American Bar Association Offers IRS Guidance On Rules Around Forked Tokens

The American Bar Association has recommended that the IRS offer taxpayers temporary safe harbor regarding cryptocurrency that they acquired as the result of a hard fork. It has also begun to explore the possible implications that such tokens might have during future tax seasons.

  • The American Bar Association (ABA) Section of Taxation has recommended that the Internal Revenue Service (IRS) offer temporary safe harbor to holders of forked cryptocurrencies so that their 2017 filings do not include taxes owed on digital assets that came into their possession due to a hard fork.


    Safe harbor is a legal mechanism guaranteeing that particular forms of conduct, which violate an existing rule, are not considered violations of that rule in the eyes of the law.

    The term hard fork refers to the splitting of a blockchain that occurs when the nodes running the chain fail to agree on which version of the chain to support. Such events can arise in the wake of changes to the blockchain’s codebase or to the contents of its ledger. When a hard fork occurs, a new set of tokens are created on the new chain but the old set continues to exist; holders of the old tokens find themselves holding both old and new tokens, so long as the wallet in which they were storing the old tokens before the fork also supports the new ones.

    The Recommendations

    A letter to the IRS, dated March 19 and signed by ABA Section of Taxation chair Karen L. Hawkins, mentions that the ABA had previously offered comments to the agency in relation to a 2014 IRS notice on cryptocurrency. That document did not include an analysis of, or recommendations concerning, the implications of hard forks. This week’s letter relates that the IRS had reached out to the ABA with a “request for comments” on these implications.

    The letter, according to its own text, was originally intended “to fully develop” an assessment of the questions raised by hard forks. However, given that the deadline for submitting personal taxes is fast approaching, the ABA section instead advised the IRS to offer safe harbor as a stopgap measure, and left the job of drafting more conclusive recommendations for another day.

    The ABA’s short-term recommendations are as follows:

    “1. Taxpayers who owned a coin that was subject to a Hard Fork in 2017 would be treated as having realized the forked coin resulting from the Hard Fork in a taxable event.

    2. The deemed value of the forked coin at the time of the realization event would be zero, which would also be the taxpayer’s basis in the forked coin.

    3. The holding period in the forked coin would start on the day of the Hard Fork.

    4. Taxpayers choosing the safe harbor treatment as set forth in the guidance would be required to disclose this on their tax returns.

    5. The Service would not assert that any taxpayer who availed themselves of the safe harbor treatment as set forth in the guidance has understated federal tax liability because of the receipt of a forked coin in a 2017 Hard Fork.

    6. The Service, with input from the Section and other stakeholders, will continue to develop its position regarding the tax treatment for future Hard Forks, and such position may be different from the one noted above and will apply prospectively.

    Although the treatment may result in capital gain as opposed to ordinary income treatment, it preserves the full value of the forked coin for taxation when the taxpayer sells it. In addition, it restarts the holding period, thus resulting in sales occurring within a year being taxed as short-term capital gains.”

    In other words, the receipt of a forked coin should be treated as a taxable event, but taxation should be deferred until the IRS has a clear policy in place with regard to the taxability of such assets. Furthermore, the framework allows for the sale of forked tokens to be subjected to capital gains taxation.

    Arguments Supporting Taxation

    The letter states that there are reasonable arguments in favor of and against treating the realization of forked coins as taxable events, and that important questions remain regarding how these assets should be valued for tax purposes.

    On the first matter, one argument in favor is:

    “The Supreme Court in Commissioner v. Glenshaw Glass liberally construed the term ‘gross income’ as ‘instances of undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion,’ reflecting Congress’ intent to tax all gains except those specifically exempted. One could argue that the ability to use the forked coin in addition to the original coin represents such an accession to wealth.”

    Another justification for taxation is that after a hard fork, “transactions on the original blockchain are valid only in [that blockchain’s native token], but invalid in [the forked currency], and vice versa,” meaning that the forked currency received is “materially different than the previously held” tokens.

    Arguments Against Taxation

    The arguments that the letter raises against taxing forked cryptocurrencies include the position that because “a forked coin resulting from a Hard Fork shares transactional and ownership history with the original coin,” the original token has arguably “always included the future potential to create a forked coin.”

    Taking the example of the bitcoin/bitcoin cash split, the authors make the case that one “could argue that the reduction of BTC value was attributable to the split with BCH, the value of which was no longer integrated with the value of BTC.” However, they say, the relationship between these values would be difficult to “empirically prove.”

    Also, because corresponding original and forked tokens can be spent using the same private key and can be traced back to “the same block” on a single blockchain, forked tokens should arguably not be taxed.

    Determining Taxable Value

    On the question of determining the taxable value of a forked coin, the letter’s authors suggest that the value should be determined at the time of the coin’s creation. However, they say, there may be a challenge in determining this valuation.

    Following a fork, the newly existing tokens undergo a “process of market price discovery” which can result in the coins temporarily having “different market values on different exchanges.” If a coin holder has their tokens on one of several “third-party exchanges that also function as a wallet provider,” then “the amount realized would be the U.S. dollar value of the forked coin on that exchange at the time it is credited to an owner’s account.”

    This scenario is simple enough, but if a token comes into being in a privately held wallet, its owner may “be able to select the most favorable exchange rate by shopping the various exchanges” as they determine its price. According to the letter:

    “This is not necessarily a problem of fairness given that the owner has a choice regarding how he or she holds the original coin involved in the Hard Fork, but it is a problem of predictability and administrability (and an opportunity for taxpayers to attempt to game the U.S. federal income tax system).”

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