Taxation of crypto staking in the United States

Thanks to the growing number of virtual asset transactions, the notion of “crypto-staking” has become more familiar for tax affairs.

Staking can be described as getting rewarded for taking part in the blockchain system, in which users validate crypto transactions by staking their coins, by monetizing more coins by using virtual currencies they possess.

Which is to say, stakers receive rewards from cash in savings accounts, the same as getting dividends from stocks. Although from US federal law perspective, digital currencies are treated differently than fiat currencies and stocks for income tax purposes.

Personal Income Tax

With reference to the Internal Revenue Service (hereinafter: – “IRS”, convertible virtual assets are treated as property for federal income tax purposes, thus general taxation rules apply to such property transactions. According to the Internal Revenue Code, the stock is relevant to corporate shares. As convertible virtual currency is not an interest of the company, it won’t be referred to as stock and neither as security and debt instruments under income tax purposes. However, for the purposes of non-income tax purposes, some categories of virtual assets might be treated as securities, meanwhile there is a bill proposing a treatment of digital assets as “covered securities” in terms of information reporting hence brokers and exchanges will be required to report original sale price in order to calculate capital gain and loss.

Taxation of mining

Thus far, there is no particular official instruction on taxation of staking transactions, while IRS Notice 2014-21 stipulates that a taxpayer who engaged in virtual asset mining is subject to tax on the new virtual currency received from those activities as ordinary income. Likewise, Revenue Ruling 2019-24 states that “a hard fork followed by an airdrop results in the distribution of units of the new cryptocurrency to addresses containing the legacy cryptocurrency.” Prior rulings might be interpreted that the IRS shall view crypto staking benefits analogous to an ordinary income provided that the taxpayer disposes of new coins at the time they are generated.

Nevertheless, in the recent case of Jarrett v. United States established that cryptocurrency mining is not a taxable transaction because it is the creation of property, much like a baker making a cake, plaintiff persuaded the federal court in seeking a refund from the Internal Revenue Service, claiming that taxpayer is not subject to tax until she/he sells or exchanges the new tokens.

Application of Security Laws

The analysis under SEC v. W.J. Howey Co. is required to determine if the cryptocurrency staking service provider qualifies as an investment contract. Howey test sets out the following factors:

  1. an investment of money;
  2. in a common enterprise;
  3. with the expectation of profit;
  4. based solely on the efforts of others.

Evidently, the aforementioned four criteria must be fully met in case of staking of cryptocurrencies, for it to qualify under securities laws and tax principles, which in most of the time, crypto-staking do not fulfill the Howey identified criterias.

Moreover, staking service providers also fail to advance the intent of securities laws. Pursuant to Securities Act of 1934, SEC was granted an authorisation to monitor public companies, with the aim to facilitate investors to make informed decisions, based on the comprehensive and reliable information which has been made available to them. Whereas, in an accessible proof-of-work network, there is already enough transparency and/or basic data asymmetries formed by a staking service arrangement. Hence, it is enough for customers to make informed judgments with respect to selecting providers.

There isn’t specialized IRS guidance on crypto staking. Yet, IRS guidance on mining insists that due to similarities to mining, crypto staking should still be implied to taxation. Following the IRS Notice 2014-21 (the guidance on mining income), earnings from crypto staking is taxable as an ordinary income at its decent market price on the date of receipt. Capital gains tax on increase in value would apply in cases when the taxpayers sell digital assets received as a staking reward. The gains will be predicated upon the holding period of assets, namely, the shorter term gains are subject to ordinary income tax rates, long term gains on the other hand, might receive discounted rates.

The content of this article is intended to provide a general guide to the subject matter, not to be considered as a legal consultation.

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