The IRS stance on crypto taxes is inconsistent - particularly when it comes to crypto staking. While they refuse to view crypto as a fiat currency - the current guidance suggests staking rewards, like mining rewards, could be taxed under Income Tax. On top of this, when you later sell, trade or spend staking rewards, you’d pay Capital Gains Tax. Many crypto investors and regulation experts have stated this stance is unfair - which is why Tezos stakers Josh and Jessica Jarrett decided to take the IRS to court to settle it once and for all. Here’s everything you need to know about the case and what it means for your crypto staking tax in the future.
How does the IRS tax staking currently?
There’s one big question at the heart of this court case - how is crypto staking taxed by the IRS?
The current guidance doesn’t actually mention staking rewards at all. But the IRS guidance is clear that mining rewards are taxable as income for the fair market value on the day you receive them. In addition to this, your mining rewards are also subject to Capital Gains Tax when you later sell, trade or spend them.
The logical conclusion many crypto investors have come to is that staking rewards would be subject to the same tax treatment - but the lack of consistency in taxation and the unclear guidance has caused a lot of undue stress and confusion for US investors.
The IRS is crystal clear that cryptocurrencies are viewed and taxed as property. So taxing mining rewards and staking rewards as income is inconsistent with this view.
This is the precise argument Josh and Jessica Jarrett made when suing the IRS.
What's the IRS staking case about?
Nashville-based Josh and Jessica Jarrett made a refund request to the IRS for taxes paid on 8,876 XTZ Tezos staking rewards for 2019. The IRS denied the refund request and in turn the couple sued them.
In his own words, Jarrett wrote, "My tax returns for 2019 reflect the basic and common-sense principle that newly created property is not income - just like when a baker bakes a cake. When the IRS wouldn't confirm this - they didn't respond to my refund claim - I filed a federal lawsuit."
Eventually in December 2021, the couple received a letter in response to their case stating the government wanted to grant a full refund of $3,793 plus interest in regard to their 2019 staking taxes.
This was the news that got widely reported on in the crypto industry with many news sites claiming that it sets a precedent that staking rewards are not subject to Income Tax and should be tax free like any other newly created property.
But it’s not so. The Jarretts realized this and decided to refuse a refund on the 25th of January 2022 after further discussions with the IRS where they refused to provide any assurance that tokens created through staking do not constitute taxable income.
Jarrett wrote, "I recently received a letter saying the government wanted to grant me a refund - in other words, a year and a half into this process, the government didn't want to defend the position that my staking rewards were indeed taxable income. At first glance, this seemed like great news. But until the case receives an official ruling from a court, there will be nothing to prevent the IRS from challenging me again on this issue. I need a better answer. So I refused the government's offer to pay me a refund."
So what’s the outcome for staking taxes?
TBC. The Jarretts' case is ongoing and could take years to fully resolve if the IRS decides to defend the position that staking rewards are taxable income. Without legal precedent, the guidance on staking rewards tax remains unclear.
Crypto lobbying organisation Coin Center agrees with the Jarretts’ view, writing that the offer of a refund signals retreat from the IRS and ongoing proceedings could reform block reward taxation.
They’re not wrong. If the Jarretts get a positive outcome in court, it sets a legal precedent for all crypto staking rewards to be viewed as newly created property and treated as such from a tax perspective. It could force the IRS to review and reform their crypto tax policies.
It also has the potential to change tax on crypto mining rewards. Coin Center says, “Any block reward from a permissionless cryptocurrency network, whether it is created through proof-of-work mining, proof-of-stake validating, or some other mechanism, is most accurately described as the creation of value through one’s own capital and labor rather than the receipt of value from an employer… they should be taxed when they are sold, not when they are created.”
Overall, the offer of a settlement does not set a legal precedent. Only the outcome of the subsequent court case has the potential to do that.
Though the offer of a settlement is a step in the right direction, the IRS may have only done this to avoid setting a legal precedent in the first place. Because if the IRS loses in court, this has the potential to result in millions of dollars in refunds for crypto investors. So watch this space - we'll update as soon as we know more.
Update October 2022
Bloomberg Tax reported on the 4th of October 2022 that the US District Court for the Middle District of Tennessee sided with the IRS, dismissing the Jarretts' case as moot.
District Judge William L. Campbell Jr wrote, "“The Court finds no reasonable expectation that Plaintiffs will be subject to the same action again. As stated above, the instant controversy was limited to whether Plaintiffs were entitled to a refund of taxes paid for the 2019 tax year. This particular issue is not capable of repetition as any subsequent claim for refund would necessarily apply to a different tax year.”
Josh Jarrett has since tweeted stating he plans to appeal.
How to report staking rewards to the IRS
So what should you do in the meantime when it comes to reporting your staking rewards to the IRS?
While we recommend a conservative approach to crypto taxes to avoid any audits from the IRS, Koinly lets you customize your crypto taxes, including staking rewards. In the settings tab within your Koinly account, you can pick whether to treat rewards as income.
We recommend that while the case is on-going, you continue to treat staking rewards as income to avoid any backdated taxes should the outcome favor the IRS position. You can apply for an income tax refund as far back as three years.