Our company has written extensively on the subject of cryptocurrency. Indeed, we have even designated a all Resource page of our website on this always interesting and constantly evolving subject. You can find it here. And, additional information about the cryptocurrency can be found here.
Because cryptocurrencies are so new, it might not surprise you to learn that there are few authoritative guidelines on the proper federal tax treatment of cryptocurrency transactions. Indeed, the first IRS guidelines were not published until 2014 with the publication of Notice 2014-21, 2014-16 IRB 938 (the “”Opinion“) in the Internal Revenue Bulletin. In that notice, the IRS indicated that it would treat virtual currency as property (not money) for federal income tax purposes. CornSignificantly, these guidelines are only the IRS’s informal position on this issue – they would not necessarily be binding on a federal court. See BMC Software, Inc. v. Comm’r, 780 F.3d 669, 676 (5e Cir. 2015) (regardless of IRS notice); but see Esden v. Bank of Boston, 229 F.3d 154, 169 n.19 (2d Cir. 2000) (concluding that an IRS notice may be “entitled to compliance” under Skidmore if it constitutes a “body of experience and informed judgment”); see also Chevron USA, Inc. v. Nat. Res. Defense Council, Inc., 467 US 837 (1984) (Federal courts must show deference to an organization’s interpretation through its promulgation of regulations).
Because cryptocurrency is so ubiquitous now, we can certainly expect more cases from the federal tax court over the taxation of cryptocurrency. And, we may not have to wait too long, given a recent court filing by taxpayers in the Middle District of Tennessee.
Jarrett v. United States
On May 26, 2021, the Jarrett’s filed a lawsuit against the United States in the Middle District of Tennessee. See Jarrett v. United States, case n ° 3: 21-cv-00419. As this matter is still in its infancy, the facts discussed below are taken from the facts alleged in the taxpayer complaint.
According to the allegations in the complaint, Mr. Jarrett was engaged in a staking business in 2019. For those unfamiliar with the term “staking”, this usually means that an individual is participating in transaction validations on proof of participation (Pos) blockchain. Through his staking activities, Mr. Jarrett used his existing Tezos tokens to efficiently create new ones. As a result of his efforts, he produced 8,876 new Tezos tokens, which he kept in his digital wallet.
The Jarretts have filed a 2019 Form 1040 with the IRS. On Form 1040, the Jarrett’s reported $ 9,407 of “other income” on Schedule C associated solely with the production of the new Tezos tokens. Later, however, the Jarretts filed an amended return requesting a refund of all taxes paid, reversing the $ 9,406 of previously reported income. Because the Jarretts never received a response from the IRS, the Jarretts filed a reimbursement claim in the Middle District of Tennessee against the United States.
The respective pleadings of the Jarrett and the United States are interesting. In the first paragraph of the Jarretts’ complaint, they state that “federal income tax law does not permit the taxation of tokens created through a staking business.” In this regard, the Jarrett’s attempt to compare Mr. Jarrett’s actions of creating Tezos tokens as similar to those of a baker or writer:
Like a baker who bakes a cake using ingredients and an oven, or a writer who writes a book using Microsoft Word and a computer, Mr. Jarrett created the property. Like the baker or writer, Mr. Jarrett will realize taxable income when he first sells or trades the new property he created, but federal income tax law does not allow the taxation of Jarrett simply because Mr. Jarrett created a new property.
In support of their claims, the Jarrett’s cite well-known Supreme Court tax rulings such as Eisner vs. Macomber, 252 US 189 (1920) and Commissioner c. Glenshaw Glass, 348 US 426 (1955). In arguing that there must be a fulfillment event to be a taxable transaction, the Jarrett’s also cite the dictionary meaning of the term “fulfill” in their complaint. See also CRI § 1001.
In their complaint, the Jarrett’s also asserted at paragraph 30 that “[v]virtual currency is property for the purposes of US federal tax laws. Interestingly, the United States disagrees. Specifically, on August 27, 2021, the United States filed its response and responded to paragraph 30 with “the United States denies that virtual currency is in any event property for the purposes of United States tax law.” While the United States does not elaborate, the question on the minds of many tax practitioners is “how is that”, especially in light of the IRS ‘seemingly contradictory conclusion in the Notice.
The Jarrett This is one that every tax practitioner should watch closely. Insofar as the United States indicates that virtual currency is not always property for federal tax purposes, it will provide important information in a variety of contexts, including tax planning and the application of tax laws.[View source.]