Ever Heard of Crypto Airdrops Tax? Here's What Investors Should Know
11 January 2023taxes
Summary : Have you ever done something as simple as receiving "free" crypto from an airdrop without hesitation? A cryptocurrency airdrop is a form of marketing that involves distributing coins or tokens to wallet addresses. In the simplest terms, it's like an online lottery. Individuals purchase tiny amounts of a new virtual currency for free or in return for a modest service, such as retweeting a post from the firm that created the currency. The ultimate objective of a crypto airdrop is to boost public awareness and usage of a new cryptocurrency or coin. So, are Crypto Airdrops Taxed? Let's have a look.
In this blog:
- What Are Airdrops?
- What Are The Tax Implications Of Airdrops?
- What If You Don't Want To Pay Taxes On Airdrops?
- Airdrop Taxes
- Where Do You Report Airdrop Rewards On Your Tax Return?
- When Should You Recognize Income From Airdrops?
- Airdrop Rewards With Zero FMV
- How Would You Go About Claiming Airdrop Rewards?
- Are Airdrops Income Taxed Twice?
- What If You Gave Away Your Airdrop Rewards?
- How Does Reporting Taxes On Airdrops Work?
- How Do You Determine The Cost Basis For Your Airdrop?
- Understanding Taxes On NFT Airdrops
- General Issues With Airdrops
- Your Airdropped Tokens' Value Has Dropped Considerably.
- You Received Airdrops that You Did Not Want.
- You Lost Your Money In An Airdrop Scam.
- How Will The IRS Know If You Got An Airdrop?
- File Your Crypto Taxes In Just Minutes
- Airdrop Taxes Calculation With CRPTM
- Endnote on Crypto Airdrop Taxes
Although an airdrop can result in cryptocurrency users receiving thousands of dollars worth of value instantly, it also comes with an associated tax liability.
More and more cryptocurrency projects are airdropping tokens to users as a way of rewarding early adopters. While this can be great, it can also cause some headaches for investors come tax season.
The IRS provides specific guidance on airdrop taxes, and we detail that information here. We also share some advice for preventing any difficulties.
What Are Airdrops?
An airdrop in cryptocurrency refers to the act of giving coins or tokens to many different wallet addresses. Blockchain ventures that wish to promote awareness and adoption of their currency or token conduct airdrops.
Users can often claim airdropped tokens by holding a certain amount of another cryptocurrency, such as Bitcoin or Ethereum. For example, if you held 1 BTC during a snapshot date, you may be eligible to receive 100 free ABC tokens.
Airdrops can also be carried out in return for performing certain tasks, such as retweeting a post or joining a Telegram group.
Airdrops are a common practice among successful cryptocurrency projects. In September 2020, the popular decentralized finance (DeFi) project Maker (MKR) airdropped $12 million worth of its governance token to users that held Ethereum. This was to incentivize people to use and become familiar with the Maker platform.
In December 2019, another DeFi project, Compound (COMP), airdropped COMP tokens to all Ethereum addresses that had a balance greater than 0 ETH. Over time, the value of these COMP tokens has increased dramatically, providing huge returns for early recipients.
What Are The Tax Implications Of Airdrops?
The IRS recognizes an airdrop as income at its fair value when you receive it. Also, airdrops are not considered taxable income until the individual has control over the token.
The IRS has finally issued guidance on how to tax crypto airdrops and hard forks. According to its 2019 crypto tax guidelines, both are taxed as ordinary income, at the market value of the asset when you received and took control of it. So if you receive tokens from an airdrop—whether willingly or not—you must report them during tax season.
This means that if you are receiving any coin and you are not paying anything for it then it should be taxable event except gift received.
The same principles apply to forks of other cryptocurrencies. So, for example, if you held Bitcoin during the Bitcoin Cash fork, you would need to report this as taxable income.
What If You Don't Want To Pay Taxes On Airdrops?
There are a few options available if you don't want to pay taxes on your airdrop.
