The IRS has finally issued guidance on staking income. They state that cash-basis taxpayers must report the staking rewards when they have gained full dominion and control over the new assets. In the majority of cases, this will mean staking rewards are taxable upon receipt. This is consistent with articles we wrote previously along with the IRS’s guidance on other types of crypto income. This stance will likely be challenged in court at some point.
First IRS Guidance on Staking Income
On July 31, 2023, the IRS released Revenue Ruling 2023-14. While the IRS had telegraphed their stance on the taxability of staking rewards in their response to the now moot Jarrett v. USA case, the agency had not released any staking-specific guidance to the public at large. As we note frequently in these articles: there is a significant lack of guidance around cryptocurrency taxation. Especially given how ubiquitous proof-of-stake protocols have become, this additional clarity is welcome.
The IRS’s stance is – for better or for worse – predictable. It is consistent with their guidance on airdrops, hard forks, and other crypto income like mining. Unsurprisingly, it is also consistent with their filings in the Jarrett case. It also aligns with the article we wrote on the taxation of staking income back on 11/01/2021. So no surprises across the board, but let’s dig into the notice itself for the specifics.
Staking Rewards Taxable Upon Dominion and Control
After a few pages outlining what proof-of-stake is and giving some background on consensus mechanisms, the IRS provides this example:
“Transactions in M, a cryptocurrency, are validated by a proof-of-stake consensus mechanism. On Date 1, Taxpayer A, a cash-method taxpayer, owns 300 units of M. A stakes 200 of the units of M and validates a new block of transactions on the M blockchain, receiving 2 units of M as validation rewards. Pursuant to the M protocol, during a brief period ending on Date 2, A lacks the ability to sell, exchange, or otherwise dispose of any interest in the 2 units of M in any manner. The following day, on Date 3, A has the ability to sell, exchange, or otherwise dispose of the 2 units of M.”
This is a fairly simple staking scenario. The taxpayer is receiving in-kind rewards with a short lock-up period. How and when does the IRS say this should be taxed?
“The 2 units of M represent A’s reward for staking units and validating transactions on the M blockchain. On Date 3, A has an accession to wealth as A gains dominion and control through A’s ability, as of this date, to sell, exchange, or otherwise dispose of the 2 units of M received as validation rewards. Accordingly, the fair market value of the 2 units of M, as of the date and time A gains dominion and control over the 2 units of M, is included in A’s gross income for the taxable year that includes Date 3.”
Again, none of this is unexpected and is consistent with all tangentially-related statements from the IRS. The income is taxable when you receive “dominion and control” over the asset (essentially when you have unfettered access to the asset, including the ability to dispose of it). Very importantly, they note that simply receiving the token is not the taxable event – it is that receipt along with gaining dominion and control.
The IRS’s Reasoning on Staking Taxation
As always, their reasoning is worth reviewing – both for staking income and for properly accounting for other sources of income where the IRS has not yet released specific guidance (such as liquidity pools). They state:
“Under section 61, “instances of undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion,” require inclusion in gross income. See Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955). “Gross income includes income realized in any form, whether in money, property, or services. Income may be realized, therefore, in the form of services, meals, accommodations, stock, or other property, as well as in cash.” § 1.61-1(a). Unless otherwise provided by a Code or regulatory provision, any receipt of property constitutes gross income in the amount of its fair market value at the date and time at which it is reduced to undisputed possession.”
“For example, a taxpayer who receives cryptocurrency as a payment for goods or services or who mines cryptocurrency must include the fair market value of the cryptocurrency in the taxpayer’s gross income in the taxable year the taxpayer obtains dominion and control of the cryptocurrency. See id., Q&A 3 and Q&A 8. Amounts received as gains derived from dealings in property, or as rents or royalties, also generally must be included in a cash-method taxpayer’s gross income in the taxable year the taxpayer obtains dominion and control of those amounts through actual or constructive receipt. See also § 1.451-1(a).”
Are Some Staking Rewards Not Taxable?
For most staking income, this will be fairly straightforward. But there may be outlier cases. The notice states that:
“Section 6045(g)(3)(D) of the Internal Revenue Code1 generally defines a digital asset, for purposes of information reporting by brokers, as any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the Secretary.”
It’s easy to envision cases where token rewards are accruing off-chain or require additional steps to exercise control. How will the IRS treat those assets? What factors will be considered in determining what is being “recorded” and what qualifies as a “cryptographically secured distributed ledger” or “similar technology”? These questions will likely be clarified either through additional IRS guidance or through court cases.
More Staking Income Lawsuits Likely
Speaking of court cases, this guidance may open the way for new challenges to the IRS’s stance on the taxability of staking income. Remember, the Jarrett case was ruled moot because the case ostensibly only affected a single tax year and the IRS gave the couple their money back. Whether it be this notice or further guidance/enforcement, the IRS is finally taking a concrete stance on staking income. There are plenty of taxpayers, crypto projects, and other groups that have significant financial incentive to challenge the IRS’s position. Whether or not they will be successful is another question entirely, but it seems unlikely this will be the last we’ll hear on this issue.
But until or unless something happens to override the IRS, all taxpayers should follow their guidance. Staking rewards should be counted as taxable income when the taxpayer receives dominion and control over the tokens.
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.
