Ethereum ‘Merge’ is the word on everyone’s lips – and it’s little wonder the cryptoverse is fascinated. Vitalik Buterin’s big play heralds massive changes for Ethereum and in turn, a seismic ripple effect on all things blockchain and DeFi. Yet, there’s still a lot we don’t know about the beacon chain Merge. For example, what does Ethereum 2.0 look like exactly? When will the Merge take place, and will ETH fork? And, not to forget, what will the Merge mean for crypto taxes?
Bitcounts Inc. tax experts have taken a look in the crystal ball to arrive at an educated guess on these questions and more. Let’s dive in!
What is the Ethereum Merge?
The Merge is exactly that – 2 blockchains joining up as one. The Ethereum Foundation tells us that that during the Merge event, the Ethereum Mainnet (the current blockchain) will merge with the Proof of Stake (PoS) Beacon Chain, marking the end of Proof of Work (PoW) as the consensus mechanism for the Ethereum blockchain.
One immediate bonus from the Ethereum Merge moving from PoW to PoS will be an approximate 99.95% reduction in the blockchain’s energy consumption.
Once on Beacon Chain, Ethereum will join ranks with other major PoS cryptocurrencies such as Binance Smart Chain (BNB), Cardano (ADA), and Solana (SOL).
As the second largest crypto after Bitcoin, and the chain that effectively launched both NFTs and DeFi, the Ethereum Merge will shake up the entire crypto space in one of the most significant moves of the last five years with immediate impacts.
As far as its impact on cryptocurrency taxation, we’re anticipating various tax implications depending on what happens following the Merge.
“One area of interest is whether there is a fork of the original PoW Ethereum blockchain. From the perspective of Ethereum developers, the Merge will see the whole Ethereum network transition with there being no change to the Ethereum token.”
“If there is no fork, it is unlikely that the change in PoW to PoS consensus mechanism resulting from the Merge will create a disposal event by virtue of there being no new crypto asset (i.e. ETH will remain as ETH),” he adds.
Why Proof of Stake?
This is by no means a rushed decision. Vitalik Buterin originally envisaged Proof of Stake to be the consensus mechanism of Ethereum, according to his whitepaper published in 2013. However, he noted in 2014 that the development of a PoS was “so non-trivial that some even consider it impossible”.
Ethereum saw work on its move to a PoS begin during 2016, with Buterin posting his philosophy as to why he believed Proof of Stake as a design would be the superior method for ensuring the security of the network.
Ethereum Merge date
So, when will the Ethereum Merge take place?
The ETH Merge date is estimated to be completed in Q3 or Q4 2022, with Ethereum developers currently targeting September 13-15 as the Merge date.
It’s important to keep in mind that the date of the Ethereum Merge has been delayed before, with numerous false starts dating back as far as 2017. While developers are indicating green lights, don’t be surprised if there’s another delay.
Nevertheless, the Merge timing will be important for crypto taxes, explains Yogesh, Founder at Bitcounts Inc., “With multiple countries currently in the middle of their tax seasons and many more about to hit the end of their financial year, the date on which the Merge takes place could significantly affect the tax positions of crypto investors over the next two financial years at least.”
Let’s talk about the potential fork
While most of the attention around the Ethereum Merge is the move to a PoS blockchain, there has been speculation that Ethereum miners will continue to mine more blocks on the current chain, possibly leading to a fork.
This potential “forked” version of Ethereum already has a name, “ETHW”, which stands for Proof of Work Ethereum. ETHW could be a “hard fork” from the main ETH chain (or vice versa), where both chains are separately maintained by different developers.
So is ETH going to fork? In short – we don’t know.
However, it’s best to consider each possibility on its merits, as well as looking at previous soft and hard forks of cryptocurrencies over the years as an indicator of what might happen this time around.
Time will tell – and we’ll update this blog immediately after the Merge to reflect on what ends up happening – and what the exact ramifications are for crypto taxes.
Ethereum Merge Taxes
First and foremost – the direct tax implications of the Merge depend on whether ETH experiences a hard fork or soft fork.
