The IRS recently issued Rev. Rul. 2023-14, providing guidance on the taxation treatment of rewards that cryptocurrency holders may receive from proof-of-stake blockchain validation. According to recent IRS guidance on cryptocurrency taxation, cryptocurrency holders participating in proof-of-stake blockchain validation will recognize taxable income when they have “dominion and control” over the received cryptocurrency rewards.
Cryptocurrency blockchains require validation from other cryptocurrency holders, and one mechanism for this validation is proof-of-stake verification. In proof-of-stake, cryptocurrency holders stake a certain amount of cryptocurrency or use it as collateral. In exchange, the cryptocurrency network may select them to validate the blockchain. If they correctly validate the blockchain, they may receive additional cryptocurrency rewards. If they incorrectly validate the blockchain, they may lose some or all of the staked cryptocurrency.
Previously, the IRS declared taxation on cryptocurrency transactions. The IRS’s stance on cryptocurrency taxation is grounded in the Internal Revenue Code and decades of case law interpreting it. The Internal Revenue Code generally taxes “all income from whatever source derived.” Courts interpret income broadly as receiving any type of property or something of value, and cryptocurrency falls under this definition due to its inherent value.
The Internal Revenue Code and case law require taxpayers to actually receive property or something of value before taxation. For instance, when a crabber tosses crab traps into the sea, they do not recognize taxable income. It’s only when a fisherman brings the caught crabs to market and exchanges them for money that income is acknowledged. Recent IRS guidance applies the same principles to cryptocurrency transactions. While cryptocurrency transactions are taxable, cryptocurrency holders do not need to pay taxes until they actually receive something of value and have control over it.
According to recent IRS guidance, cryptocurrency holders participating in proof-of-stake validation will recognize taxable income when they have dominion or control over the additional cryptocurrency rewards. This typically occurs when the additional currency is in the cryptocurrency holder’s wallet and can be freely traded or disposed of. Just as the crabber does not need to pay taxes when merely placing crab traps in the sea, cryptocurrency traders do not recognize any income when simply staking cryptocurrency or engaging in validation.
