The Internal Revenue Service (“IRS”) recently issued guidance in Revenue Ruling 2023-14, holding that taxpayers who stake their cryptocurrency and receive additional units of cryptocurrency as rewards when validation occurs must include the fair market value of the validation rewards received as gross income.

This long-anticipated ruling addresses an issue that was recently before a federal appeals court in Jarrett v. U.S.  In Jarrett, the taxpayers sought a refund on crypto staking rewards that they had previously included as income on their 2019 tax return under the theory that staking rewards are newly-created property and are only taxable when disposed of, not when received.

Jarrett has not been argued on the merits because the IRS granted the taxpayers a refund and the case was dismissed by a U.S. district court as moot since there was no longer any controversy for the court to resolve regarding the taxpayers’ liability for 2019.  The taxpayers appealed to the Sixth Circuit, arguing that the IRS cannot unilaterally end their case by sending them a refund check. On Friday, the Sixth Circuit agreed with the district court that the lawsuit became moot after the IRS issued the refund. Many were hoping that the case would offer legal clarity to the millions of crypto users who generate cryptocurrency rewards through “proof-of-stake” blockchains.

Crypto staking is the process of pledging cryptocurrency holdings to assist in the validation of transactions on a crypto blockchain.  This “proof-of-stake” consensus mechanism of validation requires validators to hold and stake cryptocurrency in exchange for transaction fees or “rewards” in the form of additional cryptocurrency.  The cryptocurrency staked may be locked up and cannot be transferred or otherwise used by the validator for a period of time, and is subject to “slashing” if a validation is unsuccessful.

In the revenue ruling, the IRS cites case law providing that an accession to wealth over which a taxpayer has complete dominion and control constitutes income.  Therefore, the IRS rules that staking rewards are taxed once a taxpayer gains dominion and control over a crypto token, which is when the taxpayer is able to sell, exchange or dispose of the cryptocurrency reward it receives.

The IRS’s ruling echoes the eagerness of Congress and the White House to resolve many unanswered crypto tax issues.