Danny Talwar explains, “One of the reasons there has been so much speculation surrounding the Merge is the tax implications if the network hard forks. In the scenario a hard fork does occur, there may be a taxable event. However, this depends on where you live.”
Reflecting on Ethereum Merge tax implications in the US, Tony Dhanjal adds, “The IRS has not issued any guidance as yet and whether they are likely to before the end of tax year on 31 December, is uncertain to say the least.
“However, the IRS offers clear guidance when it comes to hard forks and that is – if an investor receives an airdrop of new coins following a hard fork, then they have taxable income.”
Alternatively, if there is a soft fork and no new ETH tokens (like ETHW) are created, it’s unlikely there will be a taxable event.
Meanwhile, in Canada, the CRA hasn’t yet issued any specific guidance on the tax consequences of hard forks.
Founder at Bitcounts Inc., Yogesh explains, “The CRA tax treatment on an ETH hard fork largely depends on whether you’re viewed as an individual investor or conducting business activities. In Canada, if you’re viewed as an individual investor, it’s unlikely you’ll have to pay Income Tax for any crypto you receive as a result of a hard fork. However, under the adjusted cost basis method, the cost basis for any new coins you receive from the fork may be zero, meaning the full market value at the point of a disposition would be taxable.”
Similarly, for those in Australia, if you’re an investor, there will be no tax on ordinary income upon receipt. However, you will need to pay tax on any capital gains when disposing of any new ETH tokens received (and a cost basis of zero).
“Where new tokens are received as a result of a fork, investors will have to front up on disposal. Unlike many other jurisdictions, the ATO suggests that the cost basis of the new tokens is zero, implying that the full market value at the time of disposal is taxable as capital gains,” he continued.
And what about crypto taxes in the UK? Tony Dhanjal weighs in on the implications of an ETH Merge, “HMRC will treat any forked tokens as income, and thus you’ll need to pay Income Tax under the miscellaneous income sweep up provision. Capital Gains Tax will also be due, as and when those tokens are disposed. There is also a specific rule in the UK on the cost basis from a fork – as it is derived from your existing tokens from the previous blockchain and not the market value of the forked coin on the day you received it.”
He goes on to add, “HMRC in the UK have provided limited guidance on one way transfers – citing Ethereum Mainnet to Beacon Chain as a one-way transfer example. Their view is that section 43 of The Capital Gains Act 1992 will apply to this scenario – simply put, a taxable event is not triggered at the point of the Merge – instead, the cost basis of your ETH1.0 is attributed to your ETH2.0 token and any subsequent disposals will accrue a gain or loss as normal.”
“However, there are proponents in the crypto tax community who are concerned HMRC may interpret the Merge as a crypto to crypto trade, thus a taxable event. In my opinion, this is unlikely given the Merge in economic substance is an upgrade and does not create additional wealth.”
So, will the ETH Merge result in a hard fork?
A hard fork or not? “Based on history, we’ve seen hard forks happen on the Bitcoin blockchain. These were the result of disagreements between miners, developers and the community around the size of Bitcoin blocks, with “big blockers” wanting to increase Bitcoin block size higher than the 1MB limit.”
“This resulted in both BCH (Bitcoin Cash) forking from BTC (Bitcoin) and, subsequently, BSV (Bitcoin SV) forking from the BCH chain. Depending on which country you live in, this meant that the forked BCH and BSV tokens may have resulted in your local tax office recognising this as additional income, leading to Income Tax”, he adds.
While both these Bitcoin hard forks didn’t prevail as the main Bitcoin blockchain, following the DAO hack on the Ethereum blockchain in 2016, a hard fork split the network into two competing chains.
Ethereum Classic (ETC) stayed true to the original code, while Ethereum reverted the blockchain so that over $100m was returned due to a bug in the original codebase. The result was a hard fork away from the “original” chain, where the forked version (ETH) became the prevailing version of Ethereum.
It looks like ETHW will be supported by some of the current Ethereum miners. This could be a repeat of the ETH split away from ETH back in 2016, with ETHW continuing with the current codebase and ETH forking to the new PoS chain.
