Staking tax has been a contentious issue.
Joshua and Jessica Jarrett, better known as the Tezos validator who took the Internal Revenue Service (IRS) to court, are creating big waves in the crypto industry, setting a possible precedent for how authorities will tax staking rewards.
History
As the IRS has not issued any specific crypto tax guidance on staking rewards, most taxpayers have used a more conservative approach. This approach entails that the taxpayer reports their income (staking reward) when receiving such reward. When the taxpayer sells these rewards, another taxable event is triggered. The second taxable event will be on the capital growth or decline from the reward’s date.
The conservative approach from taxpayers is why staking rewards has been a controversial topic for years. However, the failure of clear guidance by the IRS has triggered the plaintiffs, Joshua and Jessica Jarrett, to pursue their court case against the US, even after the IRS has offered them a refund on their taxes previously paid.
Court Case
The court case of Joshua Jarrett, Jessica Jarrett (plaintiffs) v. US (defendant) is one worth following, especially in the crypto space.
The couple received a staking reward in 2019, and relying on the conservative approach, the couple declared the reward and paid the tax owed to the IRS on the income. However, they then decided to amend their tax return on July 31, 2020, arguing that the staking reward was not income, and thus, the tax amount on the income was invalid. Instead, they wanted to be paid back for the taxes they had previously paid the IRS.
They argued that newly created property is only taxed at the time of sale, not at the receipt of such property.
Staking Tax Cycle
If you look at the picture above, you can see you only pay taxes upon selling the book. However, you are not required to pay taxes when you finish writing a book – upon completion. The staking rewards are the final product in the above scenario, namely the completed book. The complaint by Jarrett’s to the IRS has resulted in the Tax division of the US Department of Justice ordering the IRS to issue a refund. The unexpected part is the couple refused to accept the refund.
Joshua Jarrett made the following statement explaining his reasoning behind their refusal:
Fast forward to late December 2021 when I received a letter saying the government wanted to grant me a refund—in other words, a year and a half into this process, the government didn’t want to defend the position that the tokens I created through staking were taxable income. At first glance, this seemed like great news. But until the case receives an official ruling from a court, there will be nothing to prevent the IRS from challenging me again on this issue. I need a better answer. So I refused the government’s offer to pay me a refund.
The issuing of a refund is a possible signal by the IRS that rewards derived from staking should not constitute taxable income at the time of receipt. However, the taxpayer cannot safely rely on this tax treatment; only when a formal court ruling is issued can a taxpayer depend on such tax treatment.
If the judgment favours the plaintiff, it could set a clear precedent on the taxation of staking rewards in the future.
End Result
The court case is still ongoing, but resistance against unclear policy and the feeling of a ripple effect in the industry are all signs of growth. Changes that it will bring are a step in the right direction. In addition, the outcome of Jarrett’s case will clarify to the US public how staking rewards will be taxed in the future, which will be a big win for the US digital assets industry.
It is essential to understand that the case’s outcome will only clarify how staking rewards will be taxed and not shield staked coins entirely from any tax implications.
It is an exciting time, and we can believe that other countries, for example, South Africa, may follow suit depending on the outcome of the court case.