Expanding on guidance from 2014, the IRS is issuing additional detailed guidance to help taxpayers better understand their reporting obligations for specific transactions involving virtual currency. The new guidance includes Revenue Ruling 2019-24 and 43 frequently asked questions (FAQs).
Among the answers addressed in the FAQs include what virtual currency and cryptocurrency is; how to calculate gains or losses when selling virtual currency for real currency or property; how to determine a cryptocurrency’s fair market value; and more.
“The IRS is committed to helping taxpayers understand their tax obligations in this emerging area,” said IRS Commissioner Chuck Rettig. “The new guidance will help taxpayers and tax professionals better understand how longstanding tax principles apply in this rapidly changing environment. We want to help taxpayers understand the reporting requirements, as well as take steps to ensure fair enforcement of the tax laws for those who don’t follow the rules.”
The new revenue ruling and FAQs “clarify that if a virtual currency issuer undertakes a change in its ledgering system, which causes the distribution of a new crypto currency to the taxpayer, the receipt of that currency will be treated as income in the year the new currency is under the control of the recipient and can be used in a future exchanges,” explains James Mastracchio, partner and head of law firm Eversheds Sutherland’s federal tax controversy and criminal tax practices.
“This is commonly referred to as a ‘hard fork’ event with a distribution (or airdrop),” Mastracchio says. “If the hard fork does not result in the issuance of a new virtual currency to the taxpayer, there is no taxable event associated with the ledger change.”
The FAQs provide expanded guidance on these points and clarify that the taxpayer may use FIFO (First in, First Out) or specific identification to identify virtual currency basis when computing gain or loss on the distribution of a virtual currency. The requisite holding periods and documentation required for each method is described in detail in the FAQ.
“The new rules emphasize that the taxpayer has the burden to track basis in virtual currency and the taxpayer must monitor transactions involved in the virtual currency markets, including hard forks, which may or may not have been requested by the taxpayer,” Mastracchio says. “That is, certain issuers can change its ledgering system and issue a new currency without the consent of the taxpayer, but the receipt of such currency is a taxable event, and the taxpayer must track and report such activity.”
The new guidance supplements IRS guidance issued on virtual currency in Notice 2014-21. The IRS is also soliciting public input on additional guidance in this area.
In Notice 2014-21, the IRS applied general principles of tax law to determine virtual currency is property for federal tax purposes. The Notice explained, in the form of 16 FAQs, the application of general tax principles to the most common transactions involving virtual currency.
The IRS is aware some taxpayers with virtual currency transactions may have failed to report income and pay the resulting tax or did not report their transactions properly. The IRS is actively addressing potential non-compliance in this area through a variety of efforts, ranging from taxpayer education to audits to criminal investigations.
For example, in July 2019, the IRS announced it began mailing educational letters to more than 10,000 taxpayers who may have reported transactions involving virtual currency incorrectly or not at all. Taxpayers who did not report transactions involving virtual currency or who reported them incorrectly may, when appropriate, be liable for tax, penalties, and interest. In some cases, taxpayers could be subject to criminal prosecution.
“The Revenue Ruling and the FAQs provide helpful guidance, which has been requested by stakeholders for several years and provides a step-by-step analysis for taxpayers and their tax advisors,” Mastracchio says. “The guidance also provides examples of when and where to report the virtual currency transactions depending on whether the transaction is deemed an exchange, wages, or distribution.”
“The new rules certainly apply to those filing 2018 tax returns on extension and for 2019 forward,” Mastracchio adds. “The guidance should be followed for those needing to correct prior year non-compliance as well. A tax advisor who has experience in virtual currency issuances, wallets, airdrops, and hard and soft forks can assist in ensuring proper and timely federal tax reporting.”