The IRS has officially classified cryptocurrency staking rewards as taxable income, with specific details provided in (Tax 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.
The IRS's decision is based on a lawsuit filed by cryptocurrency investors Joshua Jarrett and his wife Jessica Jarrett. The Jarretts believe that these tokens should be taxed only upon sale or transfer, rather than at the moment of creation. However, the IRS reiterated its position that staking rewards are taxable as ordinary income when received, and tokens generated through staking should be treated as income.
According to Bloomberg, the IRS has denied the arguments in the second lawsuit filed by the Jarretts, claiming that rewards constitute taxable income when received. The IRS pointed out in its response:
"According to (Tax Ruling 2023-14), taxpayers receiving staking rewards must report the rewards as income at fair market value once 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 operate a blockchain. By doing so, investors can assist in verifying transactions and securing the network, and in exchange, investors can earn rewards, typically in the form of additional cryptocurrency. This is a way to earn passive income by holding digital assets.
According to IRS guidance in 2023, block rewards (such as staking) are classified as "income" from the moment they are created and 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 those tokens. This ruling is significant for taxpayers engaged in cryptocurrency staking activities, as they are now required to report these rewards on their tax returns, with taxpayers needing to report staking rewards as "other income" on Schedule 1 of Form 1040 and report capital gains using Schedule D of Form 1040 upon disposal.
Tax dispute of Joshua Jarrett and his wife
The Jarretts' tax dispute has been ongoing since 2021 when the couple filed the first lawsuit concerning 8,876 Tezos with the IRS.
They believe that these tokens are similar to a farmer's crops or an author's manuscript, should be viewed as "property," and 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 a second lawsuit in October 2024, seeking to classify their staking rewards as property and only tax them upon sale.
In the new complaint, they seek 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: "The new property is not taxable income; rather, taxable income comes from the proceeds of selling that new property. In all other cases, the IRS acknowledges that new property is not taxable income." However, this argument in the second lawsuit has been rejected by the IRS.
For taxpayers engaged in cryptocurrency staking, this ruling means they must accurately determine the fair market value of staking rewards when they gain control over them. Due to the inherent volatility of cryptocurrency prices, this could pose considerable challenges.
[Disclaimer] The market is risky, and investments should be made with caution. This article does not constitute investment advice; users should consider whether any opinions, views, or conclusions in this article align with their specific circumstances. Invest at your own risk.
This article is reprinted with permission from: (BlockKeji)
The article "U.S. Cryptocurrency Traders Must Pay Taxes! Cryptocurrency Staking Income is 'Taxable Income' and Taxed at Estimated Market Value" was first published in 'Crypto City'