First, you could move your cryptocurrency into a tax-deferred account such as a traditional or Roth IRA. This would allow you to grow your investment without paying taxes on capital gain until you retire. However, there are some contribution limits that you need to be aware of before taking this route.
Second, you could donate your airdropped cryptocurrency to a qualified charity. This would allow you to take an itemized deduction for the full value of your donation on your tax return.
Finally, you could simply hold onto your cryptocurrency and wait until you sell it before paying any taxes. This is only an option if you don't mind deferring your taxes, as you will eventually have to pay capital gains taxes on any profits when you do sell.
Investors in cryptocurrency are accustomed to only reporting taxes when they dispose of their assets, such as by selling or trading them. However, it’s important to keep in mind that airdrops need to be reported as income even if there is no disposal event.
Where Do You Report Airdrop Rewards On Your Tax Return?
Airdrops are a great way for companies to distribute free cryptocurrency to their investors. Most investors should record airdrop incentives on Schedule 1 of Form 1040 as "Other Income." A line item should include something like "cryptocurrency airdrop" as part of the description.
When Should You Recognize Income From Airdrops?
When you should recognize income from an airdrop in some instances isn't clear. Let's look at a few of the most typical situations where this might be an issue.
If an airdrop is structured as a giveaway or bounty program, then it's generally considered income in the year you receive it.
This is because, unlike a typical investment where you provide capital and then hope to see returns later, with a giveaway or bounty program you usually don't have to do anything other than hold onto your cryptocurrency to receive the airdrop.
However, if the airdrop is structured as an investment, then the income should be reported when you dispose of the asset.
For example, if you need to purchase tokens in order to participate in an airdrop, then this would be considered an investment. In this case, you would only recognize income when you sell or trade the tokens you receive from the airdrop.
Another example would be if the airdrop is structured as a loan. In this case, the income should be reported when the loan is repaid.
As you can see, the timing of when to report income from an airdrop can vary depending on the specific circumstances. If you're not sure when to report your airdrop income, it's always best to speak with a tax professional.
Airdrop Rewards With Zero FMV
Your airdrop rewards may not have an equitable market value when you acquire them, since they are not yet actively traded. If you find yourself in this scenario, you can use the fair market price at the time a market starts to emerge.
How Would You Go About Claiming Airdrop Rewards?
It can be tricky to tell when you first obtained your cryptocurrency and what its fair market value was at the time, which then impacts how much income you should report.
For example, some airdrops necessitate that users pay a gas fee to receive their benefits. The IRS has not provided specific instructions on whether crypto investors should report income when the airdrop becomes available or when the rewards are claimed. However, it is generally advisable to claim your rewards as soon as possible to avoid any potential penalties.
The IRS is most likely going to need investors to report income when they attain "dominion and control" of their assets -– in other terms when they are able to freely sell or trade their tokens. The precise moment when investors gain "dominion and control" may differ based on the airdrop's specific mechanisms.
If you're not sure when to report your airdrop income on your taxes, talk to your tax professional about it.
Are Airdrops Income Taxed Twice
Airdropped tokens are taxed the same way as any other type of token, but you are only taxed once on this income.
Airdrop rewards are taxed as income, based on their fair market value upon receipt. If you later sell them, you will only have to pay capital gains or losses taxes according to the tokens' price change since you received them.
However, it’s always best to speak with a tax professional about your specific situation.
What If You Gave Away Your Airdrop Rewards?
If you give away your airdrop rewards, you may still be considered to have disposed of them and thus may be subject to capital gains taxes. This is because the IRS considers giving away cryptocurrency as a form of selling it.
For instance, let’s say you receive $100 worth of tokens from an airdrop. A few months later, the value of those tokens increased to $1,000. If you give half of tokens away $500 worth of those tokens as a payment to the service , you will need to pay capital gains taxes on the $450(500-50).
