On October 9, 2019, the Internal Revenue Service (Service) released Revenue Ruling 2019-24. The revenue ruling considers whether taxpayers should realize gross income under two common scenarios involving cryptocurrency and includes a number of illustrative examples. The Service concluded that a so-called “hard fork” on a cryptocurrency blockchain does not create taxable income if a taxpayer does not subsequently receive new units of cryptocurrency, but taxable ordinary income is generated by “airdrops” following a hard fork that delivers new units of cryptocurrency to a taxpayer.
For purposes of the revenue ruling, a “hard fork” occurs when a cryptocurrency on a distributed ledger undergoes a protocol change resulting in a permanent diversion from the legacy or existing distributed ledger. A hard fork may result in the creation of a new cryptocurrency on a new distributed ledger in addition to the legacy cryptocurrency on the legacy distributed ledger. Following a hard fork, transactions involving the new cryptocurrency are recorded on the new distributed ledger and transactions involving the legacy cryptocurrency continue to be recorded on the legacy distributed ledger. The Service defines an airdrop as a means of distributing units of a cryptocurrency to the distributed ledger addresses of multiple taxpayers. A hard fork followed by an airdrop results in the distribution of units of the new cryptocurrency to addresses containing the legacy cryptocurrency. However, the Service acknowledges that a hard fork is not always followed by an airdrop. These descriptions generally comport with market practice.
In a related press release, the Service observed that it is aware that some taxpayers with cryptocurrency transactions may have failed to report income and pay the resulting tax or did not report their transactions properly. It noted that in July the Service announced that it began mailing educational letters to more than 10,000 taxpayers who may have reported transactions involving virtual currency incorrectly or not at all. The Service also warned that taxpayers who did not report transactions involving cryptocurrency or who reported them incorrectly may, when appropriate, be liable for tax, penalties and interest. Ominously, the Service concluded with the warning that in some cases, taxpayers could even be subject to criminal prosecution.
Finally, in connection with the revenue ruling, the Service also updated its FAQs on the federal taxation of cryptocurrency transactions.