Many crypto investors and regulation experts were confused about the tax treatment of staking rewards given the previous lack of guidance from the IRS - 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.
IRS Staking Rewards
There’s one big question at the heart of this court case - how is crypto staking taxed by the IRS?
As of July 31, 2023, the IRS has finally updated its guidance clarifying that staking rewards are taxable once received. The ruling clarifies that staking rewards should be treated as income upon receipt and taxed as such. The guidance also clarifies the meaning of received, which is important for ETH stakers. The guidance clarifies that 'when received' in this instance means when the taxpayer has control over the assets - so for ETH stakers this means when the rewards were unlocked and stakers were able to sell their rewards following the blockchain upgrade.
Prior to this update, the IRS had no guidance on staking rewards or the tax implications of staking crypto - leading many taxpayers to be unsure about how to report their staking rewards. This is the precise argument Josh and Jessica Jarrett made when suing the IRS.
Jarrett. V United States
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."
Bloomberg Tax reported on October 4th, 2022 that the US District Court for the Middle District of Tennessee sided with the IRS, dismissing the Jarretts' case as moot. After which, Josh Jarrett tweeted stating he planned to appeal.
On July 26th, 2023, the case is back in front of the court again. The case is ongoing, but so far, Chief Judge Jeffrey S. Sutton has suggested the IRS may have issued the refund as a way of “picking off taxpayers with very good lawyers”. However, Sutton has also commented he is unclear what the issue is with the refund for the Jarretts. Overall, the Jarretts are seeking an injunction preventing the IRS from treating tokens Mr. Jarrett created as income.
Following this, on July 31, 2023, the IRS updated its guidance as above to clarify that staking rewards were taxable income.
We'll keep this piece updated as the case progresses.
So what’s the outcome for IRS staking crypto taxes?
TBC. The Jarretts' case is ongoing and could take years to fully resolve.
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.
But given the updated guidance on staking rewards from the IRS, it doesn't look like the tax office will be backing down in its stance.
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?
Koinly can help you identify the fair market value of your staking rewards in USD at the time you receive them, making it easy to calculate how much additional income you have and report this to the IRS.
More burning questions? Here's your answers...
Can the IRS be sued?
Yes, you can sue the IRS - and many people have, the Jarretts are by no means the first.
Are staking rewards taxable?
The IRS has updated its guidance as of July 31, 2023 to clarify that staking rewards are taxable income when received. If you later dispose of your staking rewards, you'll also pay Capital Gains Tax on any gain as a result.
How does Koinly deal with staking?
You can find out about staking transactions and how Koinly deals with them in our staking help guide.