The IRS published guidance on the federal income tax treatment of staking income in Revenue Ruling 2023-14. Consistent with its prior ruling on hard forks, the IRS maintains that taxpayers realize taxable income when he or she achieves dominion and control over the staking rewards.
The IRS explains that when rewards are locked and a taxpayer cannot access, sell, exchange or otherwise dispose of the staking rewards, the taxpayer lacks dominion and control. Cash method taxpayers realize taxable income when they achieve the ability to sell, exchange or otherwise dispose of the staking rewards. At that point, the taxpayer is subject to tax on the fair market value of the staking rewards.
While this Revenue Ruling clarifies many staking situations, it may be less clear when staking rewards give rise to taxable income under some blockchain protocols. Consider the following hypothetical fact pattern (which is based on an actual blockchain protocol). The protocol allows tokenholders to stake their tokens by exchanging tokens for staked tokens (“sTokens”). Assume this exchange is not a taxable event because the tokens and staked tokens are substantially the same property. While the tokens are staked, the tokenholder earns additional tokens as staking rewards. The tokenholder can exchange sTokens for regular tokens at regular eight-hour intervals.
Under these facts, it is the view of the author that the staking rewards are taxable either when earned or at the first opportunity to exchange the tokens and sTokens (within eight hours). Even though there is no direct ability to sell the tokens while staked, the taxpayer has full ability to obtain access to the restricted staking rewards. In this hypothetical protocol, the tokenholder has constructive receipt of the staking rewards. Therefore, it is the view of the author that the taxpayer in this hypothetical scenario has dominion and control over the tokens.
Because each blockchain protocol is unique, it is important to realize that there may be shades of gray analyzing when staking rewards become taxable income.