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A guide on cryptocurrency staking is released while the IRS challenges the tax timing appeal


After years of speculation about the appropriate tax treatment for staking cryptocurrency, the IRS has released guidance on the taxation of staking rewards, which people receive when they pledge their crypto to help validate blockchain transactions. The guidance makes clear the government regards the rewards as taxable income upon receipt.

According to Rev. Rul. 2023-14, cash-method taxpayers who stake crypto native to a proof-of-stake blockchain must include the fair market value of additional cryptocurrency units, earned as validation rewards, in their gross income for the tax year in which they gain dominion and control over them.

The fair market value is determined at the date and time the taxpayer obtains control of the rewards. This also applies when a taxpayer stakes crypto via a cryptocurrency exchange.

The revenue ruling also provides background on cryptocurrency, distributed ledger technology, consensus mechanisms, proof-of-stake, and validation rewards—and explains these concepts well. But it does fail to address some technical gaps.

Does the ruling apply to staking an NFT? What about slashing penalties? What if a blockchain has specific technical requirements where dominion and control of the rewards occurs but the taxpayer isn’t able to withdraw the rewards?

Regardless of these types of technical questions, taxpayers will have to abide by the main principle—staking rewards are income as received when the taxpayer gains dominion and control. Any deviations in fact from what’s spelled out in the guidance will have to be well-supported. And yet, one must ask whether the principle of taxing staking rewards as income when received is appropriate.

One couple from Tennessee has been fighting to answer that question in court.

The Jarrett Case

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The timing of the IRS’s crypto staking guidance is intriguing, because it was released only days after arguments in Jarrett v. United States. Joshua and Jessica Jarrett claim that staking rewards are property created with a zero-tax basis and taxable only upon disposal. After a district court deemed their case moot, the IRS offered them a $4,000 refund.

Their appeal to the US Court of Appeals for the Sixth Circuit arises from their desire to settle the issue in court and establish a precedent indicating that staking rewards are taxable only upon disposal—contrary to Rev. Rul. 2023-14.

The IRS has sought to avoid litigation of the Jarrett case, suggesting a lack of confidence in its position and a wariness of establishing a precedent that could challenge its authority and interpretation of law. The timing of this revenue ruling may reflect an attempt to preemptively influence the case outcome by presenting its stance as authoritative and binding.

Given the history of the IRS on income from crypto mining, hard forks, and airdrops, my standpoint has always been that any crypto income—whether from staking or otherwise—would be taxed as ordinary income.

Rev. Rul. 2023-14 supports this perspective, stating under Section 61(a) that gross income includes all income from whatever source derived, unless specifically excluded by law. Consequently, any wealth increase by a taxpayer results in taxable income, barring an explicit exemption in the tax code.

However, there are compelling arguments that staking rewards shouldn’t be taxed as ordinary income upon receipt, but rather given a zero-dollar basis and taxed as a capital gain only upon disposal.

Property Versus Cash

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The primary consideration is that we’re dealing with property, not cash. The receipt of highly volatile property, especially when rewards are dispensed frequently or even continuously, can lead to a mismatch between taxpayers’ cash flow and tax liabilities.

The tax burden faced by long-term crypto holders who accrue rewards throughout the year could be particularly problematic if coin prices crash before the tax payment is due. Even with capital losses potentially offsetting some liability, net capital losses only offset $3,000 of ordinary income.

For large stakers, this could result in a serious cash flow issue. Centralized exchanges that offer staking for customers could potentially alleviate this timing issue by withholding a portion of tax at the time of receipt. But defining who or how withholding is done for those staking independently or via a DeFi protocol is a separate challenge.

One could argue that earning staking rewards doesn’t equate to wealth accumulation. While it seems logical that receiving newly issued coins should be income, does it genuinely create new wealth, or merely dilute the value of existing coins? If the latter is true, should these rewards be taxed as income as received or should they be treated similarly to a stock split?

To illustrate this issue, suppose we have a small coin where only 10 people hold (and stake) 10 coins each, for a total of 100 coins in the network, where each is worth $1 for a total marketcap of $100. If each staker receives one coin from staking rewards, now you have 10 people each with 11 coins, for a total of 110 coins in the network.

Is each coin still worth $1, for a total value of $110, or is each coin 91 cents, meaning the total value remains at $100? If each coin is now 91 cents, then each of the 10 stakers still has $10 (91 cents x 11). If this is the case, I would then argue the taxpayer has no accession to wealth at the time of receipt of the coins.

Impact

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While Rev. Rul. 2023-14 represents an authoritative pronouncement by the IRS, it may not be the final word on the matter. The Jarretts continue their push for litigation, and the treatment of staking rewards as ordinary income—despite appearing logical in the context of gross income and staking perceptions—may not align with the economic realities of the transactions when examined more deeply.

The Jarrett case, if it proceeds, will allow these arguments to be weighed in court. Despite the appeal of a legal resolution, the odds remain long.

The case is Jarrett v. US, 6th Cir., No. 22-6023, response filed 8/2/23

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

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David Canedo, CPA, specializes in taxation of digital assets. He is the head of tax and compliance strategy at Accointing by Glassnode.

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