The View of the Internal Revenue Service (IRS)
In October 2019, the IRS released their latest updates in frequently asked questions on virtual currency transactions (FAQ) and Revenue Ruling 2019-24. This release provides additional guidance to its prior notifications from back in 2014 (IRS 2014-21, Virtual Currency Guidance) and focuses on specific transactions related to “hard forks” and “air drops”.
The IRS describes a Hard Fork as a protocol change following a permanent change of a cryptocurrency’s distributed ledger and an Air Drop as a method of distributing specific tokens of a cryptocurrency to the distributed ledger addresses of multiple users.
While the regulatory framework surrounding virtual currencies continues to evolve, the IRS has maintained that virtual currencies are considered property and that taxation regulations still apply. In the case of Hard Forks and Air Drops, the IRS attempts to address the issues of when income should be recognized based on whether or not the taxpayer has “dominion and control” over the tokens. Furthermore, once “dominion and control” is established by the taxpayer, nuances related to the determination of the fair market value of the tokens is even more important when calculating taxable income.
From an issuers point of view, these tokens that are distributed to employees, advisors, or board members as part of any transaction (including Hard Forks and/or Air Drops) have potential tax consequences. As illustrated by the guidance, such distributions can be taxed as compensation by the IRS (e.g. federal and state income tax withholding, federal insurance contributions act taxes, federal unemployment taxes, etc.). Depending on the size of the distributions, the potential tax liabilities could be significant to both the company and the individuals to whom the tokens are distributed. Furthermore, penalties at as much as 15% may apply if tax payments are not made in a timely manner (Internal Revenue Service Publication 15, Employer’s Tax Guide).
How can we help?
Teknos Associates provides valuation and advisory services for emerging growth companies and their venture capital backers. We have extensive experience in the blockchain and digital currency industries and bring a unique understanding of the key valuation issues these firms face on a daily basis. Our vast experience includes providing analyses related to tax, financial reporting, and strategic planning. To learn more, contact Teknos Associates at info@teknosassociates.com.
Special Note: From time to time, Teknos Associates has been retained by the Internal Revenue Service to perform valuation services. However, nothing in this communication may be taken to represent the official position or policy of the IRS. The opinions expressed herein are those only of Teknos Associates.
IRS Circular 230 Disclaimer: Pursuant to regulations governing the practice of attorneys, certified public accountants, enrolled agents, enrolled actuaries, and appraisers before the Internal Revenue Service, unless otherwise expressly stated, any U.S. federal or state tax advice in this communication (including attachments) is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of (i) avoiding penalties that may be imposed under federal or state law or (ii) promoting, marketing, or recommending to another party any transaction or tax-related matter(s) addressed herein.
Tax Implications for Virtual Currency Transactions
The View of the Internal Revenue Service (IRS)
In October 2019, the IRS released their latest updates in frequently asked questions on virtual currency transactions (FAQ) and Revenue Ruling 2019-24. This release provides additional guidance to its prior notifications from back in 2014 (IRS 2014-21, Virtual Currency Guidance) and focuses on specific transactions related to “hard forks” and “air drops”.
The IRS describes a Hard Fork as a protocol change following a permanent change of a cryptocurrency’s distributed ledger and an Air Drop as a method of distributing specific tokens of a cryptocurrency to the distributed ledger addresses of multiple users.
While the regulatory framework surrounding virtual currencies continues to evolve, the IRS has maintained that virtual currencies are considered property and that taxation regulations still apply. In the case of Hard Forks and Air Drops, the IRS attempts to address the issues of when income should be recognized based on whether or not the taxpayer has “dominion and control” over the tokens. Furthermore, once “dominion and control” is established by the taxpayer, nuances related to the determination of the fair market value of the tokens is even more important when calculating taxable income.
From an issuers point of view, these tokens that are distributed to employees, advisors, or board members as part of any transaction (including Hard Forks and/or Air Drops) have potential tax consequences. As illustrated by the guidance, such distributions can be taxed as compensation by the IRS (e.g. federal and state income tax withholding, federal insurance contributions act taxes, federal unemployment taxes, etc.). Depending on the size of the distributions, the potential tax liabilities could be significant to both the company and the individuals to whom the tokens are distributed. Furthermore, penalties at as much as 15% may apply if tax payments are not made in a timely manner (Internal Revenue Service Publication 15, Employer’s Tax Guide).
How can we help?
Teknos Associates provides valuation and advisory services for emerging growth companies and their venture capital backers. We have extensive experience in the blockchain and digital currency industries and bring a unique understanding of the key valuation issues these firms face on a daily basis. Our vast experience includes providing analyses related to tax, financial reporting, and strategic planning. To learn more, contact Teknos Associates at info@teknosassociates.com.
Special Note: From time to time, Teknos Associates has been retained by the Internal Revenue Service to perform valuation services. However, nothing in this communication may be taken to represent the official position or policy of the IRS. The opinions expressed herein are those only of Teknos Associates.
IRS Circular 230 Disclaimer: Pursuant to regulations governing the practice of attorneys, certified public accountants, enrolled agents, enrolled actuaries, and appraisers before the Internal Revenue Service, unless otherwise expressly stated, any U.S. federal or state tax advice in this communication (including attachments) is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of (i) avoiding penalties that may be imposed under federal or state law or (ii) promoting, marketing, or recommending to another party any transaction or tax-related matter(s) addressed herein.