A recent court case leaves many speculating about the taxation of staking rewards

The IRS has not issued any clear guidelines on the taxation of staking rewards. In 2014, the IRS issued Notice 2014-21, which provides that cryptocurrency is treated as property for federal tax purposes, but Notice 2014-21 and Tax Ruling 2019-24 and the frequently asked questions do not provide any further guidance on tax treatment. to wager rewards. This lack of guidance sparked widespread interest in a case before the Middle District of Tennessee, Jarrett vs. United Stateswhich focuses on the tax treatment of staking rewards.

What is staking?

Staking (or proof of stake) is a common method of validating blockchain-based transactions. It is often compared to mining (or proof of work), another blockchain-based transaction validation method. Mining involves an intensive process of solving complex mathematical problems using energy, computing power and other sophisticated hardware. Although the purpose of staking is the same as mining (i.e. validating blockchain transactions and earning reward tokens), the process involves pledging or pledging a specific cryptocurrency for support a blockchain protocol to validate transactions. Each time a block is added to the protocol, a new cryptocurrency within the same protocol is created, which is then rewarded to participants. Notice 2014-21, which predates the concept of staking, clarified that a cryptocurrency miner will recognize ordinary income when reward tokens are received. Income will be equal to the fair market value of the mined tokens at the time of receipt.

Jarrett vs. United States

In 2019, Joshua Jarrett engaged in staking, whereby he used his existing Tezos tokens to help create new blocks on the public Tezos blockchain. This resulted in Jarrett creating staking rewards amounting to 8,876 new Tezos tokens. Jarrett and his wife, Jessica, reported the value of the staking rewards on their 2019 joint federal income tax return as ordinary income and paid the corresponding taxes.

In July 2020, the Jarretts filed an amended tax return claiming their staking rewards were not taxable income and requested a refund from the IRS in the amount of $3,793. The IRS initially did not respond to the refund request, which allowed the Jarretts to file for a refund in May 2021. The Jarretts’ complaint claimed that federal income tax law does not allow no taxation of tokens created by a staking business and that tokens created by staking are only taxable when the tokens are sold or traded.

In December 2020, the Jarretts received a letter from the U.S. Department of Justice notifying them that the IRS had been authorized to provide the Jarretts with a full refund, plus interest. The Jarretts rejected the refund offer because the IRS did not provide a reason for the refund and left open whether creating tokens by staking is a taxable event.

A trial in the hock the case is scheduled for March 2023. But at a conference on February 10, 2022, attorneys for the United States indicated that they intended to seek the dismissal of the case on moot grounds. If the judge does not grant the motion to dismiss, the case may proceed to the merits of the matter.

The IRS refund offer has generated a lot of speculation about the taxation of staking rewards. But the offer is not a concession as to the tax treatment of staking rewards and cannot be used as a precedent by other taxpayers in similar situations. Taxpayers engaged in staking should consult with their tax advisors before taking a position on their staking rewards on their tax returns.

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