Jarrett takes IRS back to court in fight over crypto block rewards
We are supporting his new case to keep pressure on the agency after it punted the first time
Today Josh Jarrett filed a new lawsuit challenging the IRS’s taxation of block rewards, and Coin Center is pleased to be assisting him in this litigation. We have been advocating for tax parity for block rewards for years, and this is the latest step toward a fair policy outcome.
Block rewards are new cryptocurrency tokens that validators acquire when adding new blocks to a blockchain. The IRS unlawfully seeks to tax block reward tokens as “income” the moment they come into existence. The IRS’s policy is illegal because block rewards are new property and therefore not themselves “income.” Rather, any payment later received for those tokens when they are sold is income. The IRS’s policy results in unfair overtaxation, compliance problems, and the stifling of innovation.
This is not the first time Josh tried to get clarity about his tax liability from the IRS. In fact, for years the IRS has tried to avoid defending this unfair policy in court. First, the IRS ignored Josh’s request for clarity, so in 2021 he filed suit. Then, Josh’s case was dismissed, after the IRS simply refunded his payment without ever having provided clarity on how he was to pay tax the next year, apparently conceding Josh was right that his block rewards were not income. The following year Josh again faced the same tax issue, which was a surprise to no one – except for maybe the IRS. However this time, the IRS had provided clarity: block rewards would be taxed differently than every other form of new property. After the IRS paid Josh back, it issued guidance saying that staking rewards are immediately taxable income. In other words, it told taxpayers (including Josh) that they must play by a rule that it was unwilling to defend in court.
Josh stakes on the Tezos network. Like validators on other networks, Josh acquires new tokens when he adds blocks of valid transactions to the blockchain. In 2020, Josh acquired about 13,000 new Tezos tokens. When a validator acquires block rewards, those tokens have not previously been held by anybody. They are new property, and the validator is the first owner.
The tax laws—and federal agencies’ interpretations of those laws—have tremendous power to discourage Americans’ use of cryptocurrency and permissionless technologies. Some of that is unavoidable unless laws are changed, which is why we’ve championed legislative changes like the Virtual Currency Tax Fairness Act, which would create a de minimis exemption for small personal crypto transactions. But here, Josh is asking the court to rule on what existing tax law requires. In the context of block rewards, the IRS has taken a position grossly unfair to validators like Josh. According to IRS guidance released in 2023, Josh must pay income tax on the approximate value of every new token he acquires at the moment he acquires it.
We believe that taxpayers like Josh have the right to have a court decide what the law is, not an unaccountable agency. Josh’s position that new property is not income is supported by over a century of case law and practice confirming that new property is not itself income. Property you create gives rise to income when it’s sold. A farmer does not owe tax on crops the moment he harvests them, but only when the new property is sold at market. Mining gold isn’t a taxable event, and mining a bitcoin is no different.
Josh’s case has important implications for the future of cryptocurrency and decentralized technologies. It is especially important for proof of stake, where tokens, not hash power, determine one’s ability to validate transactions and help build the blockchain. Since every token holder can stake, this means the tax issue affects everyone. Millions of token holders should not have to track the moment they acquire a fraction of a reward token, and then have to book income and pay tax based on a “market value” in dollars that doesn’t reflect their financial reality.
In addition to the compliance nightmare, the IRS’s approach is provably unfair. It punishes decentralization: as more people stake, the worse the unfairness. At one extreme, if everyone staked, no one gains from staking; the new tokens are like a stock split, and taxing the new tokens’ value makes no sense. In Josh’s case, 80% of Tezos tokens participated in staking. That means that his gain from staking was only 20% of the value of his reward tokens. The definition of “income” may be quite broad, but it cannot reach property that isn’t even the taxpayer’s economic gain. Taxing that phantom income is overtaxation that the law does not require or permit. Coin Center previously published an economic analysis of Josh’s staking to demonstrate the overtaxation under the IRS’s approach.
More fundamentally, the income tax is not a tax on production or productivity. People create value all the time, and it’s not a taxable event. Miners and stakers create blocks and tokens. There is no “Bitcoin Inc.” or “Tezos Inc.” that creates them and then pays them to validators. Like every form of new property that taxpayers create, gains should be taxed when the property is sold, but not before. And that approach eliminates the overtaxation as well.
Congress is considering this issue too. Earlier this year, a new bill was introduced in the House to make clear that taxes are owed only upon the sale or disposition of tokens. This should be a priority next Congress to assure taxpayers that the tax code is neutral and not a punishment for disfavored activity. But we can’t wait for Congress to act; taxpayers have a right to know what the law requires and to keep their government from playing hide-the-ball to sow uncertainty and discourage their lawful activity. So, we’re glad to support Josh’s case to hold the IRS to account and will keep you updated as it develops.