Tax experts say those who don’t play their Ethereum (ETH) cards right could face a hefty tax bill following the Ethereum merger.
Around September 15, the Ethereum blockchain is set to transition from its current Proof-of-Work (PoW) consensus mechanism to Proof-of-Stake (PoS), to improve the network’s impact on the environment.
There is a possibility that the merger could trigger a contentious hard fork, which would result in ETH holders receiving duplicate hard-forked Ethereum tokens, similar to what happened in 2016 when Ethereum and Ethereum Classic hard forks.
Mills Fuller, head of government solutions at tax compliance firm TaxBit, told Cointelegraph that the merger raises some interesting tax implications in the event of a hard fork.
The big question for tax purposes is whether the merger will result in a hard fork in the chain.
“If not, there really are no tax implications,” Fuller explained, adding that the existing PoW ETH would now become the new POS ETH “and everyone would go their merry way.”
However, if a hard fork occurs, meaning ETH holders are sent duplicate PoW tokens, then “various tax implications may occur” depending on how well the PoW ETH chain is supported and the ETH holdings at the time of the fork.
For ETH held in user-owned on-chain wallets, Fuller points to IRS guidance stating that any new PoW ETH tokens are considered revenue and valued at the time the user holds the tokens.
Fuller explained that depending on whether the platform decides to support the fork’s PoW ETH chain, the situation may differ for exchanges holding ETH in escrow wallets:
“How custodians and exchanges handle forks is generally covered in your account agreement, so you should read it if you’re unsure.”
“If the custodian or exchange doesn’t support the chain fork, you may not have any earnings (and may have missed out on a freebie). You can take your holdings to an unhosted wallet pre-merge to verify this. You’ll get any coins (or tokens) due to a chain fork,” he explained. .
The performance of the PoW token could affect the potential tax bill, according to an August 31 tweet from CoinLedger’s director of strategy, Miles Brooks.
“If the value of the tokens drops significantly after the PoW fork (and you control it) – maybe – you will have a tax bill to pay, but you may not have enough assets to pay.”
Brooks noted that it could be beneficial for an investor to sell some tokens upon receipt of the forked coin, which would at least ensure that the tax bill is covered.
7/ What can you do to prepare? If the ETH PoW fork happens, you’ll want to know if you’re eligible for the fork, because it might be best for you to sell these tokens when you receive some to ensure you have enough for your stake. Tax payment!
— CoinLedger (@CoinLedger) August 30, 2022
In the absence of a hard fork, Ethereum miners and some exchanges are increasingly for PoW hard forks, as these miners will be forced to migrate to another PoW cryptocurrency.
Vitalik Buterin suggested at the 5th Ethereum Community Conference in July that these miners could return to Ethereum Classic instead.
Related: 3 Reasons Ethereum POW Hard Fork Tokens Won’t Get Crowded
Contrary to what was suggested in the related CoinLedger article, post-merger Ethereum will not be called ETH 2.0, but simply ETH or ETHS, with any potential fork token being called ETHW.
Crypto investors should be wary of ETH 2.0 post-merger tokens.
Cryptocurrency exchange Poloniex, which claims to be the first exchange to support both Ethereum and Ethereum Classic, has extended its support for a hard fork and added trading for ETHW.
Cryptocurrency exchange Bybit told Cointelegraph that when the fork tokens are created, Bybit’s risk management and security teams are in place to decide whether to list the PoW token on their exchange.
Bybit says that exchanges that already list ETHW tokens are profiting from user security, and cautions traders against moving to exchanges that support PoW tokens due to volatility and security concerns.
“We warn traders that Ethereum PoW forks are potentially very volatile and could pose security risks. Exchanges that already list tokens for PoW forks will profit from user security.”