The Breakdown - The Battle to Change How the IRS Taxes Mining and Staking

Starting point is 00:00:00 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexus.io, Arculus, and FtX, and produced and distributed by CoinDesk. What's going on, guys? It is Thursday, February 3rd, and today we are talking about the emerging battle to change how the IRS taxes, mining, and staking. First, if you were enjoying the breakdown, please go subscribe to the show, give it a rating, give it a review, or if you want to get deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes, or you can go to bit.ly slash breakdown pod. And as always, a quick disclosure, in addition to them being a sponsor of the show, I also work with FTX. So, last night, Blockworks broke what seemed like a huge story. Their tweet said, breaking, IRS will

Starting point is 00:01:02 not tax unsold-staked crypto as income. However, the piece title was in Win for Crypto-Stakers, IRS offers refund on untraded token rewards. So there are really two quite different things going on here. One title is a specific case, the IRS offering a refund for a specific consumer. The other is a precedent. The IRS will not going forward tax-unsold-staked crypto. So let's dig into the reality of what actually happened. For tax year 2019, Joshua and Jessica Jarrett paid $3,293 of income tax for the receipt of 8,876 Tezos tokens that they had earned from staking. In 2020, Joshua Jarrett asked the IRS to return the taxes he paid, arguing that the tokens were not income but rather, quote-unquote, created property. When the IRS didn't respond, he filed a lawsuit in May 2021 with the U.S. District Court for the Middle District of Tennessee.

Starting point is 00:02:00 The lawsuit was funded in part by the proof of stake alliance. In December of 2021, attorneys for the IRS wrote to Josh and Jessica's attorney, saying that the IRS had been, quote, authorized and directed to schedule an overpayment of $3,793 plus statutory interest. Now, the proof of stake alliance said that basically this was the IRS saying that they agreed with the Jarrett's take on things. Alison Mangiero, the acting executive director of the proof of stake alliance, said, quote, the IRS basically waived the white flag and said, here's your refund. And they wouldn't do this after

Starting point is 00:02:31 litigation has already started unless they thought there was some teeth to Jarrett's arguments. So what did the Jarrett's do then? Well, they didn't accept. They decided to decline the IRS's offer and instead are seeking to get guidance from the IRS on whether tokens that are created through this type of activity, this staking, represent taxable income when they are created or when they're sold. Mangiero says if the court reaffirms Jarrett's claim that these staking rewards should be taxed as created property, then there is a legal opinion that other taxpayers can rely on, and they can feel confident when they file their taxes every year. Josh Jarrett actually wrote a statement in his own word, so let's review that.

Starting point is 00:03:13 This is an excerpt from his Twitter thread and his statement. Josh writes, I shouldn't be taxed when I create new tokens through staking. The law newly created property is clear, but the IRS hasn't been, and that's why I sued. Here's my statement on my case. It's hard not to feel grateful for being alive during the period of the most rapid technological expansion in human history. I was in high school in the 90s when the internet became broadly available, and since the day I got my first Commodore 64, I became obsessed with computers and technology. In 2017, I learned about a new proof-of-stake blockchain protocol called Tazos.

Starting point is 00:03:44 After doing more research and digging into what made it different, I decided that this was the one I wanted to get involved in and one day used for my business ideas. Tezos was something I could figure out and participate in without needing a formal, computer science background, expensive hardware or much electricity. By staking, I created new blocks and tokens which contributes to keeping the TASOS blockchain decentralized and secure. My tax returns for 2019 reflected the basic and common sense principle that newly created property is not income, just like when a baker bakes a cake. When the IRS wouldn't confirm this, they didn't respond to my refund claim. I filed a federal lawsuit. Fast forward to late December 2021. I recently received a letter saying that the government wanted to grant me a refund. In other words, a year and a half into this

Starting point is 00:04:23 process, the government didn't want to defend the position that my staking rewards were indeed taxable income. At first glance, this seemed like great news. But until the case receives an official ruling from a court, there will be nothing to prevent the IRS from challenging me again on this issue. I need a better answer, so I refuse the government's offer to pay me a refund. In a further tweet, he reaffirms this saying, I refuse the offer because I know that until my case receives an official ruling, I have no certainty they won't try to tax me again. He then shares the letter that his lawyer, at Fenwick and West, LLP, sent to the United States Department of Justice Tax Division. He writes, the IRS will apparently not provide any assurances with respect to the sole issue that gave rise to this litigation,

