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Ethereum’s blockchain update is around the corner and it raises questions about its potential tax implications.As with many things in this maturing market, cryptocurency tax rules are still emerging.
In 2019, the US tax agency, Internal Revenue Service (IRS) published guidance saying hard forks are taxable events.Meanwhile, The Merge is widely expected to be followed by ETH’s hard fork.
What could these events mean for ETH holders’s tax obligations? Capital.com asked cryptocurrency tax experts whether ETH could be taxable following The Merge.
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What is The Merge? Will Ethereum’s hard fork follow?
The Merge is Ethereum’s blockchain’s transition from Proof-of-Work (PoW) to Proof-of-Stake (PoS) consensus mechanism.This will be done by merging existing Ethereum PoW chain with PoS system and it will mark the end of PoW for Ethereum and the full transition to PoS.
The Merge is widely believed to be followed by ETH’s hard fork – or breaking the post-Merge PoS chain into PoW chain EthereumPoW (ETHW) .
According to the IRS’s Revenue Ruling 2019-24 hard forks and airdrops are taxable events for which recipients must treat the newly received cryptocurrency as ordinary income.
Will ETH be taxable after The Merge?
IRS would *probably* view the value of ETHW as income
William & Mary Law School’s Professor of Law Eric Chason:
“Most market participants will recognize the new proof-of-stake coin as ETH.The old proof-of-work coin would continue under ETHW (or ETHPoW).
“I think the IRS would follow this pattern.The new proof-of-stake protocol continues an investor’s holding in ETH, while the old proof-of-work protocol would be considered a newly acquired coin.
“At a technical level, this doesn’t make sense as ETHW carries forward the old protocol.
But it does reflect how most in the community would view a fork.Presumably, ETH will have much greater value than ETHW.
“To answer the question, ETH itself is not taxable under the hard fork.
The question is how to treat the ETHW value.The IRS tried to give this issue some clarity in 2019, but their guidance was problematic.I think the IRS would *probably* view the value of ETHW as income.”
The Merge is a ‘soft fork’ for tax purposes, the guidance says
Suzanne Morsfield, Head of Accounting Solutions at crypto-focused software firm Lukka
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“The frustrating answer is, ‘it depends’.It can depend on many factors, but a key one is what type of fork it is for US federal tax purposes.
“And, as with many things in tax, substance vs.
form matters.So, the substance as determined under tax guidance will drive the tax treatment, regardless of what the crypto community calls The Merge.
“In other words, while the community may refer to it as a ‘hard fork’, the tax guidance may, instead, say it’s a ‘soft fork’ for tax purposes.
“New types of crypto assets received as the result of a hard fork (as determined by US tax guidance) are generally taxable.Soft forks (with the same caveat) generally are not.
“Related to that, we always also have to ask, what type of fork is The Merge likely to be for US federal tax purposes, and why? Most tax observers think that The Merge itself is consistent with a soft fork for tax purposes.Much of the thinking behind this conclusion relies on IRS Frequently Asked Questions on Virtual Currency Transactions (FAQ 30) , which defines a soft fork as “a protocol change that does not result in a diversion of the ledger and thus does not result in the creation of a new cryptocurrency.
“An important implication for holders prior to The Merge is that to avoid a taxable event afterwards, then the substance of what you hold subsequently must not be a new crypto asset.
“It is on this point that there appears to be a consensus – i.e., that you will not receive a new crypto asset as a result of The Merge.”.
