In Revenue Ruling 2023-14[1], the IRS formalized its stance regarding an issue first raised by the taxpayers in the Jarrett[2] case. The agency clarified that cryptocurrency earned from staking constitutes taxable income under federal tax law.

In the Jarrett case, the taxpayers sought legal recourse in a District Court after their claim to refund income recognized from staking, as stated on their original return, was rejected. In an attempt to prevent litigation, the IRS refunded the claimed amount to the taxpayers once legal proceedings commenced. This led the District Court to dismiss the case as moot.

Despite this dismissal, the couple endeavored to escalate the issue to the Sixth Circuit Court of Appeals, with oral arguments occurring on July 26, 2023.  However, before the panel could render a decision, the IRS issued a ruling delineating its position on the taxability of staking rewards under US tax law.

Background Material in the Ruling

The ruling provides background on how cryptocurrencies utilize blockchain technology and outlines the methods used to validate transactions before their addition to the distributed ledger.

Cryptocurrency is a type of virtual currency that utilizes cryptography to secure transactions that are digitally recorded on a distributed ledger. See Rev. Rul. 2019-24. References to cryptocurrency in this revenue ruling are to cryptocurrency that is convertible virtual currency. Units of cryptocurrency are generally referred to as coins or tokens.

Many cryptocurrencies utilize blockchain technology, a specific type of distributed ledger technology. Distributed ledger technology uses independent digital systems to record, share, and synchronize transactions, the details of which are recorded simultaneously on multiple nodes on a network. In this context, a node generally refers to a device that maintains a copy of the distributed ledger and runs copies of the software associated with the protocol for the distributed ledger at issue.

In general, it is these nodes that maintain the integrity of a blockchain by validating transactions and ensuring that new entries in the ledger, in the form of blocks of transactions, are legitimate and not duplicative so that a new block can be recorded on the blockchain. This can be done, for example, by rejecting transactions that attempt to move the same units to two different wallet addresses at the same time. The creation of new blocks on a blockchain generally requires the participation of multiple validators who are selected and rewarded pursuant to the blockchain protocol. These validation rewards typically consist of one or more newly created units of the cryptocurrency native to that blockchain.[3]

The ruling further explains how staking operates, and will go on below to provide guidance on the U.S. tax treatment of this consensus mechanism.

A consensus mechanism is a set of protocols by which nodes reach agreement on updates to the blockchain. One consensus mechanism is commonly referred to as proof-of-stake. In a proof-of-stake consensus mechanism, persons who hold cryptocurrency may participate in the validation process by staking their holdings, if they hold the requisite number of units of a particular cryptocurrency. Persons may also participate in the validation process by staking their holdings through a cryptocurrency exchange. In a proof-of-stake consensus mechanism, validators may be selected by the protocol for the blockchain associated with the specific cryptocurrency based on a variety of factors including the number of coins or tokens staked. These validators confirm transactions and add blocks to the blockchain in accordance with the protocol. If a validator is chosen by the protocol and validation is successful, the validator will receive a reward. If a validator is chosen by the protocol and validation is unsuccessful, the staked units may be subject to penalty in the form of “slashing,” a process by which the staked units, or a portion thereof, are forfeited.[4]

Facts of the Ruling

The agency provides the following set of circumstances to form the basis for this ruling.

Transactions in M, a cryptocurrency, are validated by a proof-of-stake consensus mechanism. On Date 1, Taxpayer A, a cash-method taxpayer, owns 300 units of M. A stakes 200 of the units of M and validates a new block of transactions on the M blockchain, receiving 2 units of M as validation rewards. Pursuant to the M protocol, during a brief period ending on Date 2, A lacks the ability to sell, exchange, or otherwise dispose of any interest in the 2 units of M in any manner. The following day, on Date 3, A has the ability to sell, exchange, or otherwise dispose of the 2 units of M.[5]

In a footnote the IRS provides the following clarification:

The facts in this revenue ruling do not address any type of “gas” or transaction fees other than the validation rewards described herein.[6]

Law Applicable to These Facts

The ruling delineates the fundamental rules for what is considered gross income under the Internal Revenue Code.

Section 61(a) provides the general rule that, except as otherwise provided by subtitle A of the Code, gross income means all income from whatever source derived. Specifically, gross income includes, but is not limited to, compensation for services, gross income derived from business, and gains from dealings in property. Under section 61, “instances of undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion,” require inclusion in gross income. See Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955). “Gross income includes income realized in any form, whether in money, property, or services. Income may be realized, therefore, in the form of services, meals, accommodations, stock, or other property, as well as in cash.” § 1.61-1(a). Unless otherwise provided by a Code or regulatory provision, any receipt of property constitutes gross income in the amount of its fair market value at the date and time at which it is reduced to undisputed possession. See, e.g., section 61(a); Koons v. United States, 315 F.2d 542 (9th Cir. 1963); Rooney v. Commissioner, 88 T.C. 523, 526-527 (1987); § 1.61-2(d)(1).[7]

The ruling subsequently details how these provisions apply to the receipt of property, including units of cryptocurrency.

Cryptocurrency that is convertible virtual currency is treated as property for Federal income tax purposes and general tax principles applicable to property transactions apply to transactions involving cryptocurrency. See Notice 2014-21. For example, a taxpayer who receives cryptocurrency as a payment for goods or services or who mines cryptocurrency must include the fair market value of the cryptocurrency in the taxpayer’s gross income in the taxable year the taxpayer obtains dominion and control of the cryptocurrency. See id., Q&A 3 and Q&A 8. Amounts received as gains derived from dealings in property, or as rents or royalties, also generally must be included in a cash-method taxpayer’s gross income in the taxable year the taxpayer obtains dominion and control of those amounts through actual or constructive receipt. See also § 1.451-1(a).[8]

The Ruling’s Conclusion

The ruling concludes with the following holding:

If a cash-method taxpayer stakes cryptocurrency native to a proof-of-stake blockchain and receives additional units of cryptocurrency as rewards when validation occurs, the fair market value of the validation rewards received is included in the taxpayer's gross income in the taxable year in which the taxpayer gains dominion and control over the validation rewards. The fair market value is determined as of the date and time the taxpayer gains dominion and control over the validation rewards. The same is true if a taxpayer stakes cryptocurrency native to a proof-of-stake blockchain through a cryptocurrency exchange and the taxpayer receives additional units of cryptocurrency as rewards as a result of the validation.[9]

However, in another footnote, the IRS underscores that this ruling does not tackle any potential issues that could emerge under other provisions of the Internal Revenue Code.

This revenue ruling does not address issues that may arise under any rules not specifically cited, such as section 83.[10]

[1] Revenue Ruling 2023-14, July 31, 2023, https://www.irs.gov/pub/irs-drop/rr-23-14.pdf (retrieved July 31, 2023)

[2] Jarrett v. United States, M.D. Tenn., No. 3:21-cv-00419, September 30, 2022

[3] Revenue Ruling 2023-14, July 31, 2023

[4] Revenue Ruling 2023-14, July 31, 2023

[5] Revenue Ruling 2023-14, July 31, 2023

[6] Revenue Ruling 2023-14, July 31, 2023

[7] Revenue Ruling 2023-14, July 31, 2023

[8] Revenue Ruling 2023-14, July 31, 2023

[9] Revenue Ruling 2023-14, July 31, 2023

[10] Revenue Ruling 2023-14, July 31, 2023