US IRS Faces New Lawsuit Over Crypto Staking Tax Policy

The US Internal Revenue Service (IRS) is again under legal pressure in relation to taxation of cryptocurrency staking rewards. On October 10, 2024, Josh Jarrett filed a new lawsuit with support of Coin Center and against the agency’s approach of taxing block rewards as income at the time of receipt.

US IRS Faces New Lawsuit Over Crypto Staking Tax

In a filing on Thursday, the IRS is in the spotlight over its position on block rewards, which are newly minted tokens of a cryptocurrency given to validators who add blocks to a blockchain. The agency currently considers these rewards taxable income at the moment they are received, a policy that Jarrett and Coin Center argue is unjust. 

The lawsuit states that the block rewards should be considered new property and should not be taxed as income, and such income should only be taxed when sold or exchanged for cash.

According to Jarrett, the same should apply to other forms of newly created property, for example crops or minerals, which are taxed only when sold. The lawsuit alleges that taxing staking rewards before they are sold leads to overtaxation and places additional and unnecessary regulatory burdens on cryptocurrency node operators.

Previous Attempts to Challenge Policy

This lawsuit is Jarrett’s second shot at trying to sue the IRS for its position on the taxation of staking rewards. He filed another similar case in 2021 when the IRS failed to explain how staking rewards are taxed. The US IRS issued a refund to Jarrett for the previous year’s tax payment but offered no instruction for subsequent tax years.

Instead, in 2023, the agency came out with new guidelines stating that staking rewards would be considered as income when received, in contrast to the refund decision.

Jarrett relies on the Tezos network where validators receive new tokens for the purpose of validating transaction. By the end of the year 2020, he got around 13,000 Tezos tokens through staking. He points out that such tokens must not be considered as income at the moment they are received, as they are new property that cannot be considered as earnings until they are sold.

The current Internal Revenue Service stance on taxing staking rewards affects many bitcoin users and those using other cryptocurrencies that use the proof-of-stake system such as Tezos. The lawsuit points out that the policy is cumbersome to the taxpayers, who are forced to value every reward they acquire for the purpose of the policy regardless of their plans to sell it.

Legislative Efforts and IRS Policy Changes

Concerns have been raised that this treatment is anti-competitive and hinders the deployment of the decentralized networks and innovation. In the networks where a large number of users are engaged in staking, the revenue from staking is split among many stakeholders, thus it is less reasonable to tax the entire value of the newly created tokens as an income.

This move has been made at a time when there is still a debate on the correct legal framework that should govern taxation of digital currencies. In the first half of 2024, a bill that was proposed before the House of Representatives stated that taxes on staking rewards would only be applied when the tokens are sold. 

The lawsuit will seek to make the US IRS change its policy before the legislative process to make it more reasonable.

Moreover, from 2025, the Internal Revenue Service will impose new information reporting obligations on crypto brokers, including exchanges, and other providers of wallets to report customer transactions and gains. These rules will encompass high-value non-fungible tokens (NFTs) and specific stablecoins transactions, which will extend the taxation of digital asset transactions.

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