To investors,

News broke yesterday that the tax treatment of staking protocols, and the subsequent tokens earned, could be changing in a positive way. I’m not an expert on taxation, nor staking, so I asked one of the groups (Proof of Stake Alliance) involved to write up a quick summary on what has happened and the potential implications. Here is their analysis:

On December 20th, Josh Jarrett – a Tennessee business owner, father of three, and Tezos aficionado  – received an early Christmas present. Just as his holiday vacation was starting, the DOJ sent him a letter informing him that the IRS had approved a tax refund, 18 months into his legal battle to determine how his staking reward tokens are taxed under the U.S. income tax. However the story is not over…

In 2019, after Josh created XTZ tokens through staking on Tezos, he paid income tax on those rewards based on the price of the tokens when he created them. Like so many taxpayers involved in proof-of-stake blockchains, Josh faced uncertainty and a lack of clarity in determining how the IRS would treat his staking rewards. Even though proof-of-stake protocols represent billions of dollars – and seven of the top ten blockchain protocols by market cap use, or plan to use, a proof of state consensus mechanism – the IRS has not issued guidance about the taxation of tokens created from staking.  

In 2020, Josh’s legal battle with the IRS began in earnest. He filed for a refund on the income tax he paid on his staking rewards based on their value at creation, supported by a legal brief by Abe Sutherland. The brief articulated that these rewards were created property, and that, like all other created property – whether it’s gold that is mined or bread that is baked – it should be taxed at the time of sale, not at the time of creation. 

After two years, Josh finally received a note from the IRS in December 2021, offering Josh a refund. 

This is a big deal as the IRS doesn’t roll over easily – especially in cases that are so visible and will shape the taxation of multi-billion dollar industries. Josh’s win marks the first indication of just how strong Josh’s legal position is – a huge development for the growing industry. 

But for Josh, this offer of a refund is not enough. Because the IRS has not issued guidance confirming that it will not attempt to tax staking rewards at the time they are created, this refund could be a one-off and the Jarretts could face the same uncertainty in future years.  In order to push the IRS to definitively state that it will tax staking rewards as property or have a judge decide the matter, Josh has refused the IRS refund – and is continuing his case against the IRS.  

What this means:

The offer of a refund from the IRS is a promising sign that the US tax laws treat staking – a process of creating cryptocurrency rewards through participating in a proof-of-stake blockchain network – as new property and not income. But while this news is exciting, a one-off tax refund is not sufficient to offer clarity to a multibillion dollar industry. We need the courts to resolve this once and for all, or else for the IRS to clearly agree that such tokens are not taxable income until sold.

POSA for the past three years has been leading the fight for clear IRS guidance that staking rewards are not taxable income the moment they are created. In order to advocate for the proof-of-stake industry, POSA coordinated a day of action on Capitol  Hill and meetings at the Treasury Department in November 2019, during which they briefed the IRS about the need to confirm that staking tokens will be taxed as created property.  Subsequently, the Blockchain Caucus wrote a letter to the IRS urging them to issue guidance that staking rewards would be treated as property. With proof-of-stake tokens approaching nearly $600 billion in value, and some 16% of American adults having traded, invested, or used cryptocurrencies, it's well past time for the US government to acknowledge this industry and provide it with clear, common sense and fair tax treatment. If the IRS does not offer explicit guidance confirming that staking rewards are not income, the US risks becoming a second-rate market for staking and pushing the burgeoning multi-billion dollar industry to inevitably take those dollars elsewhere. 

What’s next?

• The Department of Justice is reviewing Josh’s lawsuit. If the case continues to move forward, the court could make a determination on the taxation of Josh’s staking rewards.

• POSA is continuing to fight for a definitive statement from the IRS that it will not tax staking rewards as income when they are created – Only with explicit guidance can our growing and innovative industry plan for the future. 

• You can help us demand guidance from the IRS by raising your voice to advocate for fair taxation of staking rewards. 

• Learn more here: www.proofofstakealliance.org 

POMP’S REACTION: As you can see, this would be a really big improvement to the current tax treatment of proof-of-stake systems. It leads me to the question of “will this same tax treatment be extended to bitcoin mining or other proof-of-work systems?” The logic would be if staking is considered the creation of taxpayer property, then mining would also be considered the creation of taxpayer property.

If this logic holds, it would completely change the economic models for bitcoin miners. They would be able to hold 100% of the bitcoin they mine, net of the cost of operations. In the past, we saw miners being forced to liquidate bitcoin due to tax obligations. Removing that burden would lead to billions of dollars in profits for these businesses globally. Additionally, it would likely create a much larger incentive for investors to acquire bitcoin through mining compared to other means.

We don’t have the answers yet, but these are a few things worth considering. Hope you all have a great weekend. Talk to everyone on Monday.

-Pomp

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