$ENS Airdrop Comes With A Tax Bill

What Happened

Airdropping is a popular method used by cryptocurrency projects to reward early adopters. For instance, we saw projects like Flare and Uniswap ($UNI token) airdrop $FLR and $UNI tokens to millions of users in 2020. So far, over 133M $UNI tokens worth over 3 billion have been claimed by the users. 

Similarly, anyone who had an Ethereum Name Service (ENS) domain as of October 31, 2021, is eligible to receive free $ENS tokens. Specifically, 82,047 of the 137,689 addresses have claimed the airdrop as of November 17, 2021. The specific amount available per address depends on their level and duration of involvement with the project. Currently, $ENS is trading at approximately $50 per coin, making it a lucrative opportunity.

Key Concepts

What are Airdrops?

Airdrops are free tokens that you are eligible to receive as a result of being an early adopter of a cryptocurrency project. Some are surprises. For example, Uniswap airdropped 400 $UNI tokens to early users of the Uniswap exchange. Other airdrops are planned in advance to drive up prices and publicity. For example, Flair had been talking about a potential airdrop for $XRP holders for a while before it occurred on December 12, 2020, the snapshot date.  

The redemption processes can differ as well. Sometimes, you get airdrops automatically in your wallet without any action from your end. In other cases, you have to intentionally claim the free tokens by following the instructions provided by the project. For example, if you had an ENS domain as of October 31, 2021, you can claim your free $ENS by going to https://claim.ens.domains/. 

Airdrop Taxes

The IRS has not issued any direct guidance on airdrops sent to early adopters of a project. It is reasonable to think that such airdrops are unsolicited property for tax purposes because the recipient doesn’t have any prior knowledge about the airdrop. Moreover, the Rev. Rul. 2019-24 talks about airdrops that could happen pursuant to a hard fork. Although the background provided here may not be directly applicable to the $ENS airdrop (since there’s no Hard fork), the dominion & control doctrine used here is important when determining the tax consequences.

According to past unsolicited property tax rulings (Technical Advice Memorandum 8109003 and 8109004) and the details provided in the Rev. Rul. 2019-24, surprised airdrops like the $ENS token is likely taxed at the time the taxpayer gains dominion & control over the asset. In simple terms, this means at the time you claim the token and have the ability to transfer, exchange or sell the coin. The amount of ordinary income to be reported is the fair market value at the time you gain dominion and control. This amount would be subject to ordinary income taxes (10% – 37%) based on your income tax bracket.

For example, say you claimed (exercised dominion & control) one $ENS token on November 08, 2021. On this day, one ENS token was approximately worth $30 according to CoinMarketCap data.Therefore, you have to report $30 of ordinary income.  

Say you later sell this $ENS for $50. Then, you would pay capital gains taxes on $20 ($50 – $30).

Note that some airdrops could automatically appear on your wallet without you taking any action. In these cases, you’d have a taxable event even If you didn’t want the airdrop. This is because the dominion and control is automatically established when the coins appear on your wallet. If the price of the coin later drops and/or you don’t want the coin, you may still be liable for the tax bill based on the price at the time you received them. Here, you can liquidate the coin at a loss to offset the income reported at receipt.  

How to Plan Taxes Around the $ENS Airdrop

ENS protocol allows you to claim $ENS until May 4th, 2022. There are couple of actions you can take to reduce and defer taxes on the $ENS airdrop. First, you can wait until the prices go down before claiming the token, if you think that they will. Going with the example above, assume you claim $ENS in December 2021 when the price is $20 per coin. Here, you’d report $20 of ordinary income instead of $30. On the other hand, if the price rises, you would end up reporting more income. 

Second, you can claim your $ENS between January 1st, 2022, and May 4th, 2022. By doing so, you can defer the taxable event to the 2022 tax year. If you are subject to a lower tax bracket in 2022 compared to 2021, this will reduce your taxes on the airdrop. Further, 2022 taxes are due by April 2023. This gives you ample time to observe the prices and sell when the price is at Its highest. 

Either way, it is also important to set aside some money to pay the related taxes on the income reported on the airdrop. The amount to be set aside varies depending on your filing status and the tax bracket. If the airdrop is a large amount, it is recommended to talk to a tax adviser and calculate the estimated taxes on the airdrop.  

Finally, you can entirely eliminate taxes by not claiming the airdrop at all. If you don’t claim the tokens by May 4th, 2022, you will potentially lose access to the airdrop. According to the ENS website, tokens not claimed by this date will be sent back to the ENS DAO treasury. If you don’t claim, you will not have any taxable event because you never gained dominion & control over the asset. 

Next Steps

·      Consider claiming $ENS when the market price is low.

·      Consider claiming $ENS between January 1st, 2022, and May 4th, 2022, to defer tax liability to the next tax year. 

·      Have enough cash in hand to pay the related tax liability generated from the airdrop. 

Further Reading

·      Time To Take Advantage of This Key Crypto Tax Loophole Is Running Out, Plus Other Year-End Strategies.

·      How To Avoid Common NFT Tax Pitfalls.

         @TheCryptoCPA

        da-research@forbes.com

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