IRS rules that taxable income includes certain staking rewards

In Revenue Ruling 2023-14, the IRS has ruled that rewards received by a cash-method taxpayer “staking” cryptocurrency in connection with validating blockchain transactions must be included in the taxpayer’s taxable income in the year the taxpayer gains control over the staking rewards.

Blockchain transactions are processed and confirmed by so-called validators. While proof of work is one mechanism by which transactions are validated, it requires a significant amount of computing effort from a network of devices. Another mechanism, proof of stake, requires validators to pledge (or stake) cryptocurrency to be eligible to validate blockchain transactions. In general, the more cryptocurrency a validator stakes, the higher his or her chance to be chosen to validate a transaction. A validator who is part of a successful validation will receive a reward, generally consisting of additional units of the relevant cryptocurrency.

In the Revenue Ruling, the IRS posited a cash-method taxpayer that staked 200 units of cryptocurrency and was chosen to validate a transaction. After a successful validation, the taxpayer received two additional units of the cryptocurrency as a reward (reward units). For a short time, the reward units of cryptocurrency were “locked up” (ie, the taxpayer could not dispose of them), but after the lock-up period expired, the taxpayer was permitted to dispose of the reward units.

With the Revenue Ruling, the IRS iterated its position that cryptocurrency is treated as property for US federal income tax purposes,¹ and that the receipt of property generally gives rise to gross income when it is "reduced to undisputed possession." Possession of property is generally undisputed when a taxpayer has complete dominion over the property, as defined by the landmark Glenshaw Glass case.² Further, a taxpayer generally has dominion and control over cryptocurrency when the taxpayer can sell, exchange or otherwise dispose of it. Based on these rules, the IRS ruled that a cash-method taxpayer must include gains from property when the taxpayer has complete dominion and control over the amount (ie, when the taxpayer may dispose of it), which in the case of the Revenue Ruling would be the taxable year including the first date after the lock-up period expired. By implication, where staking rewards are deposited in a wallet and a taxpayer may trade it on a cryptocurrency exchange, we would expect the staking rewards to be considered under the taxpayer’s control.

The Service’s position in the Revenue Ruling was not unexpected and is generally consistent with prior guidance in Notice 2014-21, which provided that taxpayers receiving cryptocurrency as payment for goods and services must include the cryptocurrency in gross income on the date it was received.

Readers of this newsletter may remember our discussion of the Jarrett case, where the taxpayers argued that staking rewards should not be included in gross income until the disposition of the rewards. The Revenue Ruling may be an effort by the IRS to issue guidance that could render the Jarrett’s case moot and, accordingly, avoid a judicial ruling on the issue. However, the fate of the Jarrett’s case has not yet been determined.

Learn more about the implications of Revenue Ruling 2023-14 for your business by contacting either of the authors.

¹ Notice 2014-21
² Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955).