Of course, there are always exceptions to the rule. If you give away your airdrop rewards to a qualified charitable organization, you may be able to deduct the value of the donation from your taxes. Consult with a tax professional to see if this is an option for you.
How Does Reporting Taxes On Airdrops Work?
You report any gains or losses from the sale or exchange of an airdropped token in the same way as you would for any other type of token. However, you are not taxed twice on the same income.
Airdrop rewards, as mentioned before, are taxed like any other income according to their fair market value at the time of receipt. If you sell them later, you will only need to pay capital gains or losses taxes based on how the price of your tokens has changed since you got them.
How Do You Determine The Cost Basis For Your Airdrop?
You follow the same rules as if you had bought the tokens on an exchange or through another method. As seen in the example above, your future cost basis for airdropped tokens is equal to the amount of money you collected during the airdrop on your taxes. This is calculated by determining the fair market value of the coins at the time of distribution.
Understanding Taxes On NFT Airdrops
The IRS has yet to give a definite answer on how NFT airdrops will be taxed, though it's safe to say they'll follow the same rules as other cryptocurrency airdrops. You would recognize it's as income based on the fair marked value on the day when the NFT was dropped
General Issues With Airdrops
While airdrops may be an excellent method to reward cryptocurrency investors, they frequently come with their own tax issues. Here are three of the most prevalent ones.
Your Airdropped Tokens' Value Has Dropped Considerably.
Note that you will have to pay income taxes on the basis of your tokens' fair market value at the time they were airdropped to you. Nevertheless, this can become a problem if the token's price falls precipitously. If this happens, it's possible that you might end up owing more in taxes than you currently have available.
Use a crypto tax calculator to help you avoid underpaying or overpaying your taxes throughout the year.
You Received Airdrops that You Did Not Want.
Some projects will airdrop tokens to investors without them asking for them.
In most situations, these coins have little worth. You should record the market value of these tokens if there is one. Typically, this will be just a few dollars in earnings.
You Lost Your Money In An Airdrop Scam.
Some developers create fraudulent airdrops in order to scam people who are new to investing in cryptocurrencies. They might pretend the airdrop is from a legitimate project, then ask for the person's private key so they can steal any assets that are in their wallet.
Unfortunately, these sorts of ‘accidental losses' are generally not deductible from your income taxes.
How Will The IRS Know If You Got An Airdrop?
Some investors choose not to disclose airdrop bonuses, thinking the IRS will be unable to trace them.
However, if you don’t report your airdrop rewards, it would be considered as tax evasion and might result in fines and penalties.
To link illegal wallets to investors, the IRS hires third-party vendors such as Chainalysis. If you don't disclose your revenue, you'll be more likely to get audited and imprisoned for not paying taxes on cryptocurrency.
File Your Crypto Taxes In Just Minutes
CRPTM is revolutionizing the way we report airdrop income on our taxes. The platform makes it easy to report airdrop income in minutes, so you can get back to your life.
Airdrop Taxes Calculation With CRPTM
You may also import transactions from exchanges like Kraken, Gemini, and Coinbase automatically. You'll be able to quickly generate a complete cryptocurrency tax report when tax time comes around.
Endnote on Crypto Airdrop Taxes
Depending on the types and scales of your income, calculating your actual taxes may be quite complicated. It would be nearly impossible to calculate each airdrop individually, therefore some of that earning might go unreported on your tax return. As a result, it's critical to address these situations immediately.
CRPTM makes it simple to get an accurate tax report by providing you with the data you'll need for your complicated tax return, such as airdrop income. If you're still unsure, check out the simple instructions. Our software is capable of helping your airdrop earnings remain constant.
Technically, an airdrop is when a blockchain project gives away free tokens to users. So, if you are given free tokens as part of an airdrop, you may wonder if the IRS will come after you for taxes owed on this "income." However, by understanding the IRS's guidance on the taxation of airdrops and taking some proactive steps, you can greatly reduce any potential problems that could arise come tax season.