A possible settlement in an ongoing legal case may not precedence make.
Crypto Twitter’s staking community was thrown into a tizzy last week after several media outlets breathlessly reported that an update in an ongoing lawsuit against U.S. the Internal Revenue Service (IRS) could mean the agency was setting precedent: that it would not tax unsold staking rewards as income.
Some Twitter users celebrated the news the IRS offered a settlement to a Tennessee couple, Josh and Jessica Jarrett, who sued the agency for a refund on taxes they paid in 2019 on Tezos staking rewards, as a victory for crypto stakers everywhere.
Tax and policy experts on Twitter, however, were quick to cast doubt on the news, calling some of the reports misleading and arguing that it could cause confusion that would lead to risky tax decisions.
Last week’s furor was far from the first time the crypto community has disagreed over taxes. Even for the experts, crypto taxes can be confusing – and the confusion has been compounded by the notoriously tight-lipped IRS’ reluctance to issue clarifying guidance. Crypto investors and tax professionals have come up with their own strategies for dealing with the uncertainty, ranging from conservatively reporting everything to reporting nothing, and hoping for the best.
However, even in a climate that fosters disagreement, crypto tax experts were nearly unanimous in their reaction that the settlement offer in the Jarrett’s case did not, as reported, set a precedent for other taxpayers. Nor did it indicate a change in the IRS’ stance towards staking rewards taxes – at least, as things currently stand.
Is a settlement a precedent?
The Proof of Stake Alliance (POSA), a blockchain industry group that has financially supported the Jarretts’ case, issued a press release on Feb. 3 arguing the IRS’ settlement offer is a sign the agency recognizes it has a losing argument.
Legal counsel for the Jarretts declined the IRS’ offer to issue a $3,793 refund, plus statutory interest, on the taxes they paid on Tezos staking rewards in 2019.
By rejecting the offer, the Jarretts and their attorneys – as well as POSA and the case’s other financial backers – are hoping to force the IRS’ hand, either by pushing the slow-moving agency to issue guidance on staking or by securing a judge’s ruling that could be used to set a precedent for other taxpayers.
However, not all tax attorneys see things that way.
Matt Foreman, a New York City-based tax lawyer who frequently works with crypto investors, doesn’t think the case has much, if any, bearing on crypto taxes – even if it does push forward to a trial.
“Fundamentally, I think this is nothing,” Foreman told CoinDesk. “I understand why it's exciting, I understand why people are interested in it. I just don’t think this says anything, and I don’t think it does anything.”
Foreman said that even if the Jarretts succeed in getting a ruling from a judge in the U.S. District Court for the Middle District of Tennessee (MDTN), where the case was brought, it would not set precedent outside of that district.
“If you have a case that’s decided in the MDTN, it’s only binding on people who live in the MDTN or transactions that happened in the MDTN,” Foreman said.
If the case does end up in front of a federal judge in the MDTN, and either side appeals the judge’s decision, Foreman explained the precedent could apply to a larger group of people but would still not be binding for all taxpayers.
“Conversely, if you go to Tax Court and the IRS wins or the taxpayer wins, it is binding for everyone,” Foreman explained.
Because the Jarretts paid their taxes on the staking rewards, Foreman said they would have been unable to try the case in Tax Court.
Foreman took issue with media analysis (including CoinDesk’s) that the settlement offer was a sign of the IRS’ shifting position.
“I think that’s categorically false,” Foreman said. “The IRS could issue a statement saying, ‘We agree with the taxpayer and we’re not pushing on this anymore,’ and they overtly didn’t do that. Their entire statement has been, ‘We’re just refunding the money, we’re not litigating,’ and that’s it.”
Despite pushback, POSA remains enthusiastic about the Jarretts’ case and its potential to set a legal precedent for staking taxes.
“We think it’s important to bring awareness to the legal arguments being made in the case,” said POSA board member Alison Mangiero. “The fact that the argument being made is reasonable and backed by over 100 years of tax law, and that, in our opinion, this early concession by the government indicates not only that Jarretts’ position is reasonable but that it is correct as a matter of law.”
