Overview
Cash method taxpayers that stake cryptocurrency native to a proof-of-stake blockchain and receive additional units of cryptocurrency as rewards when validation occurs must include the fair market value of the rewards in income in the year in which the taxpayer gains dominion and control of the rewards, according to the IRS. Revenue Ruling 2023-14 (the “Ruling”), issued on July 31, explains the IRS’s position that those cryptocurrency rewards over which the taxpayer has dominion and control are income for purposes of Section 611 and the regulations thereunder. The fair market value is determined as of the date and time the taxpayer gains dominion and control over the rewards. Taxpayers have dominion and control over the rewards when they have the ability to sell, exchange, or otherwise dispose of the cryptocurrency received as rewards. The Ruling also clarified that the result is the same if the taxpayer receives cryptocurrency rewards by staking cryptocurrency native to a proof-of-stake blockchain through a cryptocurrency exchange.
The guidance is narrowly tailored to advise only on whether staking rewards are gross income, and does not provide guidance on other important open questions regarding the tax treatment of staking, such as the treatment of delegated staking, whether operating a validation node is a trade or business, or how to source income from staking rewards.
In addition, the factual scenario that the Ruling addresses is silent as to whether the staking rewards at issue involve newly-created tokens or pre-existing tokens. However, the background discussion acknowledges that "validation rewards typically consist of one or more newly created units of the cryptocurrency native to that blockchain." This context suggests that the IRS disagrees with the position that has been taken by certain industry participants that staking rewards consisting of newly-created tokens are taxable only on a subsequent sale or disposition. Although not law, the amended Lummis-Gillibrand Responsible Financial Innovation bill also reflects this perspective and, if enacted, would provide that rewards produced or received from staking activities are only includable in gross income at the time of sale or disposition.
The IRS issued the Ruling on the heels of oral arguments in Jarrett v. United States2, which took place in the Sixth Circuit on July 26. In Jarrett, the taxpayers petitioned a district court for a refund of federal income taxes, alleging that the Tezos tokens the taxpayers earned from staking activities were newly-created property, akin to a baker combining ingredients to bake a cake, and therefore, the tokens were only taxable at sale.3 The government ultimately issued a refund check to the Jarretts before a decision was rendered and, despite the Jarretts' best efforts to continue to litigate the case to gain certainty on the treatment of staking rewards, the district court dismissed the case as moot.
Some cryptocurrency stakeholders celebrated the result believing that the refund symbolized a concession by the government that staking rewards are taxable only at sale or disposition. Tax professionals, on the other hand, were more hesitant to read the government's response as any sort of indication of how the rewards will ultimately be treated. It appears that by paying the Jarretts' $4,000 refund, the IRS was able to ensure the district court did not issue a ruling against their position and buy itself more time to issue guidance in this area.
This Ruling is unlikely to be the final word on the taxation of staking rewards. Some taxpayers can be expected to continue to challenge the ability of the IRS to subject staking rewards to immediate taxation. A revenue ruling is an official interpretation by the IRS of the Internal Revenue Code, related statutes, tax treaties and regulations. However, it only represents the IRS's conclusion on how the law is applied to a specific set of facts, so the Ruling is effectively retroactive but is not binding on courts. Ultimately, it will be up to Congress (or the courts) to decide this issue.
Endnotes
1 Unless otherwise specified, all "section" or "§" references are to sections of the Internal Revenue Code of 1986, as amended.
2 Brief for Appellants, Joshua Jarrett v. United States, No. 22-6023 (6th Cir. Filed Feb. 7, 2023).
3 Complaint, Joshua Jarrett v. United States, No. 3:21-CV-00419 (M.D. Tenn. May 26, 2021).
