Although crypto airdrops are often considered “easy money,” they also come with responsibilities.
In recent months, projects like the Ethereum Naming Service (ENS) and LooksRare have delivered ENS and LOOKS tokens to their users, respectively. Both token networks are now worth hundreds of millions of dollars in market capitalization. These airdrops have managed to turn users into ardent actors. As more projects continue to drive decentralization, we anticipate more airdrops in 2022 and beyond.
This article is part of Tax Week. Miles Brooks, CPA, is Director of Tax Strategy at CoinLedger.
Investors who receive airdrops should be aware of the tax implications of their newly earned tokens to avoid unpleasant surprises from the IRS.
Most of the time, recording airdrops is easy. When you receive an airdrop, you recognize revenue equal to the fair market value of the tokens received at the time you receive them.
Has the IRS issued airdrop tax guidelines?
The IRS has defined and used the term airdrop in the official tax guide (in Revenue Resolution 2019-24). However, the word “airdrop” has only been used in relation to airdrops that follow a cryptocurrency hard fork. The agency did not provide an official word on how all airdrops should be taxed. Most tax experts agree that when you receive an airdrop, the IRS will consider that income to be included on your tax return.
How do I calculate my airdrop earnings?
To determine the fair market value of your airdrop rewards, look at what price the tokens are trading at when you receive them. Sometimes there is no immediate price data available for early token projects. If so, calculate fair market value when a market is readily available.
When should I recognize airdrop revenue?
In some cases, it can be difficult to know exactly when you will "receive" tokens. This usually happens when you control the asset, or in other words, when you are free to move or trade your tokens.
How do I report Airdrop rewards on my taxes?
If the price of your tokens is based on the value of another cryptocurrency such as ether, you will need to convert the price to US dollars to report it on your tax return. In general, airdrop income should be reported as "Other Income" on Schedule 1.
Are airdrop rewards re-taxed if I decide to sell?
If you decide to sell your airdrop rewards, you will incur a capital gain or loss at the time of sale. It is important to note that you do not pay taxes twice on the same income. Instead, you incur ordinary income when you first airdrop and capital gains income once you sell, depending on how the price of your tokens has changed since the airdrop.
For example, imagine that you receive €1,000 in UNI from the Uniswap protocol. The value of his tokens then increases to €1,500 and he decides to sell. In this case, you would recognize €1,000 of ordinary income from the airdrop and €500 of capital gain from the disposition of the tokens.
How do I determine my base cost when I sell my rewards?
If you decide to get rid of airdrop rewards in the future, you will need to know the base cost of your tokens. For airdrop proceeds, this is the value of your tokens at the time you received them, plus any relevant fees.
In the example above, by raising €1,000 in airdrop revenue, that €1,000 becomes your cost basis for those tokens going forward. You can increase your base by including gas costs spent to claim the airdrop.
What happens if the value of your airdrop rewards drops significantly?
Your tax due is based on the fair market value of the airdrop when you receive it. If the value of your tokens drops significantly, you could be liable for a large tax bill that you may not be able to pay.
To avoid this scenario, it is recommended that you set aside a portion of your rewards when you receive your airdrop to cover the associated tax bill.
Many investors convert some of their airdrop revenue into stablecoins when they receive it, then find protocols that offer rewards of interest. In this way, investors can be prepared for tax season while earning passive income.
What we don't yet know about airdrop taxes
A difficult part of taxing airdrops is that their execution has changed over time and will continue to change. Some airdrops must be claimed and may only be available under certain circumstances, while others are automatically distributed to owners of a specific room. The IRS has yet to issue guidance on each of these specific situations.
Potential problems for taxpayers arise with unsolicited airdrops. The airdrop may appear on the blockchain, but in certain circumstances a true "receipt" may not occur. For example, should you be required to report income from an airdrop if you don't even know you received it?
Because of the nuances airdrops can have and because they are likely to continue to evolve as a tool in the future, it will be very difficult for the IRS to issue timely and reasoned advice on airdrops.
You should speak to a tax advisor if you have questions about how your airdrop should be taxed. Everyone's circumstances are different, and you will benefit from the approach that works best for you.
Will the way airdrops are taxed change in the future?
Even without explicit IRS guidelines, there is a general consensus among tax experts that the IRS will treat airdrops as income when received.
It is clear that the current framework for taxing airdrops on reception poses problems. Could there be a simple alternative, imposed from the air not on receipt but only on disposal?
The IRS is unlikely to voluntarily agree to such a deferral of income, so for now, taxpayers who receive airdrops will have income upon receipt and will be forced to navigate through the uncertainty that comes with taxing airdrops, an emerging asset.
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