The IRS has officially classified cryptocurrency staking rewards as taxable income, with specific details found in (Revenue Ruling 2023-14). This ruling requires that staking rewards must be included in the taxpayer's total income for the tax year in which they gain dominion and control over the cryptocurrency.
This decision by the IRS was made based on a lawsuit filed by cryptocurrency investors Joshua Jarrett and his wife, Jessica Jarrett. The Jarretts believe that these tokens should only be taxed upon sale or transfer, rather than at the moment of creation. However, the IRS reiterated its position that staking rewards should be taxed as ordinary income when received, and tokens generated through staking should be treated as income.
According to Bloomberg, the IRS has denied the arguments made in the second lawsuit filed by Joshua Jarrett and his wife, stating that the rewards constitute taxable income at the time they are received. The IRS noted in its response: "Taxpayers receiving staking rewards must report the rewards as income at fair market value after they have the ability to sell, exchange, or otherwise dispose of the rewards."
Staking is the process of locking cryptocurrency in a smart contract to help run a blockchain. By doing this, investors can assist in verifying transactions and securing the network, and in exchange, they can earn rewards, typically in the form of more cryptocurrency. This is a way to earn passive income by holding digital assets.
According to IRS guidance from 2023, block rewards (such as staking) are classified as "income" from the moment they are created and are taxed based on the estimated market value of the tokens at that time.
The updated guidance further clarifies that staking rewards become taxable when the taxpayer has control over the assets, meaning they can freely transfer, spend, or trade these tokens. This ruling is significant for taxpayers engaged in cryptocurrency staking activities, as they are now required to report these rewards when filing taxes, and must report staking rewards as "other income" on Schedule 1 of Form 1040, and report capital gains when disposing of them using Schedule D of Form 1040.
Tax dispute of Joshua Jarrett and his wife
The tax dispute between the Jarretts has been ongoing since 2021 when the couple filed their first lawsuit regarding 8,876 Tezos with the IRS.
They argue that these tokens are similar to a farmer's crops or an author's manuscripts and should be treated as "property," taxed only upon sale. The IRS's response was to offer a $4,000 refund, which the Jarretts rejected. The court later dismissed the case.
The Jarretts filed their second lawsuit in October 2024, seeking to classify their staking rewards as property and to be taxed only upon sale.
In the new complaint, they are seeking a refund of the $12,179 in taxes paid on the 13,000 XTZ tokens earned in the 2020 tax year and a permanent injunction against the IRS's current tax treatment of their tokens. The lawsuit states: "New property is not taxable income; rather, taxable income comes from the proceeds of selling that new property. In all other respects, the IRS acknowledges that new property is not taxable income." However, the arguments in this second lawsuit have still been denied by the IRS.
For taxpayers engaged in cryptocurrency staking, this ruling means they must accurately determine the fair market value of the staking rewards at the time they gain control over them. Due to the inherent volatility of cryptocurrency prices, this can pose substantial challenges.
"The IRS officially classifies cryptocurrency staking rewards as taxable income" was first published in (Block客).