Sixth Circuit to Hear Landmark Case on Taxation of Crypto Staking Rewards

NASHVILLE, Tenn. — A pair of federal lawsuits are escalating a direct challenge to the Internal Revenue Service’s treatment of newly created cryptocurrency tokens, with a pivotal case now heading to the U.S. Court of Appeals for the Sixth Circuit. The outcome could establish a critical precedent for how and when millions of dollars in digital assets generated through a process known as “staking” are taxed, affecting a growing number of individuals and businesses in the United States.

The central dispute revolves around whether these new tokens should be treated as taxable income the moment they are created or only when they are sold or exchanged. The current ambiguity has created significant uncertainty for businesses and individuals operating in the digital asset space. Without clear guidance from regulators, taxpayers are left to interpret vague principles, leading to inconsistent reporting and potential conflicts with the IRS.

At the forefront of this legal battle is Jarrett v. United States. In 2019, Tennessee couple Joshua and Jessica Jarrett created 8,876 new Tezos (XTZ) tokens through a process called “baking,” which is analogous to staking on other blockchain networks. They reported these tokens as income on their 2019 tax return, valuing them at $9,407, and paid the corresponding income tax. However, they later filed for a refund, arguing that they had made a mistake. Their claim asserts that newly created property—whether it's a baker’s loaf of bread, a writer’s manuscript, or a new crypto token—does not constitute income until it is sold.

The IRS initially ignored the refund claim but, after the Jarretts filed a lawsuit in federal court in May 2021, the agency offered to issue the full refund. The Jarretts rejected the offer, a strategic move to prevent the government from dismissing the case as moot and thereby avoiding a court ruling that could set a precedent for other taxpayers. In a significant victory for the couple, a federal district court judge in Tennessee ruled in their favor in February 2022, agreeing that the new tokens were not income upon creation. The U.S. government is now appealing that decision to the Sixth Circuit.

The ambiguity surrounding the tax treatment of staking rewards makes financial planning and compliance incredibly difficult. In our experience, the valuation of newly created tokens is a major hurdle for taxpayers. Forcing businesses to determine the fair market value of illiquid or highly volatile assets to pay immediate income tax in U.S. dollars creates a significant operational and cash-flow burden. This is precisely the kind of complex situation where professional guidance is essential. Our tax preparation and compliance services help clients navigate these evolving rules. Businesses facing these challenges can contact C&S Finance Group LLC at csfinancegroup.com for strategic advice on structuring their operations and meeting their obligations.

The government’s position, though not formally codified in specific regulations for staking, appears to be based on its foundational 2014 guidance, Notice 2014-21, which classifies virtual currencies as property for tax purposes. Under this framework, receiving property as compensation for services is a taxable event. The IRS likely views staking rewards as payment for the service of validating transactions and securing the blockchain network. If this interpretation prevails, stakers would owe ordinary income tax on the fair market value of their rewards at the time of receipt.

Conversely, the Jarretts and their supporters argue that staking is not providing a service to a third party but rather creating new property for oneself. They contend that the taxable event should be deferred until the tokens are sold or exchanged, at which point any gain would be subject to capital gains tax. This approach would align the tax treatment of created crypto tokens with that of other created assets like crops for a farmer or minerals for a miner, where income is realized upon sale, not creation.

The financial implications for businesses, particularly small and mid-sized enterprises that may engage in staking as part of their treasury management or business model, are substantial. An immediate income tax liability requires accurate valuation and sufficient cash on hand to pay the taxes, which can be challenging when the rewarded assets are volatile and may not be immediately liquid. A deferred tax model, on the other hand, would provide greater flexibility and simplify accounting, allowing businesses to pay taxes only after they have realized actual cash proceeds from their assets.

Until the courts or the IRS provide a definitive framework, businesses must operate with a high degree of caution. We advise clients to meticulously document all staking transactions, including the date, quantity, and fair market value of tokens received, to build a robust defense for whichever tax position they take. This uncertainty underscores the urgent need for clear and practical regulations that reflect the unique nature of digital assets.

The legal community and the broader crypto industry are closely watching the Sixth Circuit's proceedings in the Jarrett case. The court's decision could either solidify the IRS's apparent position or create a powerful legal precedent favoring the taxpayer-friendly deferred-tax model. Regardless of the outcome, the case highlights the growing pressure on both regulators and Congress to establish a clear and comprehensive tax framework for the digital asset economy.