For individuals hoping to earn new tokens by providing security to large blockchains that use proof-of-stake, there may be good news ahead. IRS will not tax your unstaked crypto.
A Nashville couple argued in May that tokens obtained through proof-of-stake protocols are taxpayer-created property that should not be taxed until they are sold or exchanged. The choice to refund may help to clarify the POS tax in the future.
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Decision Is A Win For POS protocols
According to a civil lawsuit filed on May 26, 2021 with the US District Court for the Middle District of Tennessee, Joshua and Jessica Jerrett asked for a refund of $3,293 in income tax paid in 2019 for the receipt of 8,876 Tezos tokens. In addition, the pair requested a $500 increase in tax credits to compensate for lost income.
According to sources with familiar with the matter, Joshua and Jessica Jarrett received a letter from the Department of Justice on Dec. 20 stating that the Internal Revenue Service (IRS) had approved a full refund of their 2019 taxes against the tokens they earned through staking in the Tezos network, plus statutory interest.
The decision is a significant step forward in the fledgling staking industry’s fight to have staking rewards classed as property rather than taxable income. According to Staked, a leading provider of staking services that was acquired by the crypto exchange Kraken in December 2021, the business has grown to an estimated $18 billion in size.
The Jerretts contended that tokens obtained through proof-of-stake protocols are taxpayer-created property that should not be taxed until they are sold or exchanged. According to the complaint, there is no provision in US law or IRS rules and regulations that authorizes taxpayer-created property to be taxed as income.
Despite the initial success, the Jarretts’ counsel rejected the IRS’s offer of a tax refund on Jan. 25, claiming that the agency had given no assurance that they would not be taxed again.
In other words, the Jarretts won the first round of their lawsuit (Jarrett et al v. United States of America), which was filed in May 2021 in Tennessee Middle District Court, but that victory would only apply to their 2019 taxes. They intend to pursue the case in court in order to obtain long-term protection. This might create a precedent for anyone wanting to profit from cryptocurrency staking.
The ruling could have far-reaching repercussions for the future taxation of proof-of-stake miners and stakers.
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Should The IRS Tax Crypto Income?
In Notice 2014-21, the IRS said,
“A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency measured in U.S. dollars, as of the date that the virtual currency was received.”
Supporters of the Jarretts say that crypto acquired through staking is not the same as cryptocurrency earned through trading or selling, and that it should not be taxed until it is sold or traded.
For a variety of reasons, cryptocurrency is staked, that is, locked up under certain conditions, usually to earn some form of emission of more tokens. The most common one is to serve as a validator in the proof-of-stake (PoS) network. Validators in such networks put their tokens on the line as skin in the game. Capital and operational expenses (machines and electricity) play a part in a proof-of-work network. Both are safeguards against spamming and malicious activity by the distributed group of people that verify network transactions.
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Mattia Landoni of the Federal Reserve Bank of Boston and Sutherland of the University of Virginia School of Law wrote in an August 2020 article in Tax Notes that the way PoS networks continuously dilute their tokens puts taxpayers at a disadvantage if they are taxed at the time the tokens are created.
Buying and selling cryptocurrency in the US is taxable because the Internal Revenue Service (IRS) considers cryptocurrency to be property rather than currency. It levied a tax ranging from 0% to 37%. In a country like Netherlands, Cryptocurrency is subject to a 31% tax in the country. Only the portion of the gain realized on the sale of cryptocurrencies for more than $58,232 (51,645 euros) is owed to the tax authorities in Italy, which is equal to the old one hundred million lire.
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