Today we discuss the U.S. tax considerations for the upcoming main net token swap for EOS. (Note: Although U.S. citizens are not permitted to participate in the token sale, they may have acquired the EOS ERC 20 tokens on a secondary market such as Binance.)
Issue:
The EOS token sale started almost one year ago as of June 1st and ran for twelve months. EOSIO V1 was to be released a year later in June of 2018, so token sale participants were issued ERC 20 tokens as a placeholder for the eventual main net token swap.
The ERC 20 tokens if held in a wallet with private keys are mapped to an EOS public key. If held on an exchange such as Binance, many exchanges are performing the token swap on the "back end" and no action is required by the user.
On June 2, 2018, the ERC 20 token will freeze and be non-usable, and the token holder at that time will be given an EOS mainnet coin in the genesis snapshot on a 1 for 1 basis.
In addition, many projects that plan to be built on top of EOS as a decentralized application (DAPP) are issuing "tokens" silmutaneous with the genesis snapshot.
General Rules
(Note -certain excerpts below are from my tax blog intro at :https://steemit.com/money/@cryptotax/crypto-tax-blog-investing-in-bitcoin-let-s-learn-u-s-tax-rules-part-i-a)
"The IRS code requires each U.S. citizen to report a gain or loss on the personal income tax return when investment property is later sold for U.S. dollars, or exchanged for other property (except for the “like-kind” exception)." Unless the gain is specifically excluded by Congress
The IRS views Bitcoin and other digital currencies that are "convertible virtual currencies" as property for U.S. tax purposes. This means that the general sale of property rules apply to crypto transactions.
" A “convertible” virtual currency is a virtual currency that can be: (1) Digitally traded between users and (2) Purchased (and sold/exchanged) for U.S. Dollars (or other currencies including virtual currency)." (IRC Notice 2014-21)
Exceptions?
Below are few examples of situations where a gain does not have to be recognized on cryptocurrency transactions:
- The currency is not a convertible virtual currency at the time of the taxable event (definition above).
- On the date of the taxable receipt of property (i.e. mined), fair market value is $0 USD.
- If the like-kind exchange rules apply a gain can be deferred until the sale of the new property (as noted in other articles, application of like kind exchange to crypto is unlikely and only possible prior to 2018 if at all).
The above do not necessary apply to EOS as (1) the ERC 20 token was tradeable between users and exchangeable for other crypto (through June 2nd freeze date); (2) as the ERC 20 tokens are issued from a token sale there is a fair value that is transferring to the new coin (i.e. on Binance it is a seamless experience); and (3) like kind exchange rules don't apply except for real estate (after 2017).
Is there a good argument for treating the EOS token swap as not taxable?
Here is one argument for treating the mainnet swap as nontaxable (note this is not personal tax advice, consult your own advisor):
In Revenue Rulings and case law, it has been established that the purchase of pregnant livestock is treated as two purchases: (1) The purchase of the livestock and (2) the purchase of the unborn child. In this case, the birth is not creating phantom income to the owner of the pregnant livestock Each livestock are treated as separate assets effectively. The purchase price must be allocated among the two livestock in this case.
By analogy, the EOS ERC 20 token is pregnant with the eventual genesis EOS coin (which will come alive when the BP's launch the main net). Pregnant as the genesis snapshot is fully dependent on the Ethereum network EOS token/contract which maps Ethereum keys to EOS keys.
Sources: L.E. Gamble v Commissionerr, Revenue. Ruling. 86-24, Metz v US. The idea is presented courtesy of ABA Section of taxation in the context of the BCH hard fork: https://www.americanbar.org/content/dam/aba/administrative/taxation/policy/031918comments2.authcheckdam.pdf
An alternative viewpoint is gains can be deferred upon the token swap as deemed involuntary conversions. Under Section 1033, an involuntary conversion is deemed to occur if property is destroyed. A taxpayer can elect to defer a gain upon the receipt of replacement (new) property until the sale of the replacement property. By analogy, in the main net swap the ERC 20 token becomes nonfunctional and effectively worthless, however the value has been transferred to the holder's account on the EOS main net. Meaning the ERC 20 token is 'Destroyed' from the perspective of utility/value, but the replacement property is the true EOS token.
What about the air drops and side chains ("BCH" of EOS etc.)?
Note: For purposes below I am referring to "Initial distribution" airdrops, not airdrops/bounties of existing coins which are traded on a liquid exchange:
The concept of forks/airdrops is not fully developed in the IRS Notice 2014-21. As there is no liquid exchange for many of the airdrops/forks on the date of issuance, these could be potentially treated as taxable gains with a fair value of $0.00 USD. The same could potentially apply to alternative chains issued in the future that run on EOS software and honor the genesis block (yet aren't the official EOS chain).However, there will always be some level of uncertainty until the IRS issues more guidance. Additional resources on the potential tax outcomes can be found here:
https://steemit.com/bitcoin/@cryptotax/justice-for-taxpayers-my-endorsement-of-tax-relief-for-crypto-hard-forks
https://www.americanbar.org/content/dam/aba/administrative/taxation/policy/031918comments2.authcheckdam.pdf
What if I'm on an exchange for the swap and not getting air drops?
Plus, some exchanges might not honor all the side chains and air drops, so by holding EOS in the exchanges at the snapshot date, it's just another uncertainty and something that is discussed in the article from the ABA.
Takeaway
Please feel free to share any thoughts or additional questions not covered in the article.
While I hope the IRS would view the main net token swap is a non-event from a U.S. tax perspective, Notice 2014-21 is outdated and the IRS could always rule adversely. So if you are a U.S. taxpayer and unsure how to handle, connect with your tax advisor to figure out your personal plan.
Picture Credit: https://pixabay.com/en/bitcoin-cryptocurrency-btc-currency-2868703/
Disclaimer: This series contains general discussion of U.S. taxes in a developing and unclear area of tax law. As always, you should consult your own tax advisor in your jurisdiction to determine your specific situation as this is not personal advice; and consider any future guidance by the Congress/IRS after the date of this article. Under Circular 230 to the extent it applies, this article cannot be used or relied on to avoid any tax or penalties in the U.S., its States or any other jurisdictions. This post does not create a client relationship between the author and the reader.