For Foreman, however, the IRS settlement offer isn’t a sign of agreement, but rather the likely result of a decision to save money on mounting litigation costs. Foreman said if it indicated anything else it was that the IRS is thinking “long term and strategically” about crypto staking.
Seth Wilks, tax director for crypto tax giant TaxBit, agreed.
“What happened is the IRS simply came out and said ‘Look, the issue before the court is whether or not you get a refund, and if we give you a refund the case is dead in the water – it just goes away’,” Wilks told CoinDesk. “And so, from a precedent-setting standard, there is no court ruling, there’s nothing to stand behind it.”
However, Wilks said the case isn’t useless – by forcing the IRS to consider the issues presented in the case, the Jarretts and POSA have “put this on the front burner of the IRS,” which could speed up the process of issuing clarifying guidance.
Risks of under-reporting
Foreman, Wilks and other tax experts expressed concern the excitement generated by the Jarretts’ case could lead people to file their taxes incorrectly – leading to penalties and potential legal issues down the road.
“For my clients, I’m going to tell them that they should continue to declare [staking rewards] as ordinary income, it should be viewed as if it’s interest,” Foreman told CoinDesk. “That way, they don’t get caught … Were [the IRS] to catch you, they are going to rake you over the coals – and it’s not going to be a good result for the taxpayer. It’s going to be very, very bad.”
Foreman said that, if caught, the IRS could allege fraud – which has no statute of limitations and has higher interest penalties – and, if a taxpayer was large enough, potential criminal penalties.
“I would very strongly recommend taking a conservative position and not overstating the results in this unique situation,” Foreman said.
James Yochum, a Cedar Rapids, Iowa-based certified public accountant (CPA) who specializes in crypto taxes, is also advising his clients to take a more conservative approach in order to avoid accruing penalties.
“If a taxpayer omits staking rewards from their tax return completely, there’s a possibility of them being hit with an accuracy-related penalty, in addition to a failure-to-pay penalty, and interest on the outstanding debt,” Yochum told CoinDesk.
Yochum explained that, because the IRS can wait several years to audit, these penalties have the potential to snowball into enormous sums.
Not all crypto CPAs are concerned about the risk of penalties, however.
For Clinton Donnelly, the founder of CryptoTaxAudit, the lack of regulatory clarity is, at least for now, an unavoidable part of crypto investing.
“When it comes to crypto taxation, there’s a lot of gray. Most people want there to be black and white, and it simply isn’t black and white,” Donnelly told CoinDesk.
Donnelly works with his clients to understand the level of risk they’re willing to take, and offers them options for how to pay their crypto taxes. Even before the Jarrett case, Donnelly was advocating for a method of reporting staking rewards that resulted in zero taxes at the time of receipt.
Donnelly told CoinDesk that, while this could result in mounting penalties in the event of an audit, audits are relatively rare and he believes many of the penalties can be waived by filing disclosure forms when preparing taxes.
“Life is full of accepting risks,” Donnelly said. “As long as you’re willing to pay the bill, then I believe it’s a reasonable risk under the law.”
Whether they agree if staking rewards should be taxed as income or not, all the tax experts were unanimous in their agreement that crypto taxpayers should seek professional advice when doing their taxes.
“Friends don’t let friends take tax advice from Twitter,” Wilks joked.
The IRS’ silence on staking rewards has been frustrating for many in the industry, but experts think it could still take years to get clarity.
Foreman told CoinDesk he thinks the IRS could issue guidance within the next two to three years.
“The issue is that cryptocurrency is moving so fast, that by the time [the IRS] feels comfortable releasing something, things have changed and new things have happened. What they need to do is really extend resources and time and really build something out that is very thorough,” Foreman said.
The IRS has issued two pieces of crypto-related formal guidance. The first, issued in 2014, provided guidance about income generated via proof-of-work mining. In 2019, the agency released a FAQ on the tax implications of things like hard forks and airdrops that sought to expand on its 2014 guidance. Many tax experts, however, complained that the guidance raised more questions than it answered.
“They can’t keep doing the piecemeal thing they’re doing right now, that’s not helpful to anyone, really,” Foreman concluded.
Read more: Your Staking Rewards Are Still Taxable