Tax Implications of Cryptocurrency Validation Rewards: Mining and Staking

Cryptocurrency is a digital currency using encryption techniques--rather than a central bank--to generate, exchange, and transfer currency units. The IRS treats all virtual currency as “property” rather than currency for U.S. tax purposes. Thus, the IRS requires taxpayers to report any transaction involving the “sale or exchange” of cryptocurrency. However, existing IRS guidance does not fully address the cryptocurrency activities that have rapidly evolved that do not necessarily involve an obvious sale or exchange. Nonetheless, the failure to properly report and substantiate the taxpayer’s mining and staking activities could result in a challenge by the IRS and its assertion of significant tax penalties on audit.

The “mining” of cryptocurrency is one way that transactions on the blockchain ledger are verified (i.e., through a “proof of work” protocol), creating new tokens for the miner, which may subsequently be placed into public circulation. Typically, cryptocurrency miners receive newly minted virtual tokens and currencies for their mining activities, which the IRS appears to treat as a type of service, taxing the newly minted reward tokens upon receipt. Alternatively, the “staking” of cryptocurrencies utilize a “proof-of-stake” consensus mechanism, which is intended to solve the energy inefficiency of crypto mining, while offering comparable blockchain security (by ensuring that the public ledger remains decentralized). Staking crypto, as opposed to mining crypto, has recently seen a rapid increase--particularly when Ethereum announced it would switch to a proof-of-stake mechanism in September 2022 (which has been accomplished). Although the IRS recently added staking to its Priority Guidance Plan for 2023, the Service has not yet issued any explicit guidance on staking’s proper tax treatment leaving tax advisors and taxpayers in a quandary as to how best to apply the existing tax authorities to crypto block rewards.

The panel will first discuss the technological differences between mining and staking, and then briefly review the reasons underlying the substantial confusion and ongoing controversy over their respective tax implications, which have been on full display in the tax law press, in bar association reports, and in a recent U.S. District Court case involving the tax treatment of staked rewards—Jarrett v. United States (dismissed in September 2022 without prejudice). The panel will examine longstanding Tax provisions, regulations, and court cases that ostensibly inform the correct federal income tax treatment of validation block rewards so that, despite the present dearth of specific IRS guidance, advisers are able to stand on firm legal authorities in advising their clients of the risks of taking various positions on their tax returns with respect to treating mining and staking rewards as “income” (or not income), as well as such income’s timing, character, and source. The panel will also discuss the related issues of crypto token valuation, the classification of decentralized autonomous organization (DAOs), and loss harvesting.

Listen as our expert panel discusses the critical legal and factual issues that must be considered when determining the proper U.S. income tax treatment of validating crypto block reward transactions—specifically the recognition, timing, characterization, and reporting of mining and staking activities, including the miner’s or staker’s tax treatment upon a subsequent disposition of block-reward tokens.

1. Overview of Cryptocurrency Guidance to Date
2. Tax Implications of Validating Block Rewards
   • Mining of Cryptocurrencies
     • What is mining technologically?
     • IRS guidance on mining
     • Timing of Income Recognition
     • Character and Source
     • Tax traps
   • Staking of Cryptocurrencies
     • What is staking technologically?
     • Classic tax trap and controversy
     • Jarrett v. United States, U.S. Dist. Court (Central Tenn. 2022).
     • IRS Priority Guidance Plan 2023
     • Choices regarding the timing of Income Recognition
     • Choices regarding the character and Source
     • Importance of substantiating taxpayer’s tax position
3. Valuation Issues regarding Mining and Staking
4. Liability for failing to report cryptocurrency transactions properly
5. DAOs – “Decentralized Autonomous Organizations”
   • What are DAOs-
   • U.S. and international tax implications of various classifications
6. Harvesting and Reporting Losses
7. Key Takeaways and Q&A

The panel will review these and other key issues:

• How does staking differ from mining, and how do they differ in terms of their U.S. income tax treatment?
• What are the major tax pitfalls to avoid in advising clients who are involved in mining and/or staking activities?
• How and when should mining and staking block rewards be valued?
• How do decentralized autonomous organizations (DAOs) relate to the US tax analysis and tax treatment of mining and staking activities?
• How can economic losses in block rewards be harvested?
• What are the best practices in avoiding or managing an IRS examination involving mining and staking activities?

Learning Objectives

After completing this course, you will be able to:

• Recognize items of interest in IRS examination of cryptocurrency transactions
• Determine proper tax treatment of increases in cryptocurrency due to "mining"
• Discern the character of gain or loss for cryptocurrency transactions
• Verify international and domestic information reporting requirements on investments in cryptocurrency mining

• Field of Study: Taxes
• Level of Knowledge: Intermediate
• Advance Preparation: None
• Teaching Method: Seminar/Lecture
• Delivery Method: Group-Internet (via computer)
• Attendance Monitoring Method: Attendance is monitored electronically via a participant's PIN and through a series of attendance verification prompts displayed throughout the program
• Prerequisite: Three years+ business or public firm experience preparing income tax forms and schedules at mid-level within the organization, supervising other preparers/accountants. Specific knowledge and understanding of sale and exchange transactions; familiarity with virtual currency structures, foreign information reporting requirements.

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IRS Approved Provider

Strafford is an IRS-approved continuing education provider offering certified courses for Enrolled Agents (EA) and Tax Return Preparers (RTRP).