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Staking Rewards: Is IRS Digging In or Changing Its Mind?

Crypto industry groups had hoped to use the tax refund case of Jarrett v. United States, No. 3:21-cv-00419 (M.D. Tenn.) as the vehicle to prove that staking rewards received by a crypto validator only trigger gain upon the ultimate disposition of the reward, rather than constituting taxable income upon receipt. However, as previously reported here, the IRS apparently decided it was not ready to fight that battle and sought to moot the taxpayer’s suit by actually refunding (without explanation) the amount of tax the taxpayer claimed to have (over)paid on his staking rewards. The taxpayer, and a cryptocurrency policy group as amicus, asserted that the case should continue despite the refund since the IRS should not be able to avoid pending litigation by tendering a pre-emptory “settlement” and because the tax treatment of staking rewards was a recurring question for the Jarretts as well as a question of “public importance” that warranted an exception to the case’s mootness. On September 30, 2022, the court agreed with the IRS that it no longer had subject-matter jurisdiction and dismissed the case. Jarrett v. United States, No. 3:21-cv-00419, 2022 WL 4793235 (Sept. 30, 2022).

Essentially, the court relied on the nature of a claim for refund as being limited to the specific tax year at issue. Since the IRS had refunded the full amount the taxpayer claimed was overpaid, there was no longer any controversy for the court to resolve regarding the taxpayer’s liability for the year at issue, and a refund claim cannot be used to litigate prospective issues applicable to other years. The court also rejected the taxpayer’s characterization of the refund as merely an offer in settlement and was unpersuaded that the “public importance” of the issue warranted continuing a mooted case.

After the dismissal in Jarrett, the appropriate taxation of staking rewards remains uncertain. Perhaps the IRS is reconsidering its position that staking rewards are income upon receipt. But the pointed refusal of the IRS to explain its rationale for issuing the refund to the Jarretts indicates that the refund may merely reflect a strategic decision to fight the battle over the tax treatment of staking rewards on more favorable terrain at a future date. Either way, the IRS has bought itself some more time to hone its thinking on staking rewards and left the crypto industry frustrated and disappointed at the lack of a clear resolution on the staking issue.

 

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