Will the ETH Merge result in a soft fork?
Conversely, the Merge may not result in a hard fork, as this is a planned upgrade of the network, and as such, any attempts at forking ETH will be to no avail and with no support.
“I don’t think that Ethereum will result in a hard fork because ETH will remain the currency on the blockchain. Plus, with the current blockchain becoming part of the new blockchain and all smart contracts moving over, along with all the previous data – it’s unlike classic hard forks we’ve seen before,” he said.
What happens to Ethereum after the Merge?
For those reading and thinking that they might be about to double their NFTs and stablecoin positions across two different Ethereum chains – hold up.
It’s important to note that if ETHW is supported by Ethereum miners, it won’t be supported by most DeFi protocols, stablecoins and oracles. Circle (the company behind the USDC stablecoin) have publicly stated that USDC would not be supported on ETHW following the Ethereum Merge.
Chainlink has also revealed that their oracles (which update token prices across major DeFi platforms) will only support the PoS Ethereum chain, leaving ETHW without reliable price feeds.
New blocks will be created via staking rather than mining, requiring individuals (or entities) to set up their own pool. This requires 32 ETH – which may not be feasible for most. However, crypto investors are able to delegate their ETH to centralized platforms, including Coinbase, Binance, Kraken and Lido.
ETH staking vs mining taxes
Following the Ethereum Merge, the tax implications of staking (rather than mining) will depend on where you live.
For those in the US – crypto mining and staking are both subject to Income Tax upon receipt and CGT upon disposal. However, staking is a contentious topic and is currently subject to an ongoing court case, so this may be set to change in the future as the case proceeds.
In Canada, the tax you’ll pay depends on the scale of your mining activities and your intentions. While individuals and hobby miners do not have to pay Income Tax upon receipt for mining, they do pay Capital Gains Tax upon disposal. However, if your mining activities are viewed as business income, you’ll be liable for Income Tax upon receipt
However, when it comes to staking, the CRA will likely view any PoS rewards as earnings, resulting in the need to pay Income Tax upon receipt of any ETH staking rewards – based on the fair market value of tokens upon receipt.
In the UK, Tony Dhanjal says, “ETH staking and mining are generally miscellaneous income and subject to Income Tax upon receipt and CGT on disposal. However, this depends on the degree of activity, organisation, risk and commerciality.”
Finally, for Australian crypto investors, taxes on crypto mining depends on whether you’re a hobby miner or trader. There is no Income Tax for hobby miners, as rewards are viewed as a capital acquisition – however, investors will need to pay Capital Gains Tax if they dispose of their mined coins by selling, swapping, spending or gifting them.
If you’re a trader – aka a business, then proceeds will be taxed as ordinary income. However, you may be eligible to deduct allowable expenses. Whether you’ll be viewed as a hobby miner or trader by the ATO depends on a number of factors, including whether you conduct operations in a ‘business-like’ manner. When it comes to staking, however, it’s likely that the ATO will consider this as additional income and as such, investors will need to pay Income Tax upon receipt, as well as having Capital Gains obligations upon disposal.
How Bitcounts can help with crypto taxes after the Ethereum Merge
With all the different scenarios that may happen following the Merge, it can be difficult to keep up to date on the latest and calculate taxes on crypto forks.
Fortunately, Bitcounts is one step ahead. All you need to do is import all of your ETH transactions from your various crypto wallets and exchanges, into the tax software. You can do this via CSV file or through API integration for most platforms.”
“Once your data is imported, Bitcounts will make sure that we easily tag individual transactions in your crypto tax software manually. Just find the transaction in our platform and use the three dots on the right-hand side to tag it as a fork.”
For users in countries where coins as a result of a hard fork are considered income, we can also mark the forks as income.
And if you’re staking ETH, we can also help you identify the fair market value of any rewards in your local currency on the day you received them so you can easily calculate any income from crypto to report to your tax office.
Once your transactions are correctly tagged, we will calculate your crypto taxes, including any capital gains from forks and any income from forks. You can find an easy-to-read summary on your tax reports page, as well as specific tax reports to download and use when it’s time to file your taxes.
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