Tax struggles are real. If you’re an Ethereum holder in the United States, you may owe taxes for receiving an airdrop you likely didn’t want.
In September 2022, the Ethereum network migrated from using the Proof-of-Work consensus method to Proof-of-Stake. As a result, disgruntled Ethereum miners created their own fork of the Ethereum blockchain that continued to rely on Proof-of-Work. Their ‘new’ coin, ETHW, was airdropped to existing Ethereum holders.
The Ethereum Proof-of-Work (ETHPoW) fork illustrates why crypto tax policy in the United States needs reform. While countries like Australia, the United Kingdom, and Germany will treat the fork as non-taxable, American ETH holders may be required to pick up ETHW as income — whether they want the airdrop or not.
Is the Ethereum Merge taxable?
Generally, there’s no taxable event for simply holding your cryptocurrency. The same concept applies for holding your Ethereum through the Merge.
In this case, no new token is created and the old chain ceases to exist. Your basis and acquisition date in any ETH you own would stay the same and carry-over to your upgraded ETH tokens.
How the IRS will treat the ETHPoW fork
If you received ETHW from the fork event, you’ll be required to pick up income based on the fair market value of the coins at the time of receipt.
In the United States, the IRS has issued guidance for how to treat the receipt of a new token as a result of a hard fork. The guidance is clear: if you receive a new token as a result of a hard fork, you have income to pick up equal to whatever the fair market value is at the time of receipt.
Tax: The problem with the U.S. crypto tax policy
The U.S. approach to taxation of hard forks – income when the token is first received – is problematic for many reasons.
The vast majority of ETH users will never participate in this forked PoW chain. For users who want to use the main Ethereum chain, there is no need for the forked ETHW tokens. As a result, many users will have new tokens on which they have to pay tax without ever wanting or needing the new token.
Many investors will likely choose to sell ETHW at the first available opportunity to cover their tax bill. But for many more users who receive these tokens and don’t sell, the token price could very well severely drop in price by the end of the year, leaving users with a token value that no longer covers the tax bill from the original receipt of the ETHW tokens.
It’s clear that there’s a tax policy issue when investors are forced to recognize income from tokens never wanted and likely will never use. It’s worse still when users are forced to sell their holdings in order to cover their tax bill – which creates yet another taxable event.
A better example of crypto tax policy
Countries like Australia, United Kingdom, and Germany all take a much more measured and nuanced approach towards the tax treatment of airdropped tokens.
In these countries, you recognize income as a result of airdrops that you claim, or that you earn through advertising to followers on social media. This makes sense, as you put effort into obtaining these new tokens.
However if you receive a “spam” or unsolicited airdrop, in which you did nothing to receive such tokens, there is no income to pick up. As a result, cryptocurrency investors do not need to pay tax on tokens they have no intention of ever using.
While there is no income for unsolicited airdrops and hard forks when these tokens are received, it is important to note that they are taxed when they are sold (however Germany does not tax tokens held for longer than a year).
In conclusion
It’s clear that the tax policy that makes the most sense is to wait to impose tax until investors sell their ETHW – because it’s not until the tokens are sold that the taxpayer has the ability to pay.
While the IRS is unlikely to update their guidance in favor of good tax policy in this situation, Congress has the power to change the laws as to how crypto hard forks and airdrops are to be taxed in the United States. It’s another reminder as to the importance of having pro-crypto policy-makers as we enter this new phase of government regulation of crypto around the world.
About the author
Miles Brooks is a Certified Public Account and is the Director of Tax Strategy at CoinLedger, a cryptocurrency tax software platform built to automate the entire crypto tax reporting process. Miles is a crypto tax expert and has been working with the taxation of cryptocurrencies since 2017.
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