A few months ago, we discussed how staking rewards are currently taxed. In that article, we noted that under current IRS guidance we can discern that:
- Staking rewards are taxable income
- The rewards are taxable income upon receipt
But we also noted two specific reasons why this was likely to change in the future.
Precedent-Setting Staking Case
The first reason was that, like most other things in crypto, the IRS has not issued any guidance specific to staking. Our current understanding is based on principles from their guidance on hard forks, airdrops, and mining income. We’re gleaning from those areas as best we can, but it’s reasonable to assume that the explicit guidance the IRS issues (whenever that happens) will have some clarifications.
The second issue is the focus of this article.
On May 26, 2021, Joshua and Jessica Jarrett filed a lawsuit against the United States government (See: Jarrett et al v. United States of America, Case Number 3:21-cv-00419). The Jarretts staked Tezos and received staking rewards from it. They claimed the rewards as income when they filed their original return, but later filed an amendment requesting a refund. The IRS failed to respond, so the Jarretts filed suit.
The basis of their argument is an interesting one. The IRS effectively treats staking rewards as interest or dividend income – rewards for holding the asset or keeping it on deposit. The IRS has taken a similar stance on airdrops, so this reasoning is generally in line with their philosophy on other sorts of income.
The Jarretts’ Argument on Staking Income
The Jarretts are arguing that staking rewards are something different entirely. They are claiming that the staking rewards are the creation of a new asset and thereby should not be taxable until they are sold. In a press release issued when they filed the lawsuit, the Jarretts stated that:
“Newly created property, whether it be a piece of art or a baked good, is not considered income under U.S. tax law until it is sold. Innovators and entrepreneurs who participate in blockchain staking are no different from artists and bakers, and if subject to different tax treatment may be forced to seek out other countries with a more fair tax code to operate in. Proof-of-stake blockchain technology is significantly less energy intensive than proof of work systems and has become widely adopted globally as the blockchain consensus technology of choice.”
Whether or not this argument will be successful remains to be seen. If someone were going to sue over this issue, this is probably the best argument you could make. Staking does facilitate the creation of new assets on the blockchain. That’s completely true. But in many ways, it does still feel more analogous to interest or dividends than it does actively working in the studio to create a new piece of art or in the kitchen baking a pie from scratch.
We’re not sure if this argument will ultimately hold up in court, but the Jarretts’ attorneys doing an excellent job of framing the issue in favor of their clients.
The good news is that, win or lose, this lawsuit is going to be beneficial to crypto investors. Lack of clarity is one of the biggest issues facing blockchain investors at the moment. This litigation will force specific answers from the IRS. We’ll be getting concrete guidance on exactly when and how our staking rewards are taxable, which will allow us to plan appropriately for our taxes.
Any accounting, business, or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.
