IRS Issues New Directive on Taxation of Cryptocurrency Staking Rewards

On July 31, 2023, the Internal Revenue Service (IRS) issued Revenue Ruling 2023-14, which carries significant implications for individuals engaged in cryptocurrency staking. It states that those who stake cryptocurrency, particularly on Proof-of-Stake (PoS) blockchains, must now include the value of the rewards they receive from staking in their overall taxable gross income as opposed to when they sell the rewards at a later date.

Proof-of-Work (PoW) and PoS are two distinct ways that blockchain networks validate transactions and maintain their security. PoW involves miners solving complex math problems using powerful computers. The first one to solve the puzzle gets to add a new block of transactions to the blockchain and earns a reward. This process secures the network and ensures that transactions are legitimate. On the other hand, PoS eliminates the need for energy-intensive calculations. Instead of relying on miners, new blocks are generated by validators who are selected based on the number of coins they possess and “stake” as collateral. This approach is more environmentally friendly and aims to achieve similar security while promoting decentralization. Each method has unique advantages and trade-offs, influencing their suitability for different blockchain projects.

Pursuant to the newly issued IRS ruling, a cash-method taxpayer who stakes cryptocurrency native to a PoS blockchain and subsequently earns additional units of cryptocurrency as rewards during validation processes, the fair market value of these rewards must be included in their gross income in the tax year in which the individual gains full control and ownership of the earned rewards. This same principle applies if a taxpayer engages in cryptocurrency staking through a cryptocurrency exchange and later gains extra tokens as rewards due to validation.

This latest Revenue Ruling broadly adheres to the IRS’s previously established regulatory guidance. In earlier guidance, the IRS declared that when an individual successfully engages in cryptocurrency mining, the fair market value of the acquired cryptocurrency at the time of receipt should be included in their total gross income. In follow-up guidance, the IRS established that a taxpayer’s gross income is affected by an airdrop of a new cryptocurrency after a hard fork, particularly if the taxpayer gains possession of new cryptocurrency units. A hard fork in blockchain technology is a significant alteration to a network’s rules, which can turn previously rejected blocks and transactions into accepted ones, or the other way around. That pronouncement by the IRS also clarified that the recognition of cryptocurrency receipt hinges on the taxpayer’s ability to exert full authority and control over the cryptocurrency.

It’s essential to understand and comply with this new ruling, as it carries potential tax implications for staking rewards. As cryptocurrency regulations evolve, staying informed about the tax obligations associated with different activities within the cryptocurrency space becomes increasingly crucial. If you have any questions about the recent IRS Revenue Ruling and how it may affect you, contact Edward Kim, Tax Partner in Anchin’s Private Client Group, or your Anchin Relationship Partner.