In Brief

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With new technologies come new forms of assets and, eventually, new rules for the regulation and taxation of such assets. Beyond the current frontier lies the land of the digital assets—cryptocurrencies, non-fungible tokens, and the like—that have become increasingly popular over the past several years. This article covers the basics of digital assets, with a focus on the valuation and taxation of digital currencies.


Digital assets have gone mainstream. Yet despite their popularity as investments, as well as their use in commerce, the IRS has issued sparse guidance with respect to the taxation of virtual currencies and digital activity in general. Nevertheless, taxpayers must sift through what is available in order to determine when and to what extent their digital activity is reportable and/or taxable.

Although the primary focus of this article is the taxation of virtual currency (e.g., Bitcoin, Ethereum), the general term “digital asset” is quite broad in application. Virtual currencies, along with pass-through and asset backed tokens, nonfungible tokens (NFT) and a myriad of other Web3 holdings are all referred to in the aggregate as digital assets.

Definition of Virtual Currency for Tax Purposes

The IRS has defined virtual currency as a “digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value,” and has further ruled that cryptocurrency is property as opposed to currency (IRS Notice 2014-21). As such, the tax rules applicable to property transactions in general apply to transactions using virtual currency—as opposed to the detailed and targeted statutory framework surrounding the taxation of commodities and fiat currencies.

Determination of Market Value

Depending on the context, the market value of a virtual currency or other digital asset may first need to be determined in order to properly report taxable income from a particular digital transaction. For example, when an investor exchanges one virtual currency for another, or a virtual currency is used to pay for the purchase of an NFT, the tax rules applicable to “barter” transactions involving the exchange of property (or services) would apply. This means generally that the unrealized appreciation in any assets exchanged is immediately taxable as a result of the transaction. In these instances, the market value of the exchange (presumably equal on both sides) must be pegged in order to arrive at the proceeds received, which in turn is necessary for the computation of the taxable gain to be realized by each side. Note that the barter of digital assets does not qualify for IRC section 1031 like-kind exchange treatment, as such exchanges have been limited to real estate since the 2017 Tax Cuts and Jobs Act (see also ILM 202124008).

Exchange-disseminated virtual currency.

The exchange-published value of a particular virtual currency, if available, is the most common source used to determine market value. For example, the value of Bitcoin is available throughout the day, every day, similar to stock prices. And as a practical matter, if virtual currency is being deposited or withdrawn from an online wallet, the platform will typically mark the currency to the market price in U.S. dollars at the time of the transaction.

Nonlisted virtual currency.

If the market value of a cryptocurrency is not exchange-disseminated on an ongoing basis, other methodologies must be employed. One approach would be to utilize one of the many available blockchain “explorer” programs to globally search for similarly situated digital assets. If an explorer value is not used, the burden of proof falls on the taxpayer to establish the market value by any other reasonable and supportable means. But whichever methodology is employed, the value would generally be determined as of the date the transaction is recorded on its relevant distributed ledger, as that is the date on which the asset technically comes into its existence as property specific to the holder.


When individuals already in possession of virtual currency sell their holdings, they report their gain or loss as they would upon the disposition of any other asset. The gain or loss is determined by subtracting the tax basis in the asset sold from the proceeds received. (All amounts for U.S. tax purposes are reported in U.S. dollars.) Capital gain or loss is short-term or long-term, depending upon how long the virtual currency has been held. The former is taxable at ordinary income rates, whereas the latter is taxable at preferential long-term rates.

The Form 1040 virtual currency question. Starting in 2019, a new question was added to the Form 1040, requiring either a “yes” or “no” answer. The question reads: “At any time during 20XX, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?” Some tax professionals believe that leaving the answer blank could conceivably delay processing, the receipt of a refund, or even raise the audit profile of a subject tax return. But note that the IRS has indicated that the mere purchase of virtual currency during a subject tax year does not require a “yes” answer to this question (IR-2022-61, March 18, 2022).


Crypto-friendly businesses are increasingly accepting virtual currency as payment for the goods or services they provide, in addition to using it to pay employees, independent contractors, and suppliers. In such cases, the tax reporting would be handled in the same manner as where payments or receipts are made with other types of property, as opposed to with traditional currency. The amount of the payment or receipt thereof would be recorded using the market value of the virtual currency at the time of the transaction. Whenever virtual currency is used to pay an expense, or alternatively is received as payment, the unrealized appreciation or depreciation inherent in the transferred currency is realized for tax purposes

For example, the medium in which remuneration for services is paid is immaterial to the determination of whether the payment constitutes wages for employment tax purposes. Thus, the fair market value of virtual currency paid as wages, measured in U.S. dollars at the date of receipt, is subject to FICA and FUTA tax and is reported on the employee’s Form W-2, Wage and Tax Statement.

Once an employee receives the compensation in a taxable transaction, they take tax basis in the virtual currency equal to the amount of income recognized. From that point forward, the employee essentially becomes an investor in the property that was received, subject to capital gain rates on any gain or loss recognized upon ultimate disposition. Also, as previously noted, for tax purposes the employer would be forced to recognize any inherent gain or loss in the virtual currency used to pay those wages.

On the revenue side, any cash basis business that is being paid in virtual currency for services, sales, or otherwise, would recognize ordinary income upon receipt. The receipt would be taxable as of the day received (typically upon deposit into the business’s online wallet), and in the amount equal to its market value at that time. The business would take a tax basis in the asset equal to the market value upon receipt. If the business decides to retain the virtual currency, similar to the employee in the previous paragraph, it would be treated essentially as an investor in the asset from that point forward.

Special Situations

Hard forks? Soft forks? Airdrops? What are these crypto terms? They represent special situations for which the IRS has actually provided clear guidance (Revenue Ruling 2019-24).

