Tezos Validator Rejects IRS Settlement, Pushes for Clarity on Taxation of Staking Income

February 2022

BY

Kevin AinsworthPartner, National Corporate Tax

Kurtis KlawiterTax Manager, Core Tax Services

David AskewTax Manager, Core Tax Services

In a step toward greater clarity in crypto taxation, a taxpayer staking Tezos (Jarrett v. United States, No. 3:21-cv-00419 (M.D. Tenn.)) has declined a refund settlement offered by the Internal Revenue Service (IRS) in an effort to receive a final judicial decision that would set future precedent for taxation of staking rewards.

To date, the IRS has provided limited guidance on the taxation of cryptocurrency and other digital assets, including cryptocurrency acquired through “staking.” Based on Notice 2014-21, the IRS views cryptocurrency as property for federal tax purposes. The primary ambiguity in areas such as staking is when a taxable event occurs — on the date of original receipt of the asset, on the date the holder disposes of the asset, or both.

Cryptocurrencies that allow staking use a “consensus mechanism” called Proof of Stake (PoS) as the way to ensure that all transactions are verified and secured without using a bank or payment processor. Taxpayers that stake cryptocurrency participate in the PoS process and earn staking rewards, similar to the way in which a savings account earns interest income. Tezos is one of a number of cryptocurrencies that uses PoS, and therefore allows staking.

In August 2020, Jarrett filed for a refund of 2019 taxes paid on staking rewards. Jarrett’s primary argument for the refund is that although cryptocurrency acquired by a taxpayer through staking results in the taxpayer’s holding a taxable piece of property, no tax should be incurred on the initial receipt of the asset because the process of staking is akin to creating tangible property (such as, for example, an author writing a novel). Because the asset is self-created, Jarrett argues that taxation should occur upon the ultimate disposition of the cryptocurrency, which for Jarrett did not occur during his 2019 taxable year.

The IRS, after initially ignoring Jarrett’s request for refund, offered a settlement for the taxes paid during 2019. However, Jarrett rejected the IRS offer because the IRS provided no comment or clarity on their position on staking rewards. In addition, the settlement would not involve a court decision, therefore potentially subjecting other taxpayers to future litigation. By rejecting the offer, Jarrett (as well as the broader crypto community) hopes a court decision will ultimately lead to precedent that taxpayers can follow, especially given the tremendous increase in staking in recent years as a major means of crypto investment.
 

How BDO Can Help

The IRS position on cryptocurrency continues to be an area filled with uncertainty for taxpayers. BDO has extensive experience in tax matters concerning blockchain and digital asset taxation. BDO professionals can provide assistance on technical tax matters with respect to mining, staking, ICOs, crypto lending and general investment, as well as the minting and exchanging of NFTs. For more information, contact BDO.