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For those following recent developments in crypto taxation and crypto staking, the Jarretts may seem familiar. Last year, the same couple argued before the U.S. Court of Appeals for the Sixth Circuit on the same issue of whether receiving staking rewards creates taxable income on the date the rewards are received.
Jarrett initially sought a refund from the IRS in 2022, claiming that he overpaid his 2019 taxes because his 2019 tax bill included taxes incurred in connection with the creation of certain Tezos crypto tokens. filed a lawsuit. Jarrett vs. United StatesNo. 3:21-cv-00419, 2022 BL 349876 (MD Tenn, September 30, 2022). Jarrett argued that the tax was inappropriate because he created new tokens by staking existing tokens he owned. Therefore, he should have paid taxes only when selling or transferring the tokens, not when they were created. Before the parties reached oral arguments, the government granted Jarrett's request for refund and directed the IRS to schedule the overpayment. The government then moved to dismiss the case (arguing that a full refund resolved the dispute), but the district court upheld this move.
Jarrett refused to accept or cash the refund check and appealed to the Sixth Circuit, arguing that the refund claim remained pending. Jarrett vs. United StatesNo. 22-6023 (6th Cir. 2023). Although it did not affect the Sixth Circuit's decision, the IRS formally stated its position on taxation of staking rewards shortly after oral arguments concluded and announced its 2023-14 revenue ruling. The Sixth Circuit affirmed the district court's decision and concluded that IRS refund checks were at issue in the prior action.
Treat tokens created from staking as new assets
Last week's complaint, which now pertains to Jarrett's 2020 tax year, features similar facts as the previous lawsuit and takes a similar tax position regarding staking rewards. Jarrett created new Tezos tokens in 2020 by staking existing Tezos tokens. The complaint alleges that newly created tokens should be treated as new assets and, based on realization requirements, should not be taxed as income until they are transferred or otherwise disposed of. The complaint also provides various illustrative analogies between the new tokens and other forms of new property that are not taxed upon receipt, including vegetables grown by farmers, a coin drafted by Stephen King, Manuscripts, including comparisons with factory-manufactured widgets (in each case emphasizing that such real estate is not taxable until sold).
In addition to the realization requirement, the complaint also discusses the dilutive effect of staking rewards, stating that the creation of new tokens requires the creation of new tokens from newly created tokens to the extent that the new tokens reduce the value of existing tokens. It claims that there are also offsetting economic benefits. This is highlighted by comparing staking rewards to shares received through a stock split. Accordingly, the complaint alleges that taxing new tokens would result in excessive taxation to the extent that the new tokens dilute the value of existing tokens.
The Jarretts asked the district court for several reliefs. Among other demands, the Jarretts are seeking a judgment that their disputed federal income taxes were incorrectly assessed, an order granting them a refund of the amounts they paid for the 2020 tax year, and a permanent disparity barring them from being unfairly treated by the IRS. The request is for the district court to grant a cease and desist order. A token created by the Jarrett family as income.
conclusion
Because the U.S. had previously chosen to reimburse the Jarretts for the applicable taxes rather than litigate for a disposition decision, this lawsuit would require the Jarretts to comply with the IRS's disclosure regarding the taxation of staking rewards. It gives you a second chance to challenge the position. Of course, revenue rulings generally represent the IRS's interpretation of existing tax law and are not binding on courts. Therefore, a ruling in Jarrett's favor could significantly change the taxation of crypto staking rewards, potentially leading to tax deferrals on tokens rewarded in connection with a taxpayer's staking activities. Even. We expect this case to be closely watched by taxpayers engaged in crypto staking activities.
If you have any questions about the tax implications of your staking activities, please contact the author of this article or your usual McDermott contact.
