Will the Ethereum Merge end up as a tax nightmare?

The Ethereum Merge is just around the corner and will bring major changes.

The Ethereum Merge is right around the corner and will bring major changes. But what about taxes?

After the successful Bellatrix update on September 6, it should be clear: The Ethereum Merge is happening next week (hopefully with success). This will, however, be followed by significant changes in the network. This also raises the question: how should the events around the merge be assessed from a tax-law perspective?

New chain, new tokens?

Technically speaking, with the change in the consensus mechanism, new ETH coins are making their way to Hodler: the Proof of Stake ETH coins. ETH-alt becomes ETH-new, on a 1:1 basis. This process should be regarded as a soft fork. In terms of tax law, nothing changes for users. In this regard, the new Proof of Stake coin behaves like the previously held tokens.

This is also confirmed by Werner Hoffmann, CEO of Pekuna GmbH, which specializes in crypto tax solutions.

The acquisition date should not change for the new coins and must be the same as for the old coins. The situation could, however, be totally different with Ethereum's pending hard fork. Here investors could face an even bigger problem.

Ethereum hard fork and the consequences

"The consequences of a possible ETH hard fork are indeed a complete nightmare from a tax perspective," Hoffmann warns. It is now known that some miners will push back against the change in the consensus mechanism. They plan to split the Ethereum blockchain at the merge and create a new Ethereum Proof of Work Coin (ETH-POW).

The problem is that, in theory, all coins on the blockchain, including ETH, copy each other during these splits. New coins are created that flow to the holders of the existing Ethereum coins. This can be seen as a kind of "forced takeover" — regardless of whether the holders want it or not. This would also trigger taxes. A true nightmare scenario.

According to the Ministry of Finance, the acquisition costs would have to be recalculated retroactively with the new coins and allocated according to the circumstances. The BMF noted this tax treatment of income in a brief from May.

Pekuna has already criticized this regulation. The company warned in July 2021 in a statement about a draft of the letter for the looming complication of the now-applicable valuation method for hard forks:

"First, all splits of an asset should be identified and timed, then the starting prices and the main currency prices should be determined. After the calculator relates the two prices, it would create fictitious acquisitions for each acquisition transaction for the later forked coin."

The documentation of the whole matter would, however, be incredibly complicated. But holders should be prepared for it.

Where do you store the coins?

In a smooth, non-splitting process, the world would still be fine for ETH-Hodlers. But if a hard fork happens, they should be aware of the consequences.

Hoffmann is nevertheless alarmed. Most people aren’t aware of the scale of the problem yet. His firm is already in talks with the BMF to try to avert a tax disaster.

According to him, Ethereum holders are to some extent bound hand and foot. Those who don’t want to receive the coins from a hard fork can at most deposit their existing Ethereum assets on an exchange that does not support ETH-POW. Without an inflow of forked coins, there would be no taxes.

Otherwise, you’d face the tax treatment. Hoffmann finds the method that "the value at the time of the creation of the split coin is set to zero and not touched on the original coin" a more sensible assessment.

It is true that the coins can be sold tax-free after the one-year holding period. If the price of ETH-POW were to rise drastically in the meantime, many would be tempted to sell the "gift coins."

A concrete solution to the problem hasn’t been found yet. However, the Ethereum Merge is coming next week.