With new technology comes new opportunities for investors to make money. While cryptocurrencies (crypto) and the blockchain have been around for nearly a decade, they are relatively new to mainstream financial conversations, and currently, more people are investing in crypto than ever before. For those who are unfamiliar with cryptocurrency, crypto is a form of digital currency that is supported by blockchain technology whose value fluctuates based on supply and demand.
To put it simply, purchasing crypto has its own ability to generate income if the crypto you purchase increases in value. But there is also another way to generate income through crypto, called staking. Staking is the process of loaning your crypto to a wallet owned by the creators of the coin, which helps the coin validate transactions on blockchain. In return for loaning or staking your coins you receive new additional coins as payment. Think of this transaction as loaning money to a bank in a savings account in which you earn interest. Staking has become a popular tool for new coins to use to help launch their supply and reward investors of the coin. Per the major update at the bottom of the article staking is deemed to be the creation of a new coin. Crypto earn accounts in which you earn actual interest in crypto is slightly different and more like the bank analogy and we will need to wait for further IRS rulings before understanding the tax implications of it.
An example of a real-world coin would be $Magic which is the currency of the TreasureDao MetaVerse. Magic is a new coin having only been around since October 2021. Like most new coins, Magic offered to stake options to reward those who invested. There were three options provided, a three-month lockup, one-month lockup, and a two-week lockup. Each of these lockups provided a VEboost which granted additional APR to your staking in the terms of 200%, 150%, and 120% of your staked coins, respectively. If you staked 1,000 coins for a month, you would earn additional coins as if you had staked 1,500. The mine was allocated a total amount of 222,222 new coins a day and those who staked would receive a percentage of the total coins based on their staked coins over total staked coins.
Now comes the fun part. How is staking taxed? The short answer is the IRS has not officially ruled on it. However, there have been other similar rulings we should note, specifically, IRS Notice 2014-21 and Revenue Ruling 2019-24.
Notice 2014-21 describes how existing general tax principles apply to transactions using virtual currency. One of the scenarios that are mentioned is mining. Mining is using supercomputers to generate new blocks of transactions to the blockchain and thus mining new coins. According to the IRS when a taxpayer mines crypto, they are earning income based on the current fair market value of the coin.
Revenue Ruling 2019-24 was supplemental to Notice 2014-21 and discusses the tax treatment of airdrops. An airdrop occurs in crypto when owners of a currency or NFT, non-fungible token, receive new coins or NFT’s for free just for owning that currency or NFT. The IRS has determined in this instance the taxpayer would pick up an ordinary income based on the current value of the received coins based upon the time the taxpayer received them.
Yet, the IRS hasn’t specifically ruled on staking. However, based on other rulings it seems the IRS would rule the coins generated from staking would be treated as ordinary income based on the value of the coin at the time when the taxpayer claims ownership of the new coins. Stay tuned for future updates as the IRS comes out with new rulings.
February 3, 2022
The IRS has lost its first court case regarding cryptocurrency and staking. In the case Joshua and Jessica Jarrett filed a civil lawsuit against the IRS claiming the income they earned from staking the coin Tezos should be non-taxable as it was the creation of a new coin and not earned income. The court ruled that receiving coins from staking was indeed the creation of a new coin and therefore not taxable. These coins would have zero tax basis and would be taxable only when sold. In response to the loss in court, the IRS has offered to refund the Jarrett’s the tax paid on the Tezos earned from staking plus interest. While this is an offer of settlement and not actual binding precedent, this is the first decision on crypto in the courts that has been a massive win for taxpayers. The Jarrett’s are expected to pursue this case further and have a tax opinion filed with the court that would set the tax precedent. We will continue following this case and any new cases as they come out.
For more information on this topic, please contact a member of Withum’s Technology team.