The Web3 CFO's Guide to Crypto Airdrop Taxes

Most people love freebies, and crypto investors are not an exception. 

This is probably why crypto airdrops have become so popular among market participants. Many investors can't say no to financial rewards. An airdrop is also an opportunity for Web3 projects to raise awareness about their dApps, incentivize ecosystem participation, decentralized governance, and achieve other goals.

But as a Web3 CFO, you should also take crypto airdrop taxes into account before deciding to give away a part of your project's tokens to users. That's exactly the topic we are exploring today, touching on the following key points:

• An intro to the concept of crypto airdrops, as well as their different types and use cases within the digital asset industry

• The legal landscape surrounding airdrops

• When and how are crypto airdrops taxed

• How to classify and report crypto airdrop taxes

What Are Crypto Airdrops?

For investors, crypto airdrops mean a free(ish) way to earn digital assets.

Unlike with exchange trades, mining, staking, yield farming, or lending, users don't necessarily have to use their own capital to receive airdrop tokens. Instead, they can claim their rewards by only dedicating their time to complete certain tasks.

A crypto airdrop often translates to the intersection of blockchain and guerilla marketing for Web3 organizations. In many cases, projects only distribute tokens to the wallets of participants meeting certain eligibility requirements. To become eligible for airdrop rewards, users are incentivized to complete tasks set by the organization.

From a business perspective, projects can achieve the following goals with crypto airdrops:

• Raise awareness about the project

• Boost the platform's or the native token's adoption

• Decentralize the governance process

• Fix bugs and improve platform functionality based on user feedback

• Attract users from competitors

One of the most high-profile crypto airdrops includes Uniswap's event. Offering generous conditions, the decentralized exchange distributed a minimum of 400 UNI tokens to all users who utilized the protocol before September 2020.

Crypto Airdrop Types

Based on Web3 organizations' goals and the conditions for eligibility, crypto airdrops can fall into different categories, including:

• Standard airdrops: A standard airdrop doesn't require participants to complete any actions besides registering an account and sharing their wallet addresses with the host. As the supply of tokens is often limited, rewards tend to be small and are distributed on a first-come-first-served basis. In its first airdrop, Bitpanda gave away 10 million BEST to users who had signed up to its platform, verified their email addresses, and passed KYC.

• Bounty airdrops: Bounty airdrops are designed to incentivize user engagement and achieve other promotional goals by requiring participants to complete certain tasks to become eligible for rewards. Examples can include following social media accounts, retweeting posts, performing an action on the project's platform, or inviting friends. In OneRare's and CMC's airdrop, participants had to complete all nine tasks on a to-do list to be eligible to win 10 of the 10,000 available NFTs.

• Holder airdrops: As its name suggests, a holder airdrop distributes tokens to wallets already holding a certain digital asset. The latter can be an NFT issued by the project to reward the loyalty of collectors or the native coin of a competitor platform to attract its users. For example, ApeCoin's creators airdropped 150 million APE to BAYC and MAYC NFT holders in June 2022.

• Exclusive airdrops: Exclusive airdrops distribute tokens to only certain users. In most cases, the goal is to reward the most active community members. Arbitrum held an exclusive airdrop this March, giving away over 1 billion ARB tokens to eligible users. Based on the snapshot taken in February, participants' eligibility was determined using different factors. Examples include bridging funds into Arbitrum One or Arbitrum Nova, completing more than four transactions, and exceeding $10,000 in value for completed transactions.

In connection with our topic, we should also mention hard forks. A blockchain hard fork refers to the event when a project's chain splits into two separate platforms, mostly due to a disagreement in the community.

Hard forks are not exactly airdrops, as they are rarely intentional or involve promotion. But in most cases, the newly forked chain distributes (airdrops) tokens directly to the wallets of users holding the original blockchain's native digital asset prior to the fork.

Are Crypto Airdrops Taxable?

Before considering launching one, Web3 organizations should get the following question answered: are crypto airdrops taxable?

In most jurisdictions, the short answer is yes. Generally speaking, airdrop participants are subject to the following taxes:

1. Income tax: In many nations, crypto airdrops trigger taxable events when the tokens are distributed to users' wallets. The distribution of airdrop coins is viewed as a bonus and is taxed as ordinary income.

2. Capital gains tax: Besides income tax, airdrop participants also become subject to capital gains taxes if they realize a profit by disposing of their airdrop tokens at a later date. This includes exchanging them for fiat currency or other cryptocurrencies, spending them, or gifting them.

