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Crypto software giant ConsenSys will financially support an ongoing lawsuit challenging the IRS’ ability to tax staking rewards, the company announced Tuesday.
In 2021, Joshua and Jessica Jarrett sued the IRS to recover federal income taxes levied on the Tennessee couple’s stake-generated Tezos, arguing that self-generated staking rewards could not be considered taxable income under federal law.
Mid-way through the lawsuit, the IRS offered to issue the Jarretts their requested refund, but the plaintiffs refused, eager to get assurances from a court that the issue wouldn’t arise in the future. No such assurances came to pass, however: a federal judge dismissed the case in October, deeming the Jarretts' grievances moot after a tax refund was issued.
Many had hoped the case would offer legal clarity to the millions of crypto users who generate cryptocurrency daily through proof-of-stake blockchains. Such networks—including, perhaps most notably, Ethereum—operate on a mechanism that encourages users to stake cryptocurrency with the network in order to validate on-chain transactions. In return for putting up those funds for extended periods of time, users accumulate newly generated cryptocurrency.
It’s little wonder, then, why ConsenSys—the blockchain technology company started by Ethereum co-founder Joe Lubin—is monitoring the Jarretts’ legal journey so closely. (ConsenSys is one of 22 strategic investors in Decrypt.) Next month, the Shanghai upgrade will permit Ethereum users everywhere to begin withdrawing ETH held with the network through its staking program. Over $27 billion worth of funds are currently staked with the network.
“With increased liquidity in ETH staking, we expect far more everyday people to start staking, which means that getting the appropriate tax treatment for staking rewards is only getting more important,” Bill Hughes, ConsenSys Senior Counsel and Director of Global Regulatory Matters, said in a statement shared with Decrypt.
The Jarretts are currently in the process of appealing their case’s dismissal, and ConsenSys will now provide financial support for that effort.
Core to the appellants' argument is the position that staking rewards should not be considered taxable income, as no employer is doling them out. They should instead be considered effectively self-generated, or “created property,” under the federal tax code.
“Similar to a farmer who grows crops, staking rewards are created by the protocol to incentivize participating in providing security for the protocol,” Hughes said. “Created property is not taxed until sale.”
Potentially complicating that analogy, however, is the fact that most staking rewards on Ethereum are generated through a third party. Centralized crypto exchanges like Coinbase, Binance, and Kraken stake users’ ETH for them, on a massive scale; five such centralized entities currently hold over 80% of the ETH staked on Ethereum, according to Dune Analytics.
The case heads next to a federal appellate court, where a panel of judges will determine whether it should be reconsidered.