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During the weekend of December 12-13, 2020, certain wallets that held Ripple, or XRP, received an airdrop of Spark tokens. Spark is a newly launched token native to the Flare Network, which is part of the Ripple ecosystem.  

Spark tokens add decentralized finance, or DeFi, functionality to the Ripple ecosystem. DeFi generally reflects an intent to reduce or eliminate middlemen and intermediaries in financial and other business transactions. Until this airdrop, many DeFi applications have run on the Ethereum network. The Spark tokens and Flare Network represent Ripple’s entry into DeFi, seeking to compete with Ethereum for marketshare.

LEGAL TOKENS

Although this is not the first airdrop since the IRS released guidance last year regarding the treatment of airdrops, this is a prominent airdrop. In Revenue Ruling 2019-24, the IRS stated that airdrops are taxable events.

A U.S. taxpayer receiving an airdrop of cryptocurrency will recognize ordinary income to the extent of the cryptocurrency's fair market value as of the date the taxpayer has complete dominion and control over the newly received tokens. Dominion and control generally mean when a taxpayer can sell or dispose of the cryptocurrency.

Depending how and where a person holds XRP, they may have had a taxable event at the time of the airdrop or will have one in the near future, when the holder can begin trading the new Spark tokens. This ‘dominion and control’ rule could mean that some taxpayers will recognize income after the Spark tokens have appreciated in value from the time of the airdrop. This may mean a larger tax bill for some.

Given the publicity around this airdrop, it will be interesting to see whether the IRS ultimately brings any enforcement actions, such as audits, or makes any public announcements to raise taxpayer awareness as to their reporting obligations.

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Author's Assets

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Brett Cotler | Associate

Brett Cotler is an associate in Seward & Kissel's Taxation Group and Blockchain and Cryptocurrency Group. Brett structures and advises clients on investments in digital assets, offerings of digital assets, and crypto-businesses. Brett specializes in U.S. federal and state tax and regulatory matters. He also: 

  • Tokenized various assets;

  • Solves complex tax issues for companies, their principals, and their investors; 

  • Structured an upstart token exchange; and

  • Advises on New York State Virtual Currency License applications.

“Under current U.S. law, any time a person uses cryptocurrencies for payments, it's a taxable event, and a lot of casual PayPal users could end up being completely surprised by tax liabilities that could result from buying and selling bitcoin or other cryptocurrencies via PayPal.”

Brett's thoughts on PayPal's new crypto services, as published in PaymentsSource article "Why PayPal's crypto plan may not be fully mainstream”