Starting point is 00:05:04 whether tokens created through a staking a particular cryptocurrency constitute taxable income at the time of their creation. As the question will arise for the Jarrett's again in subsequent tax years, they would remain at risk, even if they accepted the proffered refund. Therefore, the Jarrett's reject the proffered refund and intend to continue vindicating their rights in court. We're happy to discuss next steps with you, your convenience. Nexo is a trusted and easy to use crypto platform where you can buy cryptocurrencies at the touch of a button and start earning up to 18% annual interest that is paid out daily. They support all of the major assets on the market and even allow you to swap one asset for another or borrow cash against your crypto without selling it. Nearly three million people in over

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Starting point is 00:06:30 Buy now at getarkilus.com. That's G-E-T-A-R-C-U-L-S dot com. The breakdown is sponsored by F-TX-U-S. F-T-X-U-S is the safe, regulated way to buy and sell Bitcoin and other digital assets with up to 85% lower fees than competitors. There are no fixed minimum fees, no A-C-H transaction fees, and no withdrawal fees. One of the largest exchanges in the U.S. F-T-X-U-S. is a very big.

Starting point is 00:07:02 also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTX, you pay no gas fees. Download the FTX app today and use referral code breakdown to support the show. So a lot to unpack here, but first, going back to the tweet that started at all, there had been some consternation about the Blockworks tweet. Remember, it said IRS will not tax unsold-staked crypto as income. Jake Chavinsky writes, the article itself doesn't even say this. It says the IRS will offer a refund in one. dispute. That's big, but it's not how the IRS sets new policy, and not at all what this tweet says. There's enough to be excited about here without overhyping it for engagement. Now, if the reality is any less than IRS makes new policy never to tax unsold-staked crypto, people will feel

Starting point is 00:07:51 let down, even if it's still a big win. Some crypto accounts disagreed. I'm not the wolf rights, but if the case goes through, then you can simply file taxes without taxing your untransacted yields. And if the IRS ever takes you to court, then you can quote this case, since IRS also doesn't provide guidelines for these situations. To which Chavinsky responded, no, settlements are not binding precedent, nor are judicial opinions from federal district courts. One district judge can rule one way and another district down the hall can rule the exact opposite way the next day, and that's lawful. Astoria tax agreed, saying, I wouldn't get too excited about an IRS settlement. The IRS can settle cases for any number of reasons unrelated to tax law interpretation. Weak evidence, weak

Starting point is 00:08:28 prosecuting team, resource allocation, etc. IRS settlement in one single case does not set precedent or guidance. Kobe, the host of Up Only, who needs no introduction, waited in to discuss whether this was just like mining income, writing, yeah, but mining is considered income, right? So receiving the staking reward could have been treated the same way as receiving the mining revenue. Matthew Nymeag said no, the idea is that mining or staking creates new property, which is not taxed until sold, but at ordinary income rates most likely. This is like if you planted tomato plants from seed, grew tomatoes, and were taxed when the tomatoes are ripe, as opposed to when you sell them. So what you're getting at is that there is a

Starting point is 00:09:03 larger question here of not just staking but mining as well. And CoinCenter sums up those bigger stakes, saying this should not be interpreted as merely a positive development for proof-of-stake validators. It's good news for Bitcoin miners as well. Any block reward from a permissionless cryptocurrency network, whether it's created through a proof-of-work mining, proof-of-stake validating, or some other mechanism, is most accurately described as the creation of value through one's own capital and labor, rather than the receipt of value from an employer. The network allows users to create wealth from their own resources, it does not pay people for their labor. Why is this the more sensible characterization? Creators of block rewards literally do not get paid by anyone. Who is the

