offerings through ICOs or otherwise that have crossed my desk in the last 12 months has exploded.  Many of those transactions have been put together with such speed that corporate structure and tax treatment are an afterthought with expensive consequences.  Even now, most of the focus seems to be on the securities law treatment of Tokens.  The following is a brief outline of some issues that are worth considering -- primarily in order to avoid adverse tax issues for founders, issuers and investors.  Following posts will discuss different structures mentioned below in greater detail. Before we get to actual structures, however, it's important to understand what kinds of adverse things can happen to you.  Many people think that selling Tokens should be taxed the same way as a stock sale is taxed -- but there is a specific Internal Revenue Code section that provides stock sales are tax free -- and it doesn't apply to Token sales. TAXATION OF TO
Read more

New Revenue Ruling on Staking Income

  Disclaimer On August 1, 2023, the IRS issued a new Revenue Ruling ( Rev. Rul. 2023-14 ) holding that income received from delegating tokens to a validator (" Staking Income ") is taxable at the time the taxpayer has "dominion and control" over the newly received tokens. No one I know thought that was a surprise.  Arguments that staked tokens were like self created intellectual property or agricultural produce (and therefore not taxable until sold) were theoretically possible (and certainly seem to apply to genesis block tokens held by founders), but they were always a stretch.  Arguments that tokens received from staking were like stock splits or simply inflationary (slicing the pizza into more pieces) denied Treasury's fundamental need to have a clear measurement date and benchmark. The meaning of "Dominion and Control" is discussed in Rev. Rule 2019-24, which can be found here , in the context of hard forks, but if there ever was any doubt, the ne
Read more