IRS Will Not Tax Unsold, Staked Rewards in First Stage of Legal Fight

A crypto couple has won a legal battle with the IRS, but we collective crypto holders have yet to win the war.

On May 26, 2021 a couple from Nashville filed a civil lawsuit against the IRS seeking a refund of $3,293 in excess income tax paid in 2019 – that tax bill had been calculated and required by the IRS for 8,876 Tezos tokens that Joshua and Jessica Jarrett had earned operating a proof-of-stake (POS) protocol. None of the tokens had been sold, exchanged, or disposed – only generated through the activities of the Jarretts. In addition, the pair requested a $500 increase in tax credits to compensate for lost income.

The couple astutely argued in the legal filing that POS derived funds are not earned through any exchange, sale, or transaction but are rather taxpayer-created property that should not be taxed until those assets are sold or disposed of in some manner or form. The complaint further stated that there is no current provision in U.S. tax code or IRS rules and regulations that require taxpayer-created property be taxed as income

In a surprising move, the IRS issued the full refund, the tax credit increase as well as statutory interest. This preliminary decision is a major symbolic step forward in the nascent staking industry’s fight to have staking rewards classed as property rather than taxable income. 

According to the most recent report on staking from DeFi tracking firm, Staked, the total amount of POS crypto assets as of December 2021 was $728 billion, marking a 571% increase compared to the year before. Those assets realized an annualized yield of 14% on average with total “unsold” values of $15 billion – those are significant funds at stake, both figuratively and literally.

Because those stakes are so high, it’s reported that the Jarretts refused the proposed settlement from the IRS for their initial complaint, because that victory would only apply to their 2019 taxes. The IRS did not promise that future POS gains would not be taxed – and that’s what the Jarretts want, long-term tax protection for their taxpayer-created property. Which is something we all should want and support as well.

Depending on how this case is finally settled, it is likely to have far-reaching consequences for cryptocurrency holders, individuals who stake a portion of their holdings, and POS whales who use that option as a primary method of asset utilization.

We will continue to watch this one closely.