Starting point is 00:09:42 employer when you are working for the Bitcoin network? Just as truly permissionless decentralized networks lack third-party promoters upon whom users rely on the context of securities law, they also lack discernible employers and employees in the context of income tax law. To be clear, this does not mean that block rewards can or should be taxed free, simply that they should be taxed like crops, minerals, livestock, artwork, and assembly line widgets. They should be taxed when they are sold, not when they are created. Treating mining and staking rewards as newly created property rather than income is also the preferred approach of a bipartisan group in Congress, who sent the IRS a letter arguing for as much in August of 2020. Today's news brings us one step closer to winning that fight

Starting point is 00:10:20 and one step closer to clear and reasonable tax policy for crypto in the U.S. This wasn't the only crypto tax discussion yesterday. Bloomberg published Intuit CEO Warns tax bill shock from Bitcoin and NFT traders. The CEO of Intuit said, we're going to see a lot of that throughout tax season, where folks just didn't understand what they did. And there's a lot of millennials that really did a lot of trading without knowing what the implications are. They're shocked as to how much money they've lost or how much they owe because they were in essence gambling with their money. One specific question is on NFTs. In the middle of January, Bloomberg ran an article. NFT investors owe billions in taxes and IRS set sites on evaders. Here's how they describe the issue.

Starting point is 00:10:59 When a creator sells an NFT, most tax experts agree that the profits should be considered ordinary income and be subject to a rate as high as 37%. Investors who buy the tokens owe capital gains taxes if they used another cryptocurrency for the purchase and when they sell it. Beyond that, the rules are murky. There are questions about whether tokens should be taxed like art collectibles, which comes with long-term capital gains rates of up to 28%. That's compared to 20% for most cryptocurrencies and stocks. The infrastructure bill, President Joe Biden, signed it a law last year, will make it harder for people to hide digital assets, but the Treasury Department has not said whether that includes NFTs. What's clear is that the IRS is gearing up. Jared Kutman, the acting executive director of cyber

Starting point is 00:11:39 and forensic services at the IRS's Criminal Investigation Division, says we subsequently will probably see an influx of potential NFT-type tax evasion or other crypto-asset tax evasion cases coming through. Now, of course, the infuriating thing here is that there just isn't guidance. Once again, people are just expected to figure it out. However, one good news, on that front, at least for those in the UK, Her Majesty's Revenue in Customs, HMRC, which is the UK's tax agency, has recently updated its guidance on some of these questions, on tax of returns that come from defy lending and from staking in POS networks. And to be honest, it is enormously complex this guidance. I'm talking like word salad that I can't even repeat on this show. However,

Starting point is 00:12:22 I wanted to point it out because at least they are trying and you have to appreciate that. One other bit of good news is that trying to get some clarity and common sense into crypto tax policy is on the agenda of our allies in Congress. As I was prepping this episode, Bitcoin magazine started reporting that a bipartisan bill has been introduced that would exempt Bitcoin transactions for taxes if associated capital gains are $200 or less. In other words, they're trying to make Bitcoin usable as a medium of exchange for small transactions. Representative Susan Del Benny, who is one of the co-authors of the bill, said antiquated regulations around verse. virtual currency do not take into account its potential for use in our daily lives, instead treating

Starting point is 00:13:01 it more like a stock or ETF. However, virtual currency has evolved rapidly in the past few years with more opportunities to use it in our everyday lives. This common sense bill cuts the red tape and opens the door for further innovations, ultimately growing our digital economy. The bill was called the Virtual Currency Tax Fairness Act and was co-authored by Representative David Schweigart and co-sponsored by representatives Darren Soto and Tom Emmer. In a statement, Schweigart said, virtual currency is reshaping our everyday lives, and the United States needs to recognize this and work to treat these currencies fairly in our tax code. This legislation is an important step forward, and it lays the groundwork for growing the digital economy.

Starting point is 00:13:38 Now, you might be at the end of this show and be just bored out of your face, right? Tax policy is not a thing that people want to spend a lot of time on, but a lot of these boring details have an outsized impact on how we interact with this space. So I'm glad that people are out there fighting the fight, and I'm looking forward to seeing more resolutions of that in the months and years to come. For now, I want to say thanks again to my sponsors, nexus.io, arculus, and FTX, and thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.

The Breakdown - The Battle to Change How the IRS Taxes Mining and Staking

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