Under new notices from the IRS, income generated from cryptocurrency is taxable, and might soon include rewards from crypto staking. Here’s everything you need to know about taxing your crypto stakes. And don’t forget to read our complete guide on crypto taxes.
What is Crypto Staking?
Crypto staking refers to the practice of keeping investment in a cryptocurrency account. It is usually seen as a show of support for a budding blockchain network and the invested resources are used to confirm transactions made in the network.
Not all cryptocurrencies allow users to stake, currently limited to major coins like Ethereum, as well as Cosmos, Tezos, and Cardano. For those that do, a staking enterprise occurs in a “staking pool,” which functions like an interest-bearing savings account.
By staking in a cryptocurrency account, the account owner receives rewards in return for their investment. Blockchain networks that allow you to stake have a so-called “consensus mechanism.”
This mechanism is a fault-tolerant system used to achieve the required agreement on a single data state or value, being corroborated with relevant systems or agents. In the context of how staking works, the consensus mechanism used is known as a Proof of Stake (PoS).
A PoS is used for the processing of transactions and the creation of new blocks in a blockchain network. It validates entries into the network, ensuring that all transactions occurring inside it are secured without the use of a financial institution or third-party support—keeping it independent and decentralized. Your invested coins become part of this consensus mechanism.
Now, your investment or stake in cryptocurrency earns you rewards because your investment helps the network function and grow. Staking rewards depend on the specific network. For example, Ethereum allows staking activities through its ETH2 network and offers a return of up to 17 percent. Other cryptocurrencies that allow staking include the following:
- EOS. This is an ERC20 token tracing its origins on the Ethereum blockchain like most altcoins in the market today. However, it eventually developed its own mainnet separate from the ETH blockchain.
- Cardano. It implements a system closer to the traditional bank savings account. Most investors and supporters of Cardano are focused on long-term growth for the virtual currency. As one of the safest staking options available, the coins never leave your digital wallet yet you earn rewards similar to bank interest. Also, it allows users to move or remove their investments at any time.
- Tezos. An emerging proof of stake altcoin that boasts an open-source blockchain network that handles its own cryptocurrency. It has no minimum stake amount, although self-bakers in charge of a node must stake at least 8000 Tezos (XTZ) tokens. Increasing crypto transactions in the network yield an annual rate of return for this cryptocurrency at 6 percent.
- Polkadot. One of the newer cryptocurrencies, Polkadot has recently announced an XCM launch for a multi-chain support capability. This means that this currency provides interoperability and interconnectivity between blockchain networks and staking transactions. Its current annual yield is around 10 percent, with a minimum staking amount of at least 40 Polkadot (DOT) coins.
- Cosmos. The Cosmos network has been around since 2014, as the platform to implement the consensus algorithm known as Tendermint. However, its white paper can be traced to 2019 and has become one of the rising players in the market today. It yields a staking reward of about 7 percent and requires a minimum staking value of 0.05 ATOM.
The Changing Discourse of Crypto Staking Taxes
Currently, there are no discrete guidelines from the Internal Revenue Service (IRS). The conversation about the taxation of crypto stakes gained traction following the publicized lawsuit Jarret v. the United States, addressed in the United States District Court in the Middle District of Tennessee. In this lawsuit, Joshua Jarret earned staking rewards from his crypto stake in the Tezos network. There is a process in the Tezos blockchain known as baking, which refers to the act of signing and publishing blocks. Investors like Jarret received staking rewards from their investments used in Tezos baking.
In the complaint, the investor explains that an individual baker on the Tezos blockchain generates new virtual coins that are issued in exchange for “baking” a new block on the network instead of just receiving new coins. This contests recent tax guidance implemented by the IRS regarding cryptocurrency. The IRS Notice 2014-21 outlines federal taxation guidelines for cryptocurrency investments and transactions. This amended tax return notice explains that for the computation of federal income tax liability in the US, cryptocurrencies are to be regarded the same as any other property.
As such, general tax principles apply to any cryptocurrency token received in exchange for mining efforts. This is taxable to the miner or trader upon receiving their staking rewards. However, the plaintiffs in the lawsuit argue that the tokens they received are not classified as taxable income like other ordinary income. The coins they received are not a compensation for their work, but rather, something they created themselves—therefore, they shouldn’t be taxed on the newly-created virtual asset.
It has sparked a conversation on the specifics of how assets are created using blockchain technology, as well as the mechanisms and cryptocurrency transactions in the network.
How are your crypto staking income taxed?
For federal income tax purposes, you’ll need to understand the tax treatment on crypto and what constitutes a taxable event in order to pay taxes.
Although the divisive Jarret lawsuit remains unresolved, traders and investors will still need to diligently understand the cost basis for each of their transactions. The basis will serve as their starting point in determining the fair taxable amount they’ll use in filing their tax returns.
The cost basis for staking income refers to the market value of your crypto investment on the day you receive your staking rewards. It is the value used to declare the fair market value of your investment and therefore an important component in the taxation of staking income. The capital gain you earn from it is reported together with your ordinary income.
Although you’ll have to keep track of it yourself, there are trading platforms that track your cost basis for you. Larger cryptocurrency trading spaces like Kraken, Koinly, or Binance allow you to import relevant transaction history and tag your staking rewards directly to an IRS Form 8949, or Sales and Dispositions of Capital Assets. These platforms let you instantly identify the fair market value for your investment. Also, there are other tax implications of gifting or donating crypto staking rewards.
For smaller trading platforms without similar features, you’ll need to use a third-party price tracker to help you determine your cost basis. You can check out CoinGecko, Coinlib, and Bitgur. For a more comprehensive understanding of tax implications on crypto, don’t hesitate to ask for legal or tax advice from tax professionals or a law firm.