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Last week the proof-of-stake (POS) and wider cryptocurrency community celebrated what seemed like a victory following an Internal Revenue Service decision to concede a lawsuit filed by Joshua and Jessica Jarrett, who sought a $3,200 refund for taxes they paid on staking rewards in past years.
This piece is part of CoinDesk's Tax Week
Much of the crypto community treated this as legal precedent, or as a signal the IRS will not tax staking rewards in the future. This analysis misinterprets the IRS decision. Staking rewards are incentives that blockchains pay participants for confirming transactions.
Omri Marian is a professor of law and the academic director of the Graduate Tax Program at the University of California, Irvine School of Law. The views expressed herein are his own.
From a legal perspective, the IRS decision is a nothingburger that could even help the IRS, if the agency’s aim is to more aggressively collect taxes on staking rewards. This possibility is why the Jarretts intend to refuse the refund and pursue the case. Had the refund been a “victory,” they would have walked away with the money.
Read More: US Crypto Tax Guide 2022
Why is the decision a nothingburger? Say you steal a car. The local police department investigates you, comes to believe you indeed stole the car and shares the investigation findings with the county prosecutor. For whatever reason – overworked department, underfunding or plain disinterest – the county prosecutor declines to file charges. Such a decision frees you from legal repercussions, but it does not mean that stealing a car is now legal.
This reasoning is likely behind the IRS’ Jarrett decision. The government lawyer overseeing the matter probably thought, “I am so constrained for time and recourses. I have thousands of active cases. I am not going to spend office time and money fighting in court over a $3,000 refund.”
That’s all. Neither a court nor the IRS decided anything, except that the agency could make better use of its time.
The end result: The IRS can still come after your staking rewards.
It might be because the IRS has a good basis to argue that unsold staking rewards are taxable. True, the IRS did not issue specific guidance on staking rewards, but it does not really need to. Current law and existing guidance are broad enough to capture unsold staking rewards under the definition of “income.”
The Jarretts filed their refund claim in the first place to challenge such interpretation of the law, not for the $3,000 refund. Partners at the law firm representing the taxpayers easily charge north of $1,000 per billable hour. I suspect the taxpayers have already accrued over $100,000 in legal fees.
A court ruling that unsold staking rewards are not taxable – not the refund – is the goal. So far, the taxpayers are losing this argument, simply because the IRS refuses to fight them.
The IRS refund decision should worry the POS community, not make it jubilant for two reasons.
- If the IRS thinking is about something other than “I just don’t have time for this,” then the decision suggests the IRS believes staking rewards are taxable. The IRS may have declined to pursue this case because the agency believes it can make a better case elsewhere. By giving the taxpayers the refund the IRS extinguished the controversy, which is going to make it harder for the taxpayers to keep the case alive. It means that – if the case is not thrown out immediately – for the next couple of years the fight in court will be about whether the court should hear the case at all. So even if the case stays alive, it will be a long time before the court gets to discuss the issue on the merits.
- Such delays give the IRS time to issue specific guidance on staking. Let’s say that in a year or two the IRS issues guidance that some or all unsold staking rewards are taxable. Such guidance will improve the IRS’ position in court because courts usually give weight to IRS guidance. The Jarretts are probably trying to force a court decision before the IRS gets a chance to issue guidance.The IRS can also try to delay any future litigation on the issue by telling courts that guidance is coming. Until then it will not pursue these types of cases. Of course, the IRS calculations can change if they need to start issuing larger refunds, but a $3,000 suit is not going to cut it.
I’ve said little about substance, and whether unsold staking rewards should or should not be taxable is a different topic on which reasonable minds can differ. I’ve focused on the ramifications of the IRS’ latest decision to issue a refund.
Read More: Crypto Capital Gains and Tax Rates 2022
As a tax scholar, I interpret this decision as legally meaningless. Other lawyers within the crypto community have noted as much. The IRS did not wave a white flag. The IRS did not concede anything important. Not only that, but the IRS may have signaled it is preparing a strong legal case to start collecting tax on staking rewards in earnest.
The day may come when the IRS decides not to tax unsold staking rewards. Or a court may decide they are not taxable. But the IRS refunding $3,000 to the Jarretts is not that day.
Further Reading from CoinDesk's Tax Week
Crypto won’t save you from taxes, but it may eventually make them easier to pay, says futurist Dan Jeffries.
Tax guidance lags innovation. So does tax software. Meanwhile, misconceptions abound. If not careful, investors can end up owing more tax than expected and having to unload crypto to pay the bill
Investors in MicroStrategy, Tesla, Block and Coinbase need to consider how wild price swings will affect results, not only directly but indirectly due to complex tax accounting rules.
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