Crypto staking involves locking up cryptocurrency in a blockchain network to validate transactions and enhance security. In return, participants earn rewards, typically through proof-of-stake (PoS) or similar consensus mechanisms. This process allows investors to generate passive income on their holdings.
Crypto Staking Taxes
Understanding how staking rewards are taxed is crucial for financial planning and compliance with the Internal Revenue Service’s regulations on digital assets.
Ordinary Income Tax
The IRS considers staking rewards taxable income when you gain dominion and control over them. This means you must report staking rewards as ordinary income when they become accessible, transferable, or spendable. You must report the fair market value (FMV) of the rewards in U.S. dollars at the time of their receipt and pay income tax on that amount when you file your tax return.
Capital Gains Tax When Selling Staking Rewards
This tax event occurs when you dispose of your crypto rewards, triggering capital gains tax based on the price difference between the FMV at receipt and the sale price. If the value increases, you will pay capital gains tax on the profit. If sold at a loss, the loss can offset other taxable gains through crypto tax-loss harvesting.
Tax Implications of Swapping Crypto for Staking
It’s a taxable event if you exchange one cryptocurrency for another to participate in staking. You must report any capital gains or losses based on the difference between the asset’s FMV at the time of the swap and your original cost basis.
Short-Term vs. Long-Term Capital Gains
Disposing of crypto staking rewards held for one year or less results in short-term capital gains, taxed at ordinary income rates up to 37%. Holding them for more than a year before disposal results in long-term capital gains rates, which are generally lower (0% to 20%).
How to Report Income From Cryptocurrency Staking Rewards
Report crypto staking rewards in the following manner:
- Collect Your Crypto Tax Documents: You’ll need your transaction records from exchanges, wallets, and staking platforms. If an exchange issues a Form 1099-MISC for miscellaneous income, download it for use at tax time. (You’re responsible for reporting your staking rewards even if the exchange doesn’t issue a tax form.)
- Determine Fair Market Value (FMV): Track the date, time, and FMV in USD when you gain control of staking rewards.
- Report Staking Income: Use the following forms to report your staking rewards:
- Individual Taxpayers Use Form 1040: Include the total value of staking rewards on Form 1040, Schedule 1 as “Other Income.”
- Businesses and Self-Employed Use Schedule C: If staking is a business activity, report it on Schedule C. This will also make your crypto-related business expenses and staking equipment tax deductible.
- Calculate Capital Gains or Losses on Disposals: When you sell, trade, or use staked tokens, compare the FMV at the time of receipt to the disposal price to determine gains or losses.
- Complete Form 8949: List each crypto disposal for the tax year on Form 8949.
- Complete Schedule D: Transfer the totals from each section on Form 8949 to Schedule D to summarize your capital gains and losses.
- File and Pay Before the Deadline: Ensure your tax return is submitted on time to avoid penalties.
Challenges in Tracking Staking Taxes
Tracking staking rewards for tax purposes can be complex due to:
- Transaction Volumes: Frequent staking rewards across multiple platforms create a massive data burden. Missing even a single transaction can lead to misreported income and IRS penalties.
- Valuing Rewards at Receipt: The IRS requires staking rewards to be reported using the FMV when you gained control. However, determining FMV accurately can be challenging given crypto’s volatility.
- Tax Regulations: Crypto tax rules continue to evolve. Investors must stay up-to-date on IRS rules for reporting and taxing staking income.
- Record-Keeping Requirements: Every staking reward must be meticulously tracked, including dates, timestamps, amounts, and FMVs. Poor record-keeping increases the risk of tax miscalculations, audits, and unexpected liabilities.
Tracking staking rewards can be overwhelming due to frequent transactions, price volatility, and changing tax rules. Working with an experienced cryptocurrency CPA helps to ensure accurate record-keeping, minimizing your tax risks.
