IRS Cracks Down on Little-Known Crypto ‘Stakers’ Who Aren’t Paying Taxes

The Internal Revenue Service, on a campaign against investors who illegally evade taxes on cryptocurrency holdings, said Monday that income from a little-known, yet lucrative, activity in the digital assets industry is taxable. 

The activity is called "staking," which is when investors or exchanges offer up their computing power and crypto holdings for a set period of time to use as collateral for another network. In exchange, stakers receive cryptocurrency for helping networks process and validate transactions.

The IRS, which treats digital currencies like it does stock, and not as money, is increasing its scrutiny of taxpayers with crypto and nonfungible tokens. Individuals who sell crypto that has appreciated owe capital gains tax; those who are paid in crypto owe ordinary income tax.

Some stakers account for their rewards using a cash method based on when those rewards are received. Others use an accounting method based on when a transaction occurs, before money is received. With digital assets, the question of receipt can get tricky — it is when rewards are earned, or when they’re withdrawn into a digital wallet?

The IRS appeared to resolve that question Monday when it said that an investor must include “the fair market value of the rewards” in his or her gross income in the taxable year in which the investors “gains dominion and control over the rewards.” The agency announced the rule in an email and said it would appear in an official publication called the Internal Revenue Bulletin on Aug. 14.

In February, the Securities and Exchange Commission forced platform Kraken to stop offering staking services in the U.S. and to pay $30 million in penalties. SEC Chair Gary Gensler, who is cracking down on the industry he has called the "wild west," has argued that some exchanges are selling crypto investments that should be registered as securities.

In a federal lawsuit the Wall Street regulator filed against Kraken in February, the SEC said that by April 2022, U.S. investors had more than $2.7 billion worth of crypto assets pledged in Kraken’s staking program. The platform, it said in 2021, offered stakers annual returns of 21%. Kraken had earned roughly $147 million in net revenue from its staking services, including more than $45 million from U.S. investors. By June 2022, more than 135,000 unique U.S.-based usernames had transferred crypto assets to participate in the Kraken Staking Program.

Not all platforms use staking. Solana and Ethereum, which calls the service a “public good,” do. So does Robinhood, which disclosed in February that it received an SEC subpoena last fall over its operations, crypto custody and support of digital currencies — all of which could encompass staking. The platform Binance, the world's largest, is battling SEC charges of violating U.S. securities laws, as is Coinbase.

The Financial Times on Monday quoted Coinbase Chief Executive Officer Brian Armstrong as saying that the SEC had asked the platform to halt all trading in some 200 cryptocurrencies except for bitcoin before the regulator sued it last month. “They came back to us, and they said . . . we believe every asset other than bitcoin is a security,” Armstrong was quoted as saying.