Wondering whether the Ethereum Merge will impact your tax bill?
After years of anticipation, developers announced an upgrade to the Ethereum network called The Merge (previously known as Ethereum 2.0) that will take place in September 2022. Many speculate that the change could increase Ethereum’s transaction volume substantially and change the crypto ecosystem forever.
Our team of tax professionals has spent time analyzing how the IRS may tax the Ethereum Merge based on existing guidelines. In this guide, we’ll break down the tax implications of the migration — whether you’re holding, staking, or planning to sell.
What is the Ethereum Merge (or Ethereum 2.0)?
The Ethereum Merge (previously called Ethereum 2.0) is an upgrade to the Ethereum blockchain, designed to lower
and increase transaction times. Among other changes, the migration will change Ethereum from a Proof of Work (PoW) to a Proof of Stake (PoS) blockchain. gas fees
Proof of Work uses the computational power of miners to secure and validate the blockchain’s network, while Proof of Stake requires ‘stakers’ to commit their crypto tokens to secure and validate the blockchain’s network.
Prior to the official Merge event, the Ethereum network deployed the Beacon Chain, which allows validators to stake their Ethereum and earn rewards. However, staked Ethereum and associated rewards could
not be transferred or withdrawn until The Merge was complete. Is the Ethereum Merge a taxable event?
It’s reasonable to assume that
you will not incur a taxable event simply for holding your Ethereum through the Merge.
Typically, you pay tax when ‘dispose' of your cryptocurrency or 'earn' cryptocurrency income. Holding your existing ETH through the Merge does not fall into either category. While the blockchain is going through an upgrade, your Ethereum coins will continue to hold the same rights and responsibilities as before.
As the IRS made clear in their 2019
, cryptocurrency forks are only taxed when holders receive new units of crypto. cryptocurrency revenue ruling What happens if I receive new units of cryptocurrency after the merge?
While you won’t be taxed for holding your existing ETH, you will be taxed
if you receive new units of crypto after the Merge.
It’s possible that Ethereum miners will maintain a Proof of Work version of the Ethereum blockchain, and airdrop existing holders of ETH this ‘new’ PoW-based cryptocurrency.
If you receive units of PoW-based Ethereum after the Merge, you’ll recognize income based on its fair market value at the time of receipt.
What taxes will I pay when I sell Ethereum?
Your cost basis and your holding period from your original ETH holdings will transfer over to your upgraded ETH post the Merge.
This means that whenever you sell or dispose of your upgraded ETH in the future, you trigger a capital gain tax event where you will realize a gain or
depending on how the price of your ETH has changed since you originally received it. loss Is staking ETH a taxable event?
As discussed in our
, crypto that is earned from staking is generally treated as income equal to its fair market value at the time it is received. guide to cryptocurrency staking taxes
Due to the lockup period associated with the validator rewards prior to the Ethereum Merge, crypto tax professionals and attorneys within the Ethereum community have debated whether your staking rewards trigger income at the time they are “earned”—as they are earned during this lockup period.
At this time, this is a grey area in the tax code. There is no clear guidance from the IRS or other tax authorities on this matter. As a result, investors take different approaches to reporting their ETH staking income based on their risk appetite.
The conservative approach is to report Ethereum staking rewards as income at the time your coins are received, even if you can’t access it.
The aggressive approach is to report Ethereum rewards as taxable at their fair market value when you have the ability to freely withdraw and trade them. Since you do not have dominion and control over your coins until after the Merge is complete, you would report your income from staking rewards at that time.
Are ETH staking rewards taxed when you sell?
Regardless of which method you choose to report your staked ETH rewards, your
will be equal to the fair market value of your coins at the time you recognize income. cost basis
That means that when you dispose of your staking rewards, you incur a capital gain or loss based on how your crypto has changed in value since you originally ‘received’ it.
For a complete overview of how cryptocurrency taxes work, check out our
. Ultimate Crypto Tax Guide How crypto tax software can help like CoinLedger can save you hours of time and effort this tax season. Cryptocurrency tax software CoinLedger can automatically import your transactions from blockchains like Ethereum and exchanges like Coinbase. Once you’re done importing your transactions, you can generate a comprehensive crypto tax report with the click of a button. Get started with a free account today.