Arbitrum Airdrop, an airdrop in name only?
when is an airdrop really an airdrop for taxes?
Many crypto users participated in the Arbitrum ARB airdrop in March of 2023. It was a widely anticipated event and spawned a slew of other protocol launch airdrops to continue to ride the wave of hype. But how does it affect you for tax purposes, and is the ARB airdrop even an airdrop at all?
An Airdrop in crypto terms
In defi user terms, an airdrop is a pretty broad term. It essentially means getting tokens for doing anything except depositing a token into a protocol. You can get an airdrop because the contract for the token you are holding was compromised or had an error, because a new chain launched, a new protocol launched, or you held and NFT.
An Airdrop in tax terms
The specific term “Airdrop” really doesn’t come up much in tax language. There is an IRS FAQ that mentions an airdrop being a result of a hard fork of a chain, which refers specifically to the BCH split from BTC in 2017. Keeping that in mind, is ARB really an airdrop at all?
Is ARB an “airdrop” in tax terms?
Is ARB really an airdrop at all if we look at it through the tax lens of tokens received as the result of a hard fork? Not at all. First, the ARB reward wasn’t even ‘dropped’ into wallets, and second, it wasn’t result of any fork. To receive ARB you actually had to go in and interact with a contract and claim the tokens. So, maybe it’s not even an airdrop according to the IRS FAQ terminology; but does that mean that it’s tax free? Probably not.
What is the receipt of ARB then? A prize?
If it’s not an airdrop what might it be? Well, let’s use a real world comparison…is there anything else out there, non-crypto, that is a promotional reward given to people that use, or promote, a product or participate in some kind of contest? Sure there is. If you are really old, maybe you remember “publishers clearing house” that would give checks away to people, or maybe you provided your personal information on a piece of paper and put it in a box in order to be drawn to win a car? What are those things called? Prizes. The language even works in order, to receive a prize you must claim it.
Have we found the ultimate tax loophole? Now that ARB is a prize…is it tax free? For Americans it is taxed as ordinary income. So, taxation at equal rates to an airdrop except for one thing. In 1956, there was a man who won a car as a prize and argued that its value was actually much less than the cash value that was assigned to the car when he received it. The case is “McCoy, 38 T.C. No. 841”. The summary of the case is that Mr. McCoy won a car that was stated by the company awarding the prize to be worth $4552. When the taxpayer went to sell the vehicle though, he could only get $3600 for it. So he argued to the tax court that $3600 was the actual fair value of the car and that is what he should get taxed on. The court agreed.
Why does that matter? It matters that in 1957, the value of a brand new Lincoln automobile was only $3600 as a testament to the inflation of the US dollar…but it also matters that the value of a prize rewarded as a prize per a liquidity chart may not be the same value that can actually be realized by a recipient if they try to use or sell that prize.
The curse of the claim button
So, if an ARB style airdrop could be a prize, could one argue the value? That’s a maybe, but it’s not as ideal of a situation as it could have been. This is because ARB was awarded via a claim button that users could interact with at any time, particularly after it had already been trading an a price had been established. This matters because; let’s say that ARB was just dropped into qualifying wallets before there were any liquidity pools or prices available. Well at that time, a recipient could argue that the airdrop when they received it had no value, and they only sold it later once value had been established, at which point they would be realizing capital gains on an airdrop with zero cost basis….which is usually better for reasons that require another article.
However, in ARB’s case, because a user had to claim it after trading had begun, they could be in for a rude awakening if they didn’t make any alternative arguments. Within the first few minutes of being live, the price for ARB was between $6 and $10 per token. If a user had claimed 100 tokens during that time, it could be argued that they realized $1000 in income even if they were still holding or sold for $110 later that day.
Claim button avoids poison pills
However, despite the annoying aspects of the airdrop claim button, it does avoid a potential poison pill that can be had from a traditional airdrop which just places tokens into wallets. Imagine that you no longer used or checked a wallet that was traditionally airdropped $1000. You now could have $1000 in taxable income that you never knew about.
Airdrops are complex
Airdrops may not always be airdrops for tax purposes. Maybe they are prizes, compensation, or they are something else. For Canadians, maybe they are tax free windfalls? In circumstances where it’s a replacement token is it just a reimbursement? If you already hold the token is it like a stock split? I hope you’ve come away from reading this as more curious about examining the mechanics of the tokens you receive.
Last, remember, absolutely none of the above is tax advice. Do not rely on anything above as tax advice, these are just tax ideas and research prompts for you to use when analyzing your own situation, or things to ask your own tax advisor in a professional engagement.