Strategies to Reduce Taxes on Staking Rewards
You can’t avoid taxes on staking rewards. However, you can use strategies to minimize it:
- Use tax-loss harvesting and sell underperforming crypto assets at a loss to offset your gains.
- Hold longer than a year to qualify for lower long-term capital gains tax rates.
- Deduct business expenses if staking is part of your business. You can deduct staking equipment such as hardware, along with electricity and internet costs.
- Consult a crypto CPA who can implement these strategies effectively while ensuring compliance with IRS regulations. They can also identify additional deductions and tax-saving opportunities specific to your situation.
IRS’s Regulatory Guidelines
In Revenue Ruling 2023-14, the IRS confirmed that staking rewards are considered taxable income once the taxpayer has dominion and control over them. The rule applies to all staking methods, including direct proof-of-stake (PoS) staking, custodial staking through exchanges, staking pools, and DeFi staking protocols.
Unresolved Legal Questions
Some taxpayers believe staking rewards should only be taxed when sold, rather than at the time of receipt. They argue that newly created tokens do not represent realized income until converted into cash or another asset. This perspective is based on the idea that staking rewards function more like self-created assets that appreciate over time rather than earned income.
Critics also argue the taxation approach that the IRS takes results in unfair tax burdens if the value of the tokens drops before they are sold. Future court cases or regulatory changes may impact tax treatment, but for now, taxpayers must follow existing IRS guidance.
But Wasn’t There a Case That Said Otherwise?
No, the case didn’t change the IRS’s stance. In a 2022 U.S. Tax Court case, a couple argued that their staking rewards shouldn’t be taxed until disposal. Although the IRS offered to refund their taxes, the case didn’t establish any legal precedent or change tax law.
Crypto Staking Scenarios
The following examples illustrate common staking scenarios.
Scenario 1: Selling Staking Rewards
Alice earned staking rewards worth $500 and reported them as ordinary income on her tax return. Six months later, she sold the tokens for $600, triggering a short-term capital gain of $100. This gain was taxed at her regular income tax rate because she held the tokens for less than a year.
Scenario 2: Monthly Staking Rewards
Frank staked his crypto two years ago and receives staking rewards every month. He records the date, time, and fair market value (FMV) of each reward when it comes under his control.
At the end of the year, Frank has 12 staking reward transactions, each with a different FMV. He reports the total as ordinary income on his tax return. If Frank sells any of his rewards, he calculates capital gains based on the reward’s original FMV at the time of receipt.
Scenario 3: Swapping ETH for stETH
Sally received staked Ether (stETH) in exchange for locking up her ETH. Her original cost basis for the ETH was $4,000. She swapped it for stETH when its value was $6,000. This created a $2,000 capital gain, subject to long-term capital gains tax.
Eight months later, Sally sold the stETH for $9,000. Her cost basis was $6,000. She reported a $3,000 capital gain, subject to short-term capital gains tax.
Scenario 4: Crypto Staking as a Business
David operates a staking node as a business and regularly earns rewards, which he reports as business income. He also deducts expenses directly related to his staking operations, such as the cost of hardware, electricity for running the node, and server fees. If David’s total expenses for the year exceed his staking income, he can claim a business loss to offset any other income or carry it forward to future tax years.
Scenario 5: Tax-Loss Harvesting to Offset Staking Gains
Emma earned $5,000 in staking rewards that she reported as taxable income. She also sold some underperforming crypto assets at a $3,000 loss. Since Emma had no gains from other capital assets, she reduced her overall tax liability by using tax-loss harvesting to offset $3,000 of her staking income.
Navigating Staking Taxes With a Crypto CPA
Tracking staking rewards and understanding their tax impact is key to compliance. Report rewards as ordinary income when received and calculate capital gains upon disposal to avoid penalties from the IRS.
To reduce taxes, use strategies like tax-loss harvesting and long-term holding. An experienced crypto CPA will help you ensure accurate reporting and maximize your tax savings.
