Are Virtual Currency Airdrops Really Taxable? IRS Clarifies New Tax & Reporting Requirements|
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The IRS released a memo on August 28, 2020, as part of an ongoing campaign to provide clarity on the taxability of virtual currency, this time focusing on whether cryptocurrency earned from microtasking is taxable income. While Aprio has been advising for years that most airdrops are taxable, spoiler alert: the IRS says yes, airdrops received for microtasking are taxable.
What is microtasking?
Microtasking is a relatively new form of crowdsourcing that aims to delegate a large job into many smaller, distributed tasks, which various people can complete over the Internet. You can think of it as a virtual gig economy driven by outsourcing, with specific vendors and digital platforms helping to facilitate the delegation of work between companies and independent workers.
Some common microtasks may include:
- Processing data
- Downloading an app
- Writing algorithms
- Labeling images
- Writing product descriptions
- Transcribing documents
- Completing online surveys
- Reviewing apps and games
Often, companies offer menial payment in the form of convertible virtual currency as an incentive to those who complete microtasks. These payments are typically facilitated through airdrops, which is a method of distributing cryptocurrency tokens or coins directly to various wallet addresses.
But don’t confuse these airdrops with the kind of credits typically distributed in the gaming world. There is a critical distinction between airdrops of virtual currency that is or is not convertible. Often, in-game credits in the gaming world are not convertible outside of the game and thus are not taxable. See Aprio’s article published in early 2020 about the taxation of credits earned in gaming.
So are airdrops of virtual currency for microtasking taxable?
Although the payment for microtasks is often a small amount, as low as a $1 or less, and delivered through an airdrop of virtual currency, it is nonetheless payment provided for a service rendered.
At least, that is the logic deployed by the author of the memo, Ronald Goldstein of the IRS, who concluded that any convertible virtual currency received as payment for completing a microtask should be considered taxable as ordinary income.
Mr. Goldstein largely bases his conclusion on Internal Revenue Code Section 61, stating that “gross income means all income from whatever source derived including compensation for services.” He also supports this with Section 83, which allocates the transfer of property in connection with the performance of services as taxable income, as well as Section 1401, which clarifies taxability for self-employment income.
While this answer seems logical and succinct, it triggers many other questions and concerns about valuation, withholding, and reporting as the IRS has provided very little guidance on these matters specific to virtual currencies – especially those distributed via airdrops.
What are the pitfalls not covered in the IRS’s memo?
In some cases, you might receive payment via an airdrop of virtual currency, such as bitcoin, which is traded often, has a readily determinable fair market value, and is easily convertible into US dollars or another fiat. However, most airdrops we see today are of tokens or coins whose trading volume may call the true fair market value into question. These types of assets likely will not be convertible directly into US dollars or any fiat and would have to first be converted into another virtual currently such as etherium or bitcoin.
Aprio has been addressing valuation on thinly traded assets like virtual currencies, as well as publicly-traded securities, for many years, and our valuation team is well versed in these matters.
Are airdrops received by individuals who did not perform any function still taxable?
This memo primarily focuses on the taxability of airdrops for people who performed certain functions through microtasking, but what about people who receive airdrops without performing these functions? Aprio has been advising clients that all airdrops should be treated as income; however, if the receipient did not perform services as explained in the memo, there may be an option to tax that income as a royalty rather than self-employment income.
Income tax reporting and withholding on airdrop payments:
US companies are required to report payments of value in excess of $600 per year, so you need to consider the total value of the assets being airdropped. If the total value of the airdrops remains under $600 for a given year, you are not required to issue a 1099. Some companies establish a trigger that halts payments when the value will exceed $600 during the year, only allowing the payments to continue when (and if) the person submits a W-9.
Airdrops totaling a value of more than $600 now also carry additional reporting requirements for companies performing the airdrops. The IRS just released new IRS Form 1099-NEC, which companies will need to provided to recipients for nonemployee compensation. However, if the payment is a royalty payment, the company would issue a 1099-MISC.
If the amount is taxable to recipients, it is deductible to the company.
If you are a US company airdropping assets to non-US recipients, you may be at risk for not withholding tax in some situations.
The bottom line
Although the IRS has yet to issue comprehensive regulations on the tax implications for virtual currency, they have been issuing piecemeal guidance on specific issues over the last two years, as exemplified by this latest memo. The IRS clearly laid out their position that payment received for completing microtasks is considered taxable income, but questions remain about the valuation of payments.
The IRS also fails to cover the other risk areas such as valuation, withholding, and reporting.
If you regularly engage in microtasking, or if you airdrop virtual currency for microtasking, you may need to consider your potential tax exposure, liability, and reporting obligations. The IRS doesn’t make this a simple process, so consider working with a knowledgeable Aprio advisor to assess your position.
Aprio has been a pioneer in the intersection of virtual currency and tax liabilities since 2013, and we constantly monitor the IRS for new guidance and information. Contact Mitchell Kopelman for more information about Aprio’s services related to cryptocurrencies.