In Revenue Ruling 2023-14, issued July 31, 2023, the IRS ruled that a cash-method taxpayer that receives additional units of cryptocurrency as rewards for validating transactions on a proof-of-stake blockchain must recognize the fair market value of the validation rewards as income in the taxable year in which the taxpayer gains dominion and control over the validation rewards. This is broadly consistent with the IRS views previously expressed on the treatment of mining income. In Notice 2014-21, the IRS concluded that a taxpayer who mines virtual currency, such as Bitcoin, has income equal to the fair market value of that virtual currency as of the date that the virtual currency is received. If the mining activity of an individual constitutes a trade or business, then the mining income is considered self-employment income and is subject to self-employment taxes.
The treatment of staking income was at issue in Jarrett v. United States, a case before the U.S. District Court for the Middle District of Tennessee, which we previously reported on here. The taxpayer in Jarrett sued for a refund of federal income taxes paid on staking income, arguing that digital assets received for staking are a form of self-created property that is taxable only at the time of sale or other disposition. There was no final judgment on the merits in Jarrett, however. The District Court dismissed the case for lack of subject matter jurisdiction because the government granted the taxpayer’s request for refund and rendered the complaint moot. The taxpayer appealed the dismissal to the Sixth Circuit Court of Appeals, and oral argument in the case was held on July 26, 2023, five days before the issuance of Revenue Ruling 2023-14. Clearly the government did not issue the refund to the Jarretts because of a change of heart regarding the proper treatment of staking rewards, but was merely trying to avoid creating legal precedent contrary to its position.
Revenue Ruling 2023-14 leaves a number of important issues unresolved. First and foremost, the ruling does not address the character of the staking income. Many important tax consequences, including the relevant tax rate, the source of the income, the potential imposition of withholding taxes, and the application of a variety of specialized tax regimes all depend on the classification of the income. A related question is whether, and under what circumstances, staking can constitute a trade or business for tax purposes, which has implications for the deductibility of certain costs associated with the staking activity, and whether certain non-U.S. persons could be subject to income tax in the United States on their net income from a U.S. trade or business.
It is interesting to contrast the IRS position in Revenue Ruling 2023-14 to recent discussions of staking and mining in the U.S. Senate, which we previously reported here. In a letter dated July 11, 2023, the Senate Finance Committee requested public input on how the various rewards and returns for validation activity, such as mining and staking, should be treated for tax purposes. Specifically, Senate Finance asked about the character and timing of the income from mining and staking. In a parallel but unrelated development, Senators Cynthia Lummis (R-WY) and Kirsten Gillibrand (D-NY) reintroduced their Responsible Financial Innovation Act, which would add new Code section 451(l) to defer inclusion of income from crypto asset mining and staking activities “until the taxable year of sale or other disposition of the assets produced or received in connection with the mining or staking activity.” Given that a Revenue Ruling is not binding legal precedent, and the early indications that Congress might adopt a different rule for mining and staking, it looks like we have yet to hear the final word on this issue.