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ARE YOU CONFIDENT IN ACCURATELY REPORTING CRYPTOCURRENCY EARNINGS ON YOUR TAX
RETURNS?

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No, it's challenging
I use an accountant
I haven't reported yet


ETH POST-MERGE: HARD FORK TAXES

If you held ETH before the Merge, you might have taxable income.

Chandan Lodha, Shehan Chandrasekera, CPA

19 ottobre 2022  ·  5 min read

Ethereum completed its highly anticipated Merge on September 15th, 2022, at 6:43
AM UTC. The Merge changed Ethereum’s consensus mechanism from a Proof-of-Work
(PoW) to a Proof-of-Stake (PoS) system. If you held Ether (ETH) on the PoW
chain, you didn’t have to do anything to transfer those tokens to the PoS chain.
Your coins were automatically upgraded onto the PoS chain as a part of the
Merge.

The purpose of the Merge was to have one unified Ethereum blockchain operating
under a PoS consensus mechanism. However, a group of miners decided not to
comply with the PoS chain and created two new PoW chains (EthereumPoW (ETHW) and
EthereumFair (ETHF)) that also contained the history of the original ETH
blockchain. The diagram below illustrates the aftermath of the Merge.

Despite the change of consensus mechanism, Proof-of-Stake ETH is considered the
main chain.

We previously discussed the tax implications of the legacy chain’s transition
into PoS in our Ethereum 2.0 tax guide. Ethereum’s protocol upgrade from a PoW
to a PoS chain is akin to a soft fork which is not taxable under the IRS
guidance (IRS CCA 202316008 & IRS FAQ 30). However, the emergence of ETHW and
ETHF chains (in addition to the PoS chain) and the creation of new coins (ETHW &
ETHF) arguably create a hard fork event, which is taxable.

As you can see in the diagram above, ETHW and ETHF split from the existing
Ethereum blockchain after the Merge, creating two new separate chains. They
share the same history and blockchain up until the split. As a result of this
hard fork, everyone holding ETH tokens before the split automatically received
an equivalent amount of the newly created cryptocurrency.

For example, if you had one ETH in your wallet before the Merge, you would
automatically receive one ETHW and ETHF after the hard fork. This event can have
different tax consequences depending on your country.


US TAXATION OF HARD FORKS

US taxpayers can refer to IRS FAQs 22-25 and Rev. Rul. 2019-24 to determine the
tax implications of receiving ETHW & ETHF coins.

A hard fork results in ordinary income when you can exercise dominion and
control (D&C) over the asset (not when you exercise D&C). In simple terms, D&C
is established when you have the ability to transfer, sell, exchange, or
otherwise dispose of the cryptocurrency.

Where you hold crypto assets can have a significant impact on when D&C is
established and the timing of your income.


CRYPTOCURRENCY HELD IN ACCOUNTS MANAGED BY EXCHANGES

If you held ETH on an exchange, you would gain D&C when the exchange credits the
new asset (ETHW or ETHF) to your account, and you have the ability to transfer,
sell, exchange or otherwise dispose of the cryptocurrency. (Usually, it takes
some time for exchanges to support the new coin and give you D&C over it.) Some
exchanges might report this income on Form 1099-MISC box 3 as “Other Income.”

Say Chris held 1 ETH on a centralized exchange account. Although the fork
occurred on September 15th, Chris did not get access to his ETHW until October
1st, 2022. When Chris got access to ETHW, it was trading at $10 a coin. Here,
Chris gains D&C on October 1st, 2022, and needs to report $10 of ordinary
income.

Currently, exchanges have varying degrees of support for the forked chain and
the resulting coins.


CRYPTOCURRENCY HELD IN SELF-CUSTODIAL WALLETS

If you held ETH in a self-custody wallet at the time of the Merge, you are
deemed to have D&C over ETHW and ETHF at the time those chains emerged, and you
had the ability to transfer, sell or dispose of the new asset. This is when you
can theoretically exercise D&C over the new asset.

For example, Chris held 1 ETH on his MetaMask account. The ETHW and ETHF chains
originated on September 15th, 2022. On this day, ETHW and ETHF were trading at
$10.58 and $17.45, respectively. Chris learned about the hard fork on September
25th and added the chains to his Metamask wallet when ETHW and ETHF were trading
at $11.39 and $2.03, respectively. Chris theoretically had D&C over assets on
September 15th, even though he didn’t know about them yet. Therefore, Chris
should report $10.58 ordinary income from ETHW and $17.45 ordinary income from
ETHF. These would also be the cost basis for these coins.

Suppose Chris sold his ETHW for $15 on September 30th. Here, Chris would have a
$4.48 ($15 - 10.58) short-term capital gain.


CANADA TAXATION OF HARD FORKS

The CRA hasn’t officially issued direct guidance on taxing hard forks and
airdrops. However, we can use general tax rules to infer how hard forks may be
taxed.

If you are in the business of mining or trading cryptocurrencies, the value of
the new coin at the time of receipt will be treated as income. Individual
investors may not face any taxable income due to hard forks. To compute the
adjusted cost base (ACB), you will use any expenses related to the acquisition
of the property. The cost to acquire a hard-forked asset is $0. When you
subsequently sell the hard-forked token, it will be subject to capital gains
tax.


AUSTRALIA TAXATION OF HARD FORKS

The Australian Taxation Office (ATO) has issued clear guidance on hard forks.
According to ATO guidance, you will not have to report any income due to hard
forks; you will have to report capital gains when you later sell the coin.

For example, Adam received 1 ETHF after the hard fork. Here, Adam doesn’t have
to report any income. The cost basis of ETHF is zero. If Adam sells this coin
later for $1,000, he will have a $1,000 ($1,000 - $0) capital gain.


UK TAXATION OF HARD FORKS

HM Revenue and Customs (HMRC) have also issued guidance on blockchain forks.
Each cryptocurrency must enter its own Section 104 pool when a hard fork occurs.
Any allowable costs in the original cryptocurrency (ETH) are split between the
two Section 104 pools for the original and the new cryptocurrency. The cost must
be divided on a “just and reasonable basis.” HMRC don’t prescribe any particular
apportionment method. If your exchange chooses not to support the new
cryptocurrency, you may seek to apportion all the allowable costs to the
original token.


INDIA TAXATION OF HARD FORKS

It is not entirely clear how the Income Tax Department (ITD) views hard forks as
they have not released any specific guidance. You could argue that a hard fork
is similar to a gift because you didn’t have to do anything to receive the new
cryptocurrency; all you had to do was own the original cryptocurrency that it
forked from. A gift is taxed to the receipt only if it exceeds Rs. 50,000. If
the amount you received from the hard fork is greater than Rs. 50,000, it would
be taxable under this approach.


If you have any questions or comments about crypto taxes, let us know on Twitter
@CoinTracker.

--------------------------------------------------------------------------------

CoinTracker integrates with 300+ cryptocurrency exchanges, 8,000+ blockchains,
and makes bitcoin tax calculations and portfolio tracking simple.

Disclaimer: This post is informational only and is not intended as tax advice.
For tax advice, please consult a tax professional.





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