October 3, 2022

District Court Dismisses Cryptocurrency Taxation Suit; Finds the Issue Moot

Jason Schwartz Commentary by Jason Schwartz

The District Court for the Middle District of Tennessee granted a motion to dismiss a tax refund suit relating to cryptocurrency staking rewards on mootness grounds after the IRS issued the refund.

The taxpayers paid ordinary income rates on block rewards they earned from consensus-layer staking on the Tezos blockchain, then sued for a refund on the theory that block rewards from consensus-layer staking should not be taxed on receipt, but on a subsequent disposition. After issuing the refund, the government petitioned to dismiss the case. The taxpayers rejected the refund and challenged the motion to dismiss on the basis that they would be harmed without a judicial determination on the merits of their claim.

In a memorandum, the court determined that a live case or controversy no longer remains because a refund had been issued and "any subsequent controversy would necessarily involve a different tax year."

Commentary

Consensus-layer stakers (like the plaintiffs in this case) run software that help maintain a blockchain in exchange for block rewards paid out by the blockchain protocol in its native token. Many crypto users stake from home, and many more stake through delegates like centralized exchanges or through decentralized protocols. Staking has become even more relevant to the crypto industry since Ethereum, by far the most widely used smart contracts platform, switched its consensus mechanism to one that relies on staking in September. Accordingly, the tax treatment of staking rewards is relevant to many taxpayers.

The IRS has yet to issue any guidance on how staking rewards are taxed. Issuing a refund to the plaintiffs - before their case could be tried on its merits - has now precluded a court from doing so.

In the absence of clear guidance, tax advisors are likely to advise U.S. stakers to pay taxes currently on their block rewards at ordinary income rates out of an abundance of caution, unless they have the means and desire to litigate with the IRS. Meanwhile, non-U.S. stakers will remain wary of delegating to professional U.S. stakers because, if block rewards are income from services (which is one possible treatment), the receipt of block rewards through U.S. delegates could cause non-U.S. stakers to be subject to U.S. taxes.

Accordingly, the absence of guidance on this important issue leaves U.S. taxpayers uncertain on how to compute their taxes and could deprive professional U.S. stakers of offshore business.

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