The ruling discusses the following facts:
- A receives 2 units of cryptocurrency M for staking units and validating transactions on the M blockchain. On Date 3, A gains the ability to sell, exchange, or otherwise dispose of the 2 M units. Thus, on Date 3, A has dominion and control over the 2 M units. As a result, A must include the FMV of the 2 M units in the tax year that includes Date 3.
The ruling, issued on July 31, holds that when a cash-basis taxpayer stakes cryptocurrency “native to a proof-of-stake” blockchain and receives additional cryptocurrency as a reward at validation, the taxpayer must include in gross income the fair market value of the rewards in the tax year in which the taxpayer gains dominion and control over the rewards. The FMV of the rewards is determined as of the date and time the taxpayer gains dominion and control over the rewards.
Proof-of-stake is a protocol that allows persons who hold cryptocurrency to participate in the process of validating cryptocurrency by staking their holdings, if they hold the requisite number of units of a particular cryptocurrency. Persons may also participate in the validation process by staking their holdings through a cryptocurrency exchange.
Validators may be selected by the protocol for the blockchain associated with the specific cryptocurrency based on a variety of factors including the number of coins or tokens staked. These validators confirm transactions and add blocks to the blockchain in accordance with the protocol.
If a validator is chosen by the protocol and validation is successful, the validator will receive a reward. If a validator is chosen by the protocol and validation is unsuccessful, the staked units may be subject to penalty in the form of “slashing,” a process by which the staked units, or a portion thereof, are forfeited.
The ruling also clarifies that the same rule applies when a taxpayer stakes cryptocurrency through an exchange and the taxpayer receives cryptocurrency as a reward at validation.
For more information about the income tax treatment of cryptocurrency transactions, see Checkpoint’s Federal Tax Coordinator ¶I-2152.
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