Should Cryptocurrency Earned Through “Staking” Be Taxed Before It’s Sold?
A Tennessee couple, Joshua and Jessica Jarrett, is challenging the IRS over how cryptocurrency earned through a process called “staking” should be taxed. The Jarretts believe that tokens created through staking should not be taxed until they’re actually sold, not when they’re first made. The IRS, however, sees it differently and considers these tokens taxable income as soon as they’re created.
So, what exactly is at stake in this case?
What is Staking, and How Do People Earn Tokens From It?
In the world of cryptocurrency, “staking” is a way for people to help keep a blockchain running smoothly. A blockchain is like a digital ledger that records all transactions for a particular cryptocurrency. When people stake, they use their existing crypto to help verify transactions on the blockchain, and in return, they receive more cryptocurrency as a reward.
For example, Joshua Jarrett stakes his cryptocurrency on the Tezos blockchain, and every year, he earns thousands of new tokens as a reward for helping with the blockchain’s work. However, the IRS considers these newly created tokens as income, which means the Jarretts are required to pay taxes on them.
Why the Jarretts Disagree With the IRS
The Jarretts argue that they shouldn’t have to pay taxes on tokens created through staking until they actually sell those tokens. They say it’s similar to other forms of “created property,” like crops a farmer grows or products a manufacturer makes. In both cases, taxes aren’t owed until the crops or products are sold and the income is realized. So why should it be any different for cryptocurrency tokens?
The Jarretts explain that, in their view, the tokens they create are “new property.” They haven’t sold them, so there’s no income yet. According to their complaint, “New property is not taxable income; instead, taxable income comes from selling that new property.” By taxing staked tokens right away, the IRS is essentially asking them to pay taxes before they’ve earned any real income from their tokens.
The IRS’s Side of the Story
Conversely, the IRS argues that cryptocurrency tokens created through staking should count as income the moment they’re made. In its Revenue Ruling 2023-14, the IRS laid out how staking rewards should be treated. The IRS considers the value of tokens received through staking as part of a person’s income, meaning taxes are due on that value right away, even if the tokens aren’t sold. The IRS says that staking income, like salary or wages, is taxable as soon as it’s received.
But this approach has created a difficult situation for people like the Jarretts, who feel they’re being taxed on something they haven’t even sold or made money from.
Why This Lawsuit Matters
The Jarretts are seeking a court ruling that would stop the IRS from treating their created tokens as income. If they win, it could set a new standard for taxing staking rewards in the U.S. Other crypto users who participate in staking would likely benefit, as they wouldn’t have to pay taxes until they sell the tokens they’ve created.
The Jarretts’ case is not new. They previously filed a similar lawsuit about their 2019 taxes. At that time, they argued that their staking rewards shouldn’t be taxed until they sold the tokens. The IRS ended up sending them a refund check, which led the court to dismiss the case. However, the Jarretts felt that this was just a way for the IRS to avoid addressing the core issue, so they’re back in court to challenge the IRS’s approach again—this time for the 2020 tax year.
What’s Next?
The outcome of this case could be a big deal for anyone involved in cryptocurrency staking. If the court sides with the Jarretts, it could mean that people who earn tokens through staking won’t have to pay taxes on them until they sell them. This would make staking less complicated for many crypto users who have had to pay taxes on tokens before they even get the chance to cash them in.
For now, the Jarretts’ lawsuit highlights the ongoing debate around crypto taxes. As the world of cryptocurrency continues to grow, so does the need for clear tax rules that make sense for both the IRS and crypto users. The Jarretts’ case may bring that clarity, potentially setting a precedent for how staking rewards are taxed in the future.
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