Cryptocurrency staking rewards are income in year received

The Tax Court held that rewards that a taxpayer received from cryptocurrency staking through a digital asset platform were includable in the taxpayer’s gross income in the year he received the rewards.

Blockchain validation protocols — proof of work and proof of stake

In its opinion, the Tax Court first briefly explained the relevant cryptocurrency concepts involved in the case, including blockchain validation protocols. Cryptocurrencies typically use one of two consensus protocols to validate the blockchain and distribute new tokens: proof of work and proof of stake. A proof–of–work protocol, used by cryptocurrencies such as bitcoin, requires participants (miners) to solve complex mathematical problems relating to recent unverified transactions. Once a miner solves the problem, the solution is broadcast to other nodes that verify that the solution is correct. If the solution is accepted, the successful miner usually receives a reward of the same type of token.

A proof–of–stake protocol, used by cryptocurrencies including ether and tezos, requires comparatively less computational effort to validate the blockchain, with no miners being involved. Instead, token holders who wish to validate transactions (stakers) lock up (stake) tokens as collateral. Stakers are selected by algorithm to confirm the validity of new blocks to the blockchain, based on the quantity of tokens they have staked, the length of their tenure as validators, or random selection. If stakers are selected and they successfully validate transactions, they receive rewards of the same type of token. However, they risk forfeiting staked tokens if they dishonestly or incorrectly validate transactions.

Background of the case

During 2021, Alvie Paschall owned an account with eToro USA LLC, a digital asset platform, in which he held tokens in cardano, a cryptocurrency using a proof–of–stake blockchain. Cardano tokens could be held on platforms other than eToro.

On Oct. 1, 2020, eToro announced a staking service for customers who held cardano tokens, through which eToro executed the staking process on behalf of its customers. By default, eToro customers’ cardano tokens were staked, but customers could opt out of the staking service. Regardless of whether their tokens were staked, eToro customers retained ownership of their tokens.

eToro customers who did not opt out received staking rewards in proportion to the number of tokens they held in their accounts, and eToro distributed the staking rewards monthly in the form of cardano tokens. Participants in the staking service received 75% to 90% of the staking rewards, while eToro retained 10% to 25% as a fee, with the exact percentage depending on the customer’s membership level. Paschall neither owned nor operated the eToro staking pool.

Paschall’s cardano tokens were staked through eToro for all of 2021, and tokens automatically were added to his account as staking rewards monthly. The tokens that Paschall received as staking rewards were identical to the existing tokens in his account, and he could sell any of his tokens for cash at any time.

On Nov. 23, 2021, eToro notified Paschall that it intended to delist the cardano cryptocurrency from its service in early 2022. From Nov. 23 until the end of 2021, eToro restricted Paschall’s ability to transfer his cardano tokens to another account or platform. Although he did not sell any of his tokens during this period, Paschall retained the ability to do so. In 2022, Paschall transferred his cardano tokens to another platform.

eToro issued Paschall a 2021 Form 1099–MISC, Miscellaneous Information, reporting $33,354 in other income attributable to the staking reward tokens he received. The form was sent to Paschall’s former address, but he did not receive it. Paschall first became aware of the Form 1099–MISC when the IRS issued him a Notice CP2000 in November 2023 proposing adjustments to his 2021 tax liability for the income on the Form 1099–MISC.

Paschall challenged the IRS’s determinations in Tax Court. He argued that the tokens he received as staking rewards should not be included in his gross income upon their receipt in 2021.

The Tax Court’s decision

The Tax Court found that the cardano tokens Paschall received in 2021 as staking rewards were an accession to wealth over which he had dominion and control because he could sell them for cash at any time. Thus, the court held that the tokens were includable in his gross income in 2021.

As the Tax Court explained, cryptocurrency is treated as property for federal income tax purposes (Notice 2014–21, Section 4, Q&A–1). The notice also provided that tokens generated from mining in a proof–of–work protocol were includable in gross income on the date of receipt (id., Section 4, Q&A–8).

In Rev. Rul. 2023–14, the IRS addressed staking rewards for a cash–method taxpayer who staked cryptocurrency on a proof–of–stake blockchain. It concluded that “the fair market value of the validation rewards received is included in the taxpayer’s gross income for the taxable year in which the taxpayer gains dominion and control over the validation rewards” and that the fair market value of the rewards would be determined as of that date.

To decide whether Paschall’s staking reward tokens were includable in his gross income upon receipt in 2021, the Tax Court applied the tax principles applicable to all assets. Under Sec. 61(a), a taxpayer’s gross income generally includes “all income from whatever source derived.” The Supreme Court stated in James, 366 U.S. 213, 218–19 (1961), “The starting point in all cases addressing the question of the scope of what is included in ‘gross income’ begins with the basic premise that the purpose of Congress [in Sec. 61] was ‘to use the full measure of its taxing power.'” The Court further found in James that when Congress wishes to exempt income from inclusion, it does so explicitly (id. at 219).

