Stakers—taxpayers involved in proof of stake (PoS) validation of blockchain transactions—continue to operate in uncharted tax waters. PoS blockchains represent over half of the $1.68 trillion cryptocurrency market capitalization, with five of the top 10 PoS blockchains having a stake rate greater than 50%. Despite the remarkable growth of the PoS market in the last two years, there is no government guidance about the tax treatment of staking rewards.
In a closely followed case in the US District Court for the Middle District of Tennessee, Jarrett v. United States, No. 3:21-cv-00419 (M.D. Tenn.), a taxpayer paid tax on staking rewards and sued for a refund. The question before the district court is whether the receipt of staking rewards generates taxable income at the date the rewards are received.
On February 3, 2022, it was reported that the Internal Revenue Service (IRS) offered to refund the taxpayer’s money for taxes paid on staking rewards. The taxpayer rejected the IRS’s offer to receive a definitive ruling that will be binding on the IRS.
In this article, we look at the issue before the district court and address the significance of the recent offer by the IRS to refund the taxpayer’s tax payment.
IN DEPTH
VIRTUAL CURRENCY STAKING
In PoS systems, stakers are chosen by combinations of random selection plus the amount of units making up their stake and/or the amount of time they agree to lock up the stakes in a specific digital wallet. Staked units support the blockchain operations by validating transactions on the blockchain and earning rewards. Unlike the mining activities of proof of work (PoW) blockchain miners, stakers validate new blocks by forging the next block on the blockchain without mathematical computations. Certain platforms participate in staking by pooling their customers’ tokens and sharing the staking rewards.
Although each blockchain protocol is different, PoS protocols require stakers to hold (for an agreed…