Even in countries that have more favorable rules, participants of your Web3 organization's airdrop will most likely be subject to some form of tax. For example:

• In Canada, while airdrops are not taxed as ordinary income for individuals, selling, spending, or disposing of token rewards in other ways makes users subject to capital gains taxes.

• In Germany, airdrop participants don't have to pay income taxes if a random element or chance decides the size of rewards. Users are not subject to capital gains taxes either if they dispose of their tokens after holding them for more than 365 days. However, bounty airdrops (where the amount of rewards has been predefined from the start) are taxable at the progressive income tax rate after receipt. Capital gains tax also applies in case holders dispose of them within 365 days.

How Are Crypto Airdrops Taxed?

Let's see how crypto airdrops are taxed based on the guidance of tax authorities in the US and the UK.

United States

Based on the IRS' 2019 guidance, airdrops and hard forks (if they result in token distributions) are treated the same way. In particular, this means that a taxpayer becomes subject to ordinary income taxes if he exercises "dominion and control" over the received assets.

Airdrops are taxed as ordinary income at the asset's fair market value (FMV) at the time they were transferred to the recipient's wallet address and must be reported on tax returns.

Suppose your Web3 organization's native token is called $INCENTIVE, and you distribute 10 $INCENTIVE into the wallet of every airdrop user. With $INCENTIVE worth $1,000 at the time of receipt, each participant that qualifies as a US taxpayer must report $10,000 of income on their tax returns.

Besides income taxes, US airdrop participants may also be subject to capital gains taxes. CGT applies in case taxpayers dispose of their airdrop tokens and realize a profit on the difference between their current fair market price and their value at the time of receipt.

Taking our previous example, a user would pay $5,000 in capital gains taxes after selling all 10 $INCENTIVE tokens valued at $1,000 each ($10,000 in total) at the time of receipt for $1,500 each ($15,000 in total) at a later date.

United Kingdom

In the UK, income taxes after airdrops are paid similarly as in Germany.

According to the HMRC's internal manual, an airdrop is taxed as miscellaneous income if the taxpayer received it in return for a service or in expectation of a return. Basically, this makes every bounty airdrop subject to income taxes based on their fair market value on the day of receipt.

Participants must also pay income tax as receipts of an existing trade if the airdrop is part of a trade or business related to exchange tokens or mining.

Suppose that participants of the $INCENTIVE airdrop must join the project's Discord and retweet one of the team's posts to become eligible. Due to receiving the tokens in return for a service, users must report 10,000 GBP as miscellaneous income on their tax return after claiming 10 $INCENTIVE worth 1,000 GBP each at receipt.

On the other hand, the $GENEROSITY airdrop's participants only have to register for the event to become eligible. As these are not received in return for a service or the expectation of a return (and $GENEROSITY is neither related to exchange tokens or mining nor received as part of a trade), users are not subject to income taxes in this case.

Even if an airdrop is not subject to income taxes, UK taxpayers must report and pay CGT after realizing a profit by disposing of the assets.

When Are Crypto Airdrops Taxed?

In the last section, we have explored how crypto airdrops are taxed in the US and the UK. Now, let's define the events triggering tax liability for airdrops, with a focus on when airdropped assets come fully under the recipient's control based on the IRS's guidance.

As mentioned earlier, the IRS makes an airdrop subject to income taxes if the taxpayer has complete dominion and control over the airdropped tokens. Let's see a few example scenarios to better understand this.

Suppose the project hosting the airdrop distributes tokens to a non-custodial wallet the participant has exclusive access. This means the user is not only in full control of the private keys but also the airdropped assets, which he is free to dispose of at any time. It's a rather straightforward case when the receipt of the tokens in the airdrop participant's wallet instantly triggers a taxable event.

But what happens when a project airdrops tokens to a crypto user's wallet without his permission or active participation in such an event?

The above wouldn't trigger a taxable event in the UK and Germany as rewards are random and are not received in (the expectation of) returns for a service. However, according to IRS' current guidance, US taxpayers must report airdropped tokens as ordinary income at fair market value on the day of receipt even if they haven't opted-in to receive them.

In some cases, the recipient can't (yet) exercise full control over the token after receipt. For example, the taxpayer receives the assets in a custodial wallet managed by a crypto exchange that doesn't immediately support the airdropped coins. Consequently, the user can't exercise full dominion or control over the tokens, which are not yet credited to his exchange account.

In the above case, the user won't be subject to income taxes until the exchange credits the airdropped tokens to his account. But when that happens, he will gain the ability to dispose of the assets, triggering a taxable event.

How to Classify and Report Airdrop-Related Taxes?