Hard forks.

A hard fork occurs when a distributed ledger undergoes a protocol change, resulting in a permanent split from the legacy distributed ledger and its related virtual currency. This may result in the creation of a new distributed ledger, which will continue side by side with the legacy distributed ledger. If no new cryptocurrency is received by virtue of the hard fork, whether through an airdrop (as explained below) or some other kind of transfer, the fork is a ‘non-event” for tax purposes. This bears similarities to a stock split, where in effect no new economic value has been created. But in the case where a new crypto asset is in fact received by virtue of a hard fork, the transaction is viewed as accretive and therefore taxable. For example, the receipt of Bitcoin Cash (BCH) as a result of the Bitcoin (BTC) hard fork was taxable (Chief Counsel Advice 202114020).


An airdrop is the distribution of virtual asset to multiple taxpayers’ addresses on a distributed ledger. If a hard fork is followed by an air drop in which new virtual currency is received, taxable income is generated as of the day of receipt, in the amount of the fair market value of digital asset received.

Soft forks.

A soft fork occurs when a distributed ledger undergoes a protocol change that does not result in a split of the ledger into two, but instead modifies the legacy chain going forward. This event would generally not result in the creation of any new cryptocurrency; thus, it typically would not result in taxable income.

Recent Developments

At present, virtual currency cannot be used to pay federal tax obligations. But several states are moving in this direction. For example, in early March of this year, Colorado enacted a measure to accept payment in virtual currency for income taxes and certain licenses and permits (although when this will begin is as yet uncertain). Wyoming passed a bill to authorize the creation of a state-issued “stable token,” a form of digital currency. Florida is also working on allowing businesses to pay their taxes in virtual currency.

The Department of Labor (DOL) issued guidance (Compliance Assistance Release 2022-01, 3/10/22) cautioning fiduciaries to “exercise extreme care” before adding cryptocurrencies to the menu of investment options in 401(k) and other retirement plans. Although the DOL noted that this investment option is speculative and volatile, it has not thus far barred fiduciaries from offering it to plan participants. As of this writing, there are several retirement account providers that do in fact allow, and will custody, digital assets in their fiduciary accounts.

Finally, the Infrastructure Investment and Jobs Act (PL 117-58) added new requirements for “brokers” to report digital asset transactions occurring in 2023 and later years. This means a party facilitating the transfer of cryptocurrency on behalf of another must report this on Form 1099-B, Proceeds from Broker or Barter Exchange Transaction. In addition, businesses that receive cryptocurrency worth more than $10,000 in a single transaction must report this on Form 8300, Report of Cash Payments Over $10,000 Receive in a Trade or Business.

There is a measure of uncertainty surrounding these new rules. For example, how is a broker defined? Because a high percentage of transactional activity in digital assets is carried out on an anonymous wallet or VPN basis, securing counterparty information to report to the U.S. Treasury could be problematic under certain circumstances. Although the legislation directed the Treasury to issue regulations governing the application of the new requirements, that time frame is yet unknown.

In response to this uncertainty, and prior to regulations being issued, Treasury Assistant Secretary for Legislative Affairs Jonathan Davidson sent a letter to six bipartisan and interested senators—partially clarifying the government’s position, stating that crypto miners and other “ancillary parties who cannot get access to information that is useful to the IRS are not intended to be captured by the reporting requirements for brokers.” This letter helps clarify matters somewhat, yet unanswered questions remain. For example, what specifically does the term “digital assets” mean in the context of the legislation—does the term include NFTs? And will taxpayers be required to complete and submit Form W-9 so that brokers can report digital transactions under applicable taxpayer identification numbers, such as Social Security Numbers (SSN) for individuals or Employer Identification Numbers (EIN) for entities?

Other Issues Remain

Looking ahead, several unresolved issues face tax professionals in the digital asset space. For example, can frequent trading in digital assets give rise to “trader” status, and thereby allow for an IRC section 475 mark-to-market election? The flush language of IRC section 475(f) limits its overall application to traders in either “securities” or “commodities.” Although digital assets are clearly not securities, whether or not they can be characterized as commodities remains an open question. IRS Notice 2014-21 makes no mention of either term, and the definition of a commodity in IRC section 475(e) merely alludes to a “commodity which is actively traded.” For regulatory purposes—thus, without direct application to taxes—since 2014, the position of the Commodity Futures Trading Commission has been that digital assets are in fact commodities under the Commodity Exchange Act. Until guidance from the IRS is forthcoming, it would appear that taxpayers must rely on the interpretational ambiguity surrounding the term “commodity” in order to avail themselves of the IRC section 475(f) election.

Awaiting More Guidance

The tax rules for cryptocurrencies and other digital assets continue to evolve, and more legislation and IRS guidance is expected in the near future. Early in June, a document purporting to be a complete copy of a proposed bill regulating the U.S. cryptocurrency ecosystem was leaked from somewhere within the Biden Administration or Congress. If, and to what extent, the leaked document is authentic is open to speculation. But interestingly, the leaked bill seemed to indicate that virtual currencies would henceforth generally be treated as commodities, which would provide welcome clarity from the twin perspectives of both regulation and taxation. For now, additional information on virtual currency is available at, which contains a link to FAQs on virtual currency transactions.

Sidney Kess, JD, LLM, CPA, is of counsel to Kostelanetz & Fink. He is a member of The CPA Journal Editorial Advisory Board.
Thomas Riggs, JD, CPA, MAS, is managing director of the PKF O’Connor Davies Financial Services Tax Group, New York, N.Y. Adapted with permission of the New York Law Journal, copyright 2022 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited; contact 877.257.3382 or