The Internal Revenue Service (IRS) recently published Revenue Ruling 2023-14 on July 31st, providing clarity on how revenue from staking digital assets should be taxed for tax purposes. According to the new ruling from the U.S.’s main tax agency, cryptocurrency investors in the U.S. are required to record IRS Rules Crypto Staking rewards as gross income in the same year they were received.
IRS Rules Crypto Staking: What Is Crypto Staking?
Crypto staking is the process of validating transactions on proof-of-stake blockchains and receiving cryptocurrency as a reward. On proof-of-stake networks like Ethereum, stakers lock up their crypto to help validate transactions, essentially acting as miners on proof-of-work networks like Bitcoin. Stakers on proof-of-stake networks are chosen to validate transactions based on how much crypto they have staked. The more coins they stake, the greater their chance of being selected to validate blocks. Stakers then receive cryptocurrency rewards for their work validating transactions.
IRS Rules Crypto Staking: Key Details Of The New IRS Ruling
The IRS ruling applies to taxpayers who use the cash method of accounting and receive any type of cryptocurrency as compensation for validating transactions on proof-of-stake blockchains. It also applies whether staking cryptocurrency directly or through a centralized cryptocurrency exchange.
According to the ruling, the fair market value of the crypto rewards received should be included in gross income and calculated at the time the rewards are received. Dominion refers to when the investor has complete control over the crypto rewards and can sell, trade, or otherwise dispose of them however they want.
How Crypto Staking Rewards Were Previously Taxed
The IRS has traditionally taxed both income and capital gains on cryptocurrency mining rewards, but did not have any guidance for staking rewards until now.
According to crypto tax company Koinly, the IRS likely saw staking rewards as similar to mining rewards, so they should be treated the same for tax purposes. With mining, the rewards are clearly tied to validating transactions on proof-of-work blockchains. Staking serves the same validation purpose on proof-of-stake networks.
Reactions To The New IRS Staking Rewards Guidance
While the ruling is not surprising, some in the crypto industry are disappointed with the IRS’ approach.
Jason Schwartz, a tax partner at Fried Frank and co-head of the firm’s digital assets practice, stated that “while the ruling is therefore unsurprising, it’s still disappointing.”
This tax guidance comes as U.S. federal regulators like the Securities and Exchange Commission (SEC) are cracking down on crypto staking service providers and exchanges, alleging they are conducting illegal securities offerings.
Others point out the ruling provides much-needed clarity on staking rewards taxes. Investors and exchanges now know how the rewards will be treated instead of waiting for potential future guidance.
Tax Implications Of Staking Crypto
Based on the IRS guidance, if you received $100 worth of crypto by staking Ethereum in 2022, you would have to include the $100 value as income on your 2022 tax return.
This applies even if you immediately traded the staking rewards for a stablecoin or just held the rewards. The full value at receipt is ordinary income.
When you eventually sell or trade the staking rewards, you would then owe capital gains taxes on any appreciation over the original value at the time you received the rewards.
Staking Services May Need To Issue 1099 Forms
The ruling also has implications for platforms and exchanges that facilitate staking services. The IRS says staking reward administrators may need to issue Form 1099s to reflect the rewards paid out to investors.
This would be similar to how crypto exchanges issue 1099-B and 1099-K forms for capital gains and gross proceeds. Staking platforms and exchanges may now need to send 1099-MISC forms to users and the IRS reporting staking income.
Tax Planning Strategies
Here are some tips to minimize taxes on crypto staking rewards:
- Hold staking rewards for over a year before selling to qualify for long-term capital gains rates. Short-term gains under 1 year are taxed as ordinary income.
- Deduct expenses like electricity, hardware costs, etc. related to staking activities to offset some of the income.
- Contribute to retirement accounts like 401ks or IRAs to lower taxable income.
- Harvest tax losses by selling other crypto holdings at a loss to offset staking income.
- Use staking rewards to purchase NFTs or other crypto assets so you don’t realize immediate income.
The IRS has made it clear that cryptocurrency staking rewards will be treated as taxable income when received by investors. This provides much-needed guidance to taxpayers, investors, and crypto platforms facilitating staking activities. However, some crypto advocates argue this approach is short-sighted and discourages participation in blockchain networks. Investors will need to carefully track staking rewards and plan accordingly to minimize their tax liability.