After exploring the scenarios when users are subject to crypto airdrop taxes, let's proceed with a step-by-step guide on how to classify and report them in the US and the UK.

Step 1: Determine the Fair Market Value

The first step to reporting crypto airdrop taxes is determining the fair market value of the airdropped tokens after taking control of them. In most cases, this is the time when the user receives the assets in his wallet.

For income taxes, the current value of the tokens doesn't matter, only their fair market value at the time of receipt. Users can utilize a price-tracking website, like CoinMarketCap or CoinGecko, or a reputable exchange to determine the assets' FMV.

Step 2: Report Income Taxes

Next, individuals must report the tokens received from airdrops as "other income" on Form 1040 Schedule 1 in the US, with federal income tax brackets ranging between 10% and 37%. If airdropped assets were received by a business entity, then this revenue should be reported as part of the organization's annual tax return (Form 1120, Form 1120-S, or Form 1065).

If they are not eligible to be exempt from income taxes (with rates ranging between 0% and 45%), individual taxpayers in the UK can report the revenue from airdrops as "miscellaneous income" via the HS325 Self Assessment helpsheet. For organizations, airdropped tokens can be reported as corporation tax, which can be filed online or via the CT600 form.

Step 3: Calculate and Report Capital Gains Taxes

As explored earlier, airdropped tokens are also subject to capital gains taxes when holders realize a profit after disposing of them.

Taxpayers can calculate the CGT by subtracting the cost basis from the assets' market price at the time of disposal. This cost basis is already known, as it was the fair market value of the airdropped tokens when they came under taxpayers' control.

In the US, capital gains and losses can be reported via Form 8949 and Form 1040 Schedule D. The short-term CGT rate is the same as the ordinary income tax rate that falls between 10% and 37%. By holding airdropped tokens for more than 365 days after receipt, US taxpayers may be eligible for long-term capital gains treatment. Ranging between 0% and 20%, this rate is significantly lower than the short-term CGT and depends on the annual income level and filing status.

US taxpayers can offset their capital gains with losses. But it is important to highlight that they must first deduct losses from gains of the same type (e.g., short-term losses from short-term gains). After that, taxpayers can offset net gains with net losses of a different type (e.g., long-term gains with short-term losses).

If taxpayers still have an overall net capital loss for the year, up to $3,000 of this loss can be deducted from the total annual income. Any losses exceeding this $3,000 level can be carried forward into the following tax years.

Individual UK taxpayers can file CGTs using the Self Assessment Tax Return or the real-time Capital Gains Tax Service. Business entities can report both income and capital gains/losses on airdrops as corporation tax via the corporate tax return. It can be filed online or via the CT600 form. CGT ranges between 10% and 20% for individuals, while most organizations are taxed at 19% or 25% based on annual profits.

UK taxpayers can offset capital losses against gains of the same tax year. However, the current year's capital gains can't be carried back against gains of earlier years. If a taxpayer's total taxable gain still remains above the tax-free allowance, he can deduct unused losses from previous years. Excess losses can be carried forward to future tax years.

No matter the jurisdiction, it is a must for every participant to accurately record crypto airdrop transactions and report this information on tax returns. Failure to do so may trigger an audit from tax authorities and lead to severe penalties.

Hassle-Free Airdrop Accounting and Tax Compliance

Crypto airdrops and taxes go hand in hand. As the CFO of a Web3 project considering the launch of its airdrop, you should be aware that the event's participants will likely be subject to both ordinary income taxes and capital gains taxes.

For the Web3 project hosting the event, a crypto airdrop often produces several thousands of records (to date, over 220,000 addresses have claimed UNI after Uniswap's airdrop). Manually recording, managing, and tracking all these transactions can be strenuous for financial teams.

Integral saves time for Web3 projects by automatically categorizing airdrop transactions via intuitive rule creation. They can distribute tokens to participants without worrying about the accounting nightmare following such events. Simultaneously, financial teams get a precise and complete picture of their crypto organizations' financials with real-time treasury visibility, powerful integrations, and minute-by-minute pricing.

We also have a solution for Web3 organizations that haven't hosted airdrops but earned tokens by participating in such events. With Integral, they can automatically calculate their capital gains and losses and synchronize them with their preferred ERP. If needed, they can also leverage our crypto accounting stack to generate compliant and detailed reports for digital asset profit & loss, cost basis, position closures, and other purposes.

Integral puts you in control of your project's accounting, saves time for your team, and simplifies your financial processes.

Book a demo with our team, and we'll get you started in no time!