Proof-of-stake validation rewards are income in tax year received

Taxpayers must include the fair market value (FMV) of proof-of-stake validation rewards in their gross income for the tax year in which they gain dominion and control over the validation rewards, the IRS ruled Monday in Rev. Rul. 2023-14. The ruling applies to cash-method taxpayers who stake cryptocurrency native to a proof-of-stake blockchain and receive additional units of cryptocurrency when validation occurs (i.e., validation rewards). The FMV is determined as of the date and time the taxpayer gains dominion and control over the validation rewards, the IRS said.

In addition, the revenue ruling clarified that the result is the same if a taxpayer stakes cryptocurrency native to a proof-of-state blockchain through an exchange, then receives more cryptocurrency units as rewards through that validation.

Proof of stake is a way to decide which user or users validate new blocks of transactions and earn a reward for doing so correctly.

Proof-of-stake validation is less expensive and involves less work than proof of work, which requires validators to compete to produce a hexadecimal number. In its explanation, Investopedia says that under proof of work, “thousands of mining programs work on one block until the hash is solved, then move to the next block.”

Ethereum, the second-largest digital asset, switched last year to proof of stake from proof of work. Bitcoin uses proof of work.

In its ruling, the IRS cited as the basis of its determination Sec. 61(a), which provides that, as a general rule, except as otherwise provided by Subtitle A of the Code, gross income means all income from whatever source derived. 

Under Sec. 61, “Instances of undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion” are included in gross income. Unless otherwise provided by a Code or regulatory provision, any receipt of property constitutes gross income in the amount of its fair market value at the date and time at which it is reduced to the taxpayer’s undisputed possession.

In Notice 2014-21, the IRS stated that a digital asset that has an equivalent value in real currency — a “convertible virtual currency” — is treated as property for federal income tax purposes, and general tax principles applicable to property transactions apply to transactions involving convertible virtual currency. Thus, a taxpayer must include in gross income the FMV of a validation reward in the year in which the taxpayer gains dominion and control over the reward.

AICPA advocacy

The AICPA requested IRS guidance on the staking issues addressed in Rev. Rul. 2023-14 in various AICPA Virtual Currency and Digital Assets Tax Task Force (VCDATTF) meetings with IRS officials as well as in a 2018 comment letter (on p. 12) and in comments on the IRS Priority Guidance Plan (issued May 9, 2023). The AICPA VCDATTF says it is pleased that the IRS has formally stated their position on staking and provided guidance that taxpayers can rely on in this area. Like many tax questions about digital assets, the transactions are often varied and multifaceted. The task force finds the guidance helpful and will continue to review it and consider what related issues remain, such as whether the answer is different for an accrual basis taxpayer and how expenses should be treated.

— To comment on this article or to suggest an idea for another article, contact Martha Waggoner at Martha.Waggoner@aicpa-cima.com.