The internet is buzzing over the news that a couple in Tennessee was awarded a refund from the IRS for income tax on staking rewards that were never sold or traded for the tax year 2019.
Unfortunately, this news does not mean that the IRS has changed its stance on staking rewards, as many sources have claimed.
Joshua and Jessica Jarrett’s lawsuit against the IRS claims that staking rewards should not be taxed as income at the time of receipt, but that they should only be taxed when sold. On the eve of trial, the government offered to concede the refund and interest claimed.
We spoke to Rogelio Villageliu, Of Counsel to Gordon Law Group and a tax attorney who served for over 40 years in the IRS Office of Chief Counsel, about the IRS litigation process. Here’s what you need to know about this staking tax refund.
1. There’s no official IRS guidance on staked tokens.
The IRS has not issued any official guidance on staked tokens, but it has issued guidance on mined tokens. This states that cryptocurrency received for mining is income taxable at the time of receipt. Without any further clarification, the treatment of staked tokens has been interpreted from there.
Editor’s Note Nov. 13, 2023: The IRS has since released Rev. Rul. 2023-14, clarifying that staking rewards are taxable at the time you have “dominion and control” over them. Learn more about staking taxation here.
2. A refund is different from a court ruling.
The IRS granted the Jarretts the refund and interest they were seeking in order to avoid bringing the case to court. If the case is settled without a legal opinion, it will have no legal precedential value; in fact, because of this, the Jarretts refused the offered refund. They hope to force the court to issue an opinion.
“All they’ve got is the decision for 2019 for this specific taxpayer that says, ‘Here, we’re gonna give you back your money,’” says Villageliu. “That doesn’t have any precedential value for any other years, and it doesn’t have any precedential value for any other taxpayers.”
3. One federal court decision wouldn’t necessarily change the U.S. Tax Code.
This case was set to be tried in the US District Court for the Middle District of Tennessee. Therefore, even if this case did receive a ruling from the court, that ruling would not set a binding legal precedent for any other district.
“What this taxpayer is doing is important and it would be wonderful if he could get a decision, because it would show what one judge did and [would be] pretty persuasive of what another judge is likely to do, but it’s not binding,” says Villageliu. “Until a case goes to the Supreme Court, it’s not binding for the whole country.”
4. Want to challenge staking taxes? You have options… if you report and pay upfront.
For those who report staking income and pay the taxes in full, there are ways you can attempt to get that money back. But those who choose not to report the income based on this case are risking hefty penalties. First, let’s go over some options for a refund (but please consult with a tax professional about your specific situation!).
Protective refund claim
One option is to file a protective claim for a refund. This is an option when the IRS has not yet issued guidance on a specific issue, and it allows you to stake a claim for a refund in the event that future guidance rules in your favor.
A protective claim for refund will not be addressed until the IRS rules on the specific matter at hand—in this case, staked tokens—and that can sometimes take years. But since you normally have only a 3-year window to file an amended return and request a refund, it can extend your options.
Sue for a refund
Additionally, every taxpayer has the option to dispute a particular issue on their tax return by paying the tax in full, then suing the IRS for a refund.
Of course, most taxpayers wouldn’t choose to sue the IRS over $3,293, as the Jarretts did; the legal fees for taking such a case to U.S. Tax Court could easily reach $30,000 or even $100,000. In this case, the plaintiff’s legal fees were funded by the Proof of Stake Alliance, an organization working to bring legal and regulatory clarity to proof of stake technology, because they hoped for a precedent-setting court ruling.
But for some taxpayers who pay significant amounts of income tax on staking rewards, suing for a refund is an option worth considering. It would either lead to a refund or clear guidance from the IRS.
Continue to report all income
In the meantime, don’t stop reporting your staking rewards as income at time of receipt just yet.
“If you do not report the money… you’re playing on the lottery,” says Villageliu.
By failing to report staking income, taxpayers could risk an accuracy-related penalty of 20% of the unreported amount, along with other penalties. Plus, if you fail to report 25% or more of your income in a given tax year, the IRS will have 6 years to initiate an audit on that tax return instead of the usual 3 years.
Although the Jarretts’ case is an important one to watch (and sets a promising tone for similar lawsuits seeking a tax refund), it’s much too early to claim that the IRS has made a definitive ruling on staking rewards.
If you have questions about staking taxes or other cryptocurrency taxes, reach out to our crypto tax lawyers—we’re here to help!