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(Kitco News) - The Internal Revenue Service (IRS) has ruled that U.S. cryptocurrency investors must report staking rewards as part of their gross income in the year it was received, according to a Monday ruling released by the agency.
With proof-of-stake (PoS) cryptocurrency networks, users are able to lock their tokens with a validator, through an exchange, or on their own to participate in the validation process and earn rewards for their contribution.
Up to this point, it has been unclear whether investors needed to report any earnings generated by staking activities. There has also been confusion around when these rewards need to be reported, as rewards can accumulate in a smart contract, and a user doesn’t take possession until they claim those rewards.
“If a cash-method taxpayer stakes cryptocurrency native to a proof-of-stake blockchain and receives additional units of cryptocurrency as rewards when validation occurs, the fair market value of the validation rewards received is included in the taxpayer's gross income in the taxable year in which the taxpayer gains dominion and control over the validation rewards,” the IRS said in its ruling.
“Dominion” is defined as the time when the investor controls and has the ability to sell, exchange, or otherwise dispose of the cryptocurrency rewards.
The fair market value of any rewards is determined by the “date and time the taxpayer gains dominion and control over the validation rewards,” the ruling states. “The same is true if a taxpayer stakes cryptocurrency native to a proof-of-stake blockchain through a cryptocurrency exchange and the taxpayer receives additional units of cryptocurrency as rewards as a result of the validation.”
This ruling comes after regulators in the U.S. have taken enforcement actions against multiple cryptocurrency exchanges and their staking-as-a-service offerings, saying these programs amount to the unlawful offering of securities.
The Securities and Exchange Commission filed a lawsuit against Kraken in February for its staking program, which the exchange ultimately shut down and agreed to never relaunch in the U.S.
“When a company or platform offers you these kinds of returns, whether they call their services ‘lending’, ‘earn’, ‘rewards’, ‘APY’, or ‘staking’, that relationship should come with the protections of the federal securities laws,” SEC Gensler said at the time. “That means you, the investor, should receive important disclosures.”
The regulator also filed similar charges in June against Coinbase, the largest crypto exchange in the U.S., and Binance.US, the U.S. arm of Binance Global.
This ruling from the IRS seeks to provide clarity regarding taxpayer requirements related to PoS blockchains, and its the latest development in the slowly evolving regulatory landscape around digital assets in the U.S. The IRS previously subjected crypto-mining rewards to both income and capital gains tax but had no provisions for staking rewards until now, according to crypto tax firm Koinly.
While the ruling provides a basic level of clarity, it also leads to more questions as the world of PoS evolves.
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According to Jason Schwartz, tax partner and digital assets co-head at Fried Frank, some of the areas that will need to be addressed include whether “slashing penalties” count as ordinary losses, income tax on foreigners, withholding from foreigners, and how to report the nuances of liquid staking.
Schwartz also noted the difference in how physical mining proceeds are taxed compared to the new guidelines for PoS rewards.
“When taxpayers extract minerals, harvest crops, breed livestock, produce art or goods, or otherwise exercise dominion and control over property for which no previous owner exists, they aren't taxed until they sell the property,” he said. “If newly minted tokens are more like newly extracted minerals than service [payments] or found treasure trove, they shouldn’t be taxed until sold. Blockchains are not tax ‘persons,’ so they're not payers.”
While confusion still exists, Schwartz encouraged all taxpayers to abide by the new law or face the potential consequences.
“I note that while revenue rulings are binding only on the IRS (not on taxpayers), they tend to be viewed as persuasive,” he said. “Thus, U.S. home stakers would be well-advised to pay taxes on their rewards unless they're ready to go to court.”
“That said, there might be some hope in the future,” Schwartz added. “The Lummis-Gillibrand bill would not tax mining or staking rewards until sale. Wyden and Crapo's recent request for comments on the taxation of digital assets suggests that they are amenable to a similar approach.”