Based on Glenshaw Glass Co., 348 U.S. 426 (1955), the Tax Court found that gross income includes all accessions to wealth realized and over which the taxpayer has complete dominion and control. Under Regs. Sec. 1.451–1(a), when a taxpayer computes taxable income under the cash–basis method of accounting, the taxpayer must report income for the earliest year in which it is actually or constructively received. Under Regs. Sec. 1.451–2(a), a taxpayer has constructively received income in the year in which the money is credited to the taxpayer’s account, set aside for the taxpayer, or otherwise made available so that the taxpayer may draw upon it at any time. If control of this money is subject to a substantial limitation or restriction, however, the taxpayer has not constructively received the income.

The IRS and Paschall agreed that he received staking rewards in the form of additional cardano tokens credited to his eToro account. After he received the staking reward tokens, like the underlying staked tokens, they were not subject to any sale restrictions, and Paschall could convert them to cash at any time.

Paschall argued that he did not possess dominion and control over his staked tokens because eToro restricted his ability to transfer cardano tokens to another wallet. But as the Tax Court had pointed out, he could convert the tokens to cash at any time, and the Supreme Court in Helvering v. Horst, 311 U.S. 112, 118 (1940), had stated that “the power to dispose of income is the equivalent of ownership of it.” The Tax Court further determined that even though Paschall did not sell the staking reward tokens he received during 2021, he could have done so, and thus, the restriction on transfers of the tokens to wallets hosted by services other than eToro did not negate his accession to wealth upon his receipt of them. Consequently, it held that Paschall had income when he received the staking reward tokens.

Paschall made several other arguments regarding why the staking reward tokens should not be treated as income on their receipt, all of which the Tax Court rejected. First, he argued that staking reward tokens should not be “taxed until realized through a sale or disposition,” equating them “to growth or accretion in value,” citing Eisner v. Macomber, 252 U.S. 189 (1920). In that case, the Supreme Court held that pro rata stock dividends (i.e., the distribution of additional shares to existing shareholders in proportion to their respective interests) generally are not taxable income upon receipt.

The Tax Court found that crucial to the Supreme Court’s conclusion in Macomber was that “stock dividend[s] really take nothing from the property of the corporation and add nothing to that of the shareholder” (id. at 212). In the Tax Court’s view, the stock dividend at issue in Macomber created no increase or shift in the value owned by the shareholder; it merely increased the total number of outstanding shares. However, unlike the stock dividend in Macomber, the court observed, the staking reward tokens Paschall received increased his proportion of all outstanding cardano tokens. Accordingly, the court determined that Macomber did not apply in Paschall’s case.

Analogizing his case to Macomber, Paschall asked the Tax Court to take judicial notice of cardano’s finite pool of 45 billion tokens, including staking reward tokens. Paschall also suggested that the fixed supply of cardano tokens is a “non–inflationary system” and that “rewards are redistributed from a fixed supply.”

The Tax Court determined that accepting this as fact would not change its conclusion, and it did not agree with Paschall’s characterization of cardano’s mechanics. The court found that the distribution of staking reward tokens from a fixed supply increased both the proportion and the value of Paschall’s interest in cardano, and it did not see any indication that staking reward tokens were “redistributed from a fixed supply.” Only a portion of the overall supply of cardano tokens was in circulation already; the remainder was held in reserve for future staking rewards. Thus, the distribution of staking rewards increased the supply and aggregate value of cardano in circulation.

Paschall also theorized that the staking rewards constituted self–created property, contending that “tokens created through staking are like a baker’s cake or a writer’s book — products of labor and capital that yield income only upon sale.” The Tax Court found his analogy was misplaced. Stakers, according to the court, do not create anything by themselves. Instead, the staked tokens validate transactions on the blockchain, and in exchange for validation, the cryptocurrency’s protocol grants stakers additional tokens. The fact that these tokens may be newly created is immaterial because the stakers are not the ones who created them. Further, the court noted that Paschall did not own or operate a staking pool, and, unlike a baker or writer, he lacked the power to decide whether (and when) the property was created.

Citing Loper Bright Enterprises v. Raimondo, 144 S. Ct. 2244 (2024), Paschall contended that Rev. Rul. 2023–14 was inapplicable and that any reliance on it was misplaced. In Loper Bright, the Supreme Court held that a court must use its independent judgment in determining whether an agency has acted within its statutory authority in interpreting a statute. He also argued that the revenue ruling, which was issued in 2023, could not apply to him retroactively in 2021.

The Tax Court determined that it did not need to address Paschall’s arguments regarding Rev. Rul. 2013–14 because neither the IRS’s arguments nor its own conclusion rested on it. Instead, they rested on Sec. 61 and related case law.

Reflections

In a footnote to its discussion of Paschall’s argument regarding self–created property, the court noted that Paschall cited Jarrett, No. 21–cv–00419, (M.D. Tenn. 9/30/22), aff’d, 79 F.4th 675 (6th Cir. 2023), in support of his argument. In Jarrett, the taxpayers made arguments similar to Paschall’s, and the IRS subsequently conceded that the taxpayers were entitled to a refund. However, the Tax Court noted that the IRS never addressed the merits of the taxpayers’ arguments in Jarrett, and the IRS’s concession that the taxpayers were entitled to a refund in that case was not binding in Paschall’s case.

Paschall, T.C. Memo. 2026–46

Contributor

James A. Beavers, CPA, CGMA, J.D., LL.M., is The Tax Adviser’s tax technical content manager. For more information about this column, contact thetaxadviser@aicpa.org.