IRS signals retreat in court battle that could reshape block reward taxation

Last year, Joshua Jarrett sued the IRS for a refund. In 2019 he earned block rewards on proof-of-stake networks, paid taxes as if those rewards were income (as per the limited guidance we have so far from the IRS), but also asked for a refund, arguing that the rewards should be treated as newly created property (e.g. like ears of corn grown in a field) and therefore shouldn’t be taxed until he sells them. The IRS denied that refund, and so he sued saying it was misinterpreting the law.

The lawsuit is still ongoing. However, as announced today by the Proof of Stake Alliance, the IRS may be trying to get out of it before they lose. They are now offering Josh his refund without admitting the merits of his argument.

Rightly, Josh is not taking the refund because he wants clear guidance from the IRS, not a mere monetary victory. So he hasn’t won yet, but it does look like the IRS is realizing that their current policy may not be adequately justified by law, and may not survive a judgement from the court. That’s great news.

Moreover, as we’ve previously written, this should not be interpreted as merely a positive development for proof of stake validators, it’s good news for Bitcoin miners as well:

Any block reward from a permissionless cryptocurrency network, whether it is created through proof-of-work mining, proof-of-stake validating, or some other mechanism, is most accurately described as the creation of value through one’s own capital and labor rather than the receipt of value from an employer. The network allows users to create wealth from their own resources, it does not pay people for their labor. Why is this the more sensible characterization? Creators of block rewards literally do not get paid by anyone. Who is the employer when you are working for the bitcoin network? Just as truly permissionless decentralized networks lack third party promoters upon whom users rely in the context of securities law, they also lack discernible employers and employees in the context of income tax law. To be clear, that does not mean that block rewards can or should be tax free, simply that they should be taxed like crops, minerals, livestock, artwork, and assembly line widgets: they should be taxed when they are sold, not when they are created.

Treating mining and staking rewards as newly created property rather than income is also the preferred approach of a bipartisan group in Congress who sent the IRS a letter arguing as much in August of 2020. Today’s news brings us one step closer to winning that fight and one step closer to clear and reasonable tax policy for crypto in the US.