Cryptocurrencies continue to be a growing asset class, but with limited guidance from the IRS and treasury--and differing points of view on whether certain forms of cryptocurrency are assets, income, or securities--many are left wondering how to tax and report them properly.
To make matters even more confusing, no guidance has been provided regarding the tax treatment of “staking rewards”. Staking rewards are the crypto assets an investor can earn by performing a “proof of work” or “proof of stake” protocol, which are the two most common ways that transactions are validated on a blockchain.
Proof of Work Vs. Proof of Stake Validation
The proof of work validation process involves “miners” who must solve a cryptographic puzzle in order to earn the right to propose a new block in the blockchain. In exchange for their efforts, the miner receives the transaction fees and newly minted cryptoasset.
In the proof of stake validation process, “validators” must have an economic stake in the blockchain’s underlying digital asset to participate in the protocol. Validators are required to place their own tokens into a smart contract where they are held for a period of time while they validate the block. The validator then receives staking rewards, which are newly minted tokens, in exchange for their successful validation.
Currently, there is limited guidance from the IRS regarding mining and staking rewards. Should rewards be considered taxpayer-created property, or income recognized upon receipt?
Should Staking Rewards Be Considered Property or Income?
Some argue that since the rewards did not previously exist before the validator engaged in the mining process, and would not exist had they not participated, that the validator therefore creates the new tokens. Under this line of thinking, the tokens would be considered property, and the validator would not need to include the property in his income until the tokens are sold or otherwise disposed of.
On the flipside, some argue that the validator is receiving the tokens in exchange for a service provided. In this case, the tokens would be considered income, which would need to be reported at the time that the tokens are deposited into the validator’s online wallet.
Either way, the rewards will need to be reported—the key question here is timing. Should rewards be reported when they are received, or when they are later sold or disposed of? Tokens also appreciate over time, so delaying reporting may impact your tax liability.
As we wait for further guidance, it would be wise to consult a tax professional when determining how to report your staking rewards, as your specific circumstances may impact which reporting method will be most beneficial. If you have questions about staking rewards or reporting cryptocurrency assets, leave a comment below or feel free to contact me directly. I’m happy to help!