The crypto revolution has created many unprecedented possibilities and conundrums. One of the latest legal dilemmas is focused around the question of what to do when people create new tokens through staking - a process that involves using crypto holdings to verify transactions on the blockchain.
Now the IRS has “waved the white flag” in a legal case that has profound implications for the future of this promising new area of crypto.
It has offered to refund a man called Joshua Jarret for the taxes he paid after creating “property” through staking. In 2019, he paid income tax on the tokens that were generated by staking, before filing for a refund in 2020.
The IRS refused his request, forcing him to pursue the matter in federal court. Now, the taxmen and women have finally offered to give him the taxes back, but Jerret has turned the offer down and is planning to press on with his case to ensure the IRS does not target him for tax in the future.
Abraham Sutherland, one of Jarrett's lawyers, said, "While I appreciate the IRS's offer, Jarrett needs a definitive ruling that the property he created through staking is not income."
Jarrett’s initial victory has been hailed as an indication that it may back down fully and decide to avoid taking property created through staking until it is sold. The Proof of Stake Alliance (POSA), a partial funder of the lawsuit, released a statement that stated: “?Bread baked by a baker or a novel written by an author is only taxed when it is sold.”
The industry group “applauds Jarrett's decision to continue his lawsuit” and said his continued legal action could “open up the possibility of a court ruling that will give him, and millions of other taxpayers in the same position, the ability to confidently plan for the future”.
Jarret has many high-profile supporters, including Coin Center, the Blockchain Association, and several members of Congress.
"The IRS doesn't just lay down in court, especially in cases that could affect millions of taxpayers on a very basic point of law,” said Alison Mangiero, Board Member and acting Executive Director of POSA. “It means they've got a losing argument. For the sake of fair tax administration, and American innovation, I hope the IRS follows this up quickly with clear guidance that staking rewards aren't taxable income. As more and more blockchains use Proof of Stake to come to a consensus and more and more American taxpayers participate in these networks, the government needs to catch up and apply years of settled tax law to the new property created by using this new technology."
Proof of stake is becoming leading a blockchain consensus mechanism, with the market capitalization of the top 30 proof of stake tokens now at roughly $600 billion. It is more environmentally-friendly than Bitcoin’s Proof of Work mechanism.
Ethereum, which has a market cap of more than $260 billion, will switch from Proof of Work to Proof of Stake later this year. Solana, Cosmos, Avalanche, Cardano, and Tezos all use Proof of Stake.
As well as its green benefits, Proof of Stake offers users the chance to earn money by directing their funds to stake in order to gain rewards.
If Jarrett is successful, millions of Americans will be able to make money by staking. If he loses, they will have to pay tax on this income - before they sell it.
Coinbase, Gemini, and Kraken now offer staking services to their retail customers. The two largest staking providers are Bison Trails, which was acquired by Coinbase, and Blockdaemon, a company now valued at more than $3.25B).
Evan Weiss, Founder of POSA added: "Proof of stake tokens will only increase in popularity in the coming years as web3 becomes mainstream, and the IRS must signal that it's prepared for innovations in the space. Back in 2019, we briefed officials at the Treasury Department as well as other policymakers on Capitol Hill about the need for a clear statement that staking rewards are not taxable income.
“Today we continue to urge the department to put forth an advisory that makes it clear that staking rewards will only be taxed when sold. We cannot risk making the US a second-rate market for staking, pushing the burgeoning multi-billion-dollar staking industry to inevitably take those dollars elsewhere."
POSA is funding the court case because it wants to ensure that Americans are not “overtaxed or deterred from participating in this new technology”.
