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Crypto software giant ConsenSys will financially support an ongoing lawsuit challenging the IRS’s ability to tax stake rewards, the company announced Tuesday.
In 2021, Joshua and Jessica Jarrett sued the tax authorities to recover federal income taxes imposed on the Tennessee couple’s stake-generated Tezos, arguing that self-generated stake rewards could not be considered taxable income under federal law.
Midway through the lawsuit, the IRS offered to issue the Jarretts their requested refund, but the plaintiffs refused, eager to get assurances from a court that the problem would not arise in the future. No such assurances were forthcoming, however: a federal judge dismissed the case in October, ruling Jarrett’s complaints moot after a tax refund was issued.
Many had hoped the case would provide legal clarity to the millions of crypto users who generate cryptocurrency daily through proof-of-stake blockchains. Such networks — including, perhaps most notably, Ethereum — operate on a mechanism that encourages users to stake cryptocurrency with the network to validate on-chain transactions. In return for setting up these funds for longer periods of time, users accumulate newly generated cryptocurrency.
It’s no wonder why ConsenSys—the blockchain technology company started by Ethereum founder Joe Lubin—is monitoring Jarrett’s legal journey so closely. (ConsenSys is one of 22 strategic investors in Decrypt.) Next month, the Shanghai upgrade will allow Ethereum users everywhere to start withdrawing ETH held with the network through the staking program. Above 27 billion dollars worth of funds are currently invested with the network.
“With increased liquidity in ETH staking, we expect far more ordinary people to start staking, which means getting the right tax treatment for staking rewards only becomes more important, said Bill Hughes, ConsenSys Senior Counsel and Director of Global Regulatory Matters. a statement is shared with Decrypt.
The Jarretts are currently in the process of appealing the closure of the case, and ConsenSys will now provide financial support for this work.
At the heart of the appellants’ argument is the position that effort rewards should not be considered taxable income, as no employer distributes them. They should instead be considered effectively self-generated, or “created property,” under the federal tax code.
“Like a farmer growing crops, stake rewards are created by the protocol to incentivize participation in providing security for the protocol,” Hughes said. “Created property is not taxed until sale.”
Potentially complicating this analogy, however, is the fact that most stake rewards on Ethereum are generated through a third party. Centralized crypto exchanges like Coinbase, Binance and Kraken stake users’ ETH for them, on a massive scale; five such centralized entities currently hold over 80% of ETH staked on Ethereum, according to Dune Analytics.
The case heads next to a federal appeals court, where a panel of judges will decide whether it should be reconsidered.
