Get your tickets for the 2023 Coin Center Annual Dinner – April 26 in Austin, TX

Congress to IRS: Proof-Of-Stake block rewards should not be taxed as income

New letter asks for sensible policy that better reflects the nature of token creation via staking, and its logic applies to proof-of-work as well.

A bipartisan group of members of Congress have sent a letter to the Internal Revenue Service asking that staking rewards for validators in proof-of-stake networks be taxed when sold rather than treated as income. 

This is another in a series of letters from Congress that are the direct result of poor policy making from the IRS in the realm of cryptocurrencies. While the IRS seems willing to devote tremendous effort to enforcement actions and privacy-violating investigations, little effort has been spent by the IRS to actually develop and announce clear policy that would make it easy for cryptocurrency users to comply. This letter about proof-of-stake is not an aberration, it deals with yet another area of muddled tax policy that should have been cleared up years ago. 

When a validator on a proof of stake network creates a reward for maintaining that network’s blockchain, tax law could treat her proceeds in two alternative ways: (1) she’s been paid some revenue and therefore has income to report, or (2) she’s created some valuable item directly through her labor. The first is essentially like being paid a wage for a job, the second is essentially like growing valuable crops on one’s own lands or extracting minerals from one’s own mines. Cryptocurrency activities are something new and so there isn’t any established precedent for treating mining or staking rewards one way or the other, and, as the letter explains, treating these rewards as income creates a tremendous administrative burden on both the taxpayer and the Service. 

The issue addressed in the letter is not unique to proof of stake awards. 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.    

We applaud these members of Congress, as well as the Proof of Stake Alliance, for putting some deserved pressure on the IRS to make reasonable and pro-innovation policy in the realm of block rewards. Now lets see if it takes another 5 years for the service to actually make some real progress.