Staking rewards are almost similar to receiving interest on your term bank deposits. It is beyond debate that your assets go off when a Blockchain gives you a certain number or percentage of the cryptocurrency related to the blockchain based on the number of coins you staked. Until now, there has been no written law or any Rulings by the IRS on the taxation of crypto coins that you receive due to the staking of coins. But now, after this Revenue Ruling, receiving the crypto coins is also a taxable event in your life!
What is the staking of Cryptocurrency?
Staking refers to the act of holding and locking up a certain amount of cryptocurrency in a blockchain network to participate in the validation and verification of transactions on that network. In return for staking, individuals can earn rewards through additional cryptocurrency.
Here’s an example: Imagine you want to participate in a cryptocurrency network like Ethereum. Instead of holding your Ethereum in a wallet, you can “stake” your coins by locking them in the network’s protocol. By doing so, you are helping to validate and verify transactions on the web, which contributes to the security and stability of the entire network. For this help, you will receive rewards of additional crypto coins. That is staking gains!
IRS Ruling on Staking Rewards: Rev. Rul. 2023-14
The IRS Ruling 2023-14 has answered the following questions related to the taxability of gains due to the staking of cryptocurrency to a blockchain :
If a taxpayer that uses a cash method of accounting (cash-method taxpayer) stakes cryptocurrency native to a proof-of-stake blockchain and receives additional units of cryptocurrency as rewards when validation occurs (validation rewards or rewards), must the taxpayer include the value of the rewards in the taxpayer’s gross income and, if so, in which taxable year?
The Ruling concluded that the additional units of cryptocurrency received as rewards must be included in the taxpayer’s gross income in the taxable year in which the taxpayer gains dominion and control over the validation rewards. The exact wordings of this Ruling by the IRS are as under :
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.
Deciphering the Ruling in Staking Rewards
Certain blockchain terms and conditions only decide if the Revenue Ruling 2023-14 applies. For example, the ruling starts on an issue that relates to ” If a cash-method taxpayer stakes …” It means this ruling does not apply to a case of a taxpayer who does not follow the cash method of accounting for cryptocurrency staking gains. So, let us know :
- What is cash-method accounting?
- What is dominion and control over cryptocurrency?
What is cash-method accounting?
When you follow the cash method of accounting, it means you recognize income only when you receive it. Similarly, you will recognize expenses only when you pay the amount of expenditure.In contrast, in the accrual accounting system, transactions are recorded on a due basis. So, the cash method of recording gains means when you receive the staking rewards in your wallet over which you have control, you will recognize the gains and account for them.
What is dominion and control over cryptocurrency?
The IRS Virtual Currency FAQs (October 2019) A.23 explains, “…you have dominion and control over the cryptocurrency so that you can transfer, sell, exchange, or otherwise dispose of the cryptocurrency.”. Similarly, Rev. Rul. 2019-24 states, “If the taxpayer later acquires the ability to transfer, sell, exchange, or otherwise dispose of the cryptocurrency, the taxpayer is treated as receiving the cryptocurrency at that time.”
Thus, the rewarded crypto coins staked to a proof-of-stake blockchain for validation are taxable income in the year you receive in a wallet over which you have complete control.
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