The most exciting thing about cryptocurrency airdrops is the fact that they are exciting, but at the same time, they seem to come with some tax which is unknown to most crypto enthusiasts out there. It is wise to know how to file taxes correctly on airdrops so that everything runs smoothly with the law and the taxman. The article shall take you through a step-by-step process in reference to the keywords: tax filing, crypto enthusiasts, and airdrop taxes.
Table of Contents
- Introduction
- How Airdrops are Taxed
- What is a Taxable Event
- Computing the Value of Tokens Airdropped
- Reporting Airdrops on Your Tax Return
- Errors to Avoid When Filing Your Airdrop Taxes
- Tips for Record Keeping
- Conclusion
Introduction
Airdrops are a common occurrence in the crypto space where holders of a particular cryptocurrency receive free tokens. Such assets come with tax liabilities for any lover of cryptocurrencies. Proper tax filing for these airdrops needs to be effected such that one avoids penalties and ensures their tax return is accurate.
Now let's first get to the general understanding of what forms the taxable event in cryptocurrency before we get on with airdrop-specific taxes. What is meant by a taxable event is an incident from which a taxpayer owes the state some tax. Concerning cryptocurrency, the most common forms of taxable events are:
- Purchase and sale
- Exchange of one cryptocurrency for another
- Use of money for the purchase of goods and services
- Acquisition of money as payment for work or via an airdrop.
Each of these events has different tax implications, but the focus for this article is on the last—receiving cryptocurrency through an airdrop.
How Airdrops Are Taxed
Most tax authorities, including the IRS, treat the receipt of cryptocurrency through an airdrop as taxable income. In most jurisdictions, the value of the airdropped tokens at the time of receipt is treated as ordinary income, and accordingly, you need to report this in your tax return.
Ordinary Income vs Capital Gains
It's quite important you distinguish between the concept of ordinary income and capital gains as an airdrop receiver. When you receive an airdrop, the tokens have assumed value and thus constitute ordinary income. The selling price minus the original value in the subsequent sale will reflect the capital gain that you are under obligation to report.
For example, if you receive $500 value in an airdrop and you later sell those tokens for $1,000, then the first $500 is ordinary income, and the remaining $500 is a capital gain.
Value of airdropped tokens: Determine the FMV (Fair Market Value) of the tokens airdropped at the time of receipt. In general, this is the FMV when using a common exchange immediately as the airdrop occurs.
You can estimate the FMV of an airdrop by referencing the current price of the token on an exchange where it is listed. Make sure to refer to a good source for the information, and document the value at the particular point in time of receiving the tokens.
Figuring out the value of the token becomes harder if the token has not yet listed on any of the exchanges at the time of the airdrop. In such cases, one may need to take help from a tax expert to arrive at a logical value of the token.
How to Report Airdrops on Your Tax Return
Once you've determined the value of your airdropped tokens, it's time to file them on your tax return. In the US, airdrop income is generally reported on Form 1040, Schedule 1 under the line for "Other Income."
In the United States, airdrop income is generally reported on your federal tax return in the year of your receipt. You must include the fair market value of the tokens as ordinary income. If you later sell the tokens, you will report any capital gains or losses on Form 8949 and Schedule D.
Filing in Other Countries
Tax laws vary by country, so if you're not in the U.S., you need to check your local regulations. While some countries consider airdrops taxable, others may not, hence reporting also varies. Ideally, it would be best to consult with a tax consultant who has knowledge of cryptocurrency tax laws in your country.
Common Mistakes to Avoid When Filing Airdrop Taxes
Filing taxes using airdrops can be tricky. Some of the mistakes crypto enthusiasts should avoid include:
Ignoring the Airdrop Income
One of the biggest common mistakes is the failure to report airdrop income. Some crypto lovers think that because they got the tokens for free, there is no need to report them. This is far from the truth, and incurring penalties is a possible outcome for those who do not report their airdrop income.
Misreporting the Value of Airdropped Tokens
It is important to report the value of the airdropped token properly. Using the wrong fair market value may lead to reporting less income than is actually supposed to be reported, or even more income, with both scenarios causing issues with the taxman. Double-check the value of the fair market price at the moment of reception and document all your calculations.
Failure to Keep Records
Another common mistake is not keeping accurate records of airdrops. You should, therefore, keep a clear record stating when you got an airdrop, the fair market value of the tokens at that time, and what other transactions you carried out using the tokens. Documentation, in general, should be kept for audit purposes.
Making Sure the Records Are Accurate
Proper record-keeping is the most fundamental approach to filing your airdrop information correctly for taxing. Here are some key tips to keep it organized:
- Keep Track of All the Airdrop Transactions: Make the effort to keep a record of all airdrop transactions in a spreadsheet or well-known crypto tax software. Include attributes like the date of the airdrop, the amount received, and the fair market value on the date.
- Save the Data: Preserve the exchange rates that you used to calculate the fair market value of the airdropped tokens. This will be crucial information if you ever need to explain this calculation to the taxman.
- Document All Communication: Record and keep all emails or communication about the airdropped tokens. This record can be proof of the receipt of the said tokens and, if there is any problem, can be a means to solve it.
Conclusion
Although tax filing on cryptocurrency airdrops can be a hectic task, all this can be managed with proper understanding and record-keeping. As a crypto enthusiast, it's in your best interest to educate yourself on how to handle these airdrops and report them properly on your tax return. According to the guidelines above, your compliance and stress-free tax filing are guaranteed.
Remember, the tax landscape for cryptocurrencies is extremely dynamic, so stay informed about the regulations and consult with a tax professional if in doubt. Proper tax filing not only keeps you compliant with the law but also allows you to enjoy the benefits of your crypto investments with peace of mind.
