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.
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.