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Digital Assets

Digital Assets Weekly | Crypto Staking

By:

Hugh Meyer

Crypto Staking: What Is It and How Does It Affect Your Tax Situation?

Cryptocurrencies have become quite popular today, not just as an alternative to fiat currency, but as investment tools. Many ways to build wealth with crypto exist, and one of the more interesting is called “staking”.  Staking offers a chance to earn passive income but comes with implications for your tax situation and overall risk objectives.

What Is Staking?

You can think of staking as loaning crypto. It works on certain blockchains, like Ethereum. The actual process is designed to help make blockchains more secure, but it involves locking your coins. In return, you’re able to earn a reward for doing so – additional crypto that’s calculated similarly to interest. And, because its interest, most national governments view it as income.

In staking, you’ll deposit coins into a wallet or staking pool, such as StakeWise or Binance. Staked coins help validate transactions on the blockchain, allowing more coins to be minted.

Proof of Stake

Staking (actually, proof of staking) is similar to proof of work, or PoW, the process that underlies coin mining. The difference is that PoS networks achieve consensus through a group of participants (validators) who create and attest to transaction blocks. Validators are required to stake their assets to the network in question.

When a transaction is submitted to the network, the network will randomly assign a validator. The odds of being chosen as a validator are tied to the number of coins you have staked – the more staked coins you have in the network, the greater the chance that you’ll be assigned as a validator and earn rewards. However, if you fail to validate or attest blocks, or act maliciously within the network, you can lose your stake (crypto assets).

Is Staking Taxable?

Staking itself is not taxable. This is because the process only involves moving coins from one wallet to another, which is not considered a “taxable event”. Deposits like these are not taxed by the IRS. However, that does not mean you have no tax liability.  Please always consult a professional tax advisor.

The Benefits of Staking Are Taxable

Staking offers benefits to the blockchain, but coin owners want to be compensated for locking their coins. This comes in the form of rewards – additional crypto earned for the use of the original coins. It’s like earning interest when you loan someone fiat currency. You can also think of it as earning interest on cash in a savings account, or any other investment vehicle, including CDs, all of which are taxable. When you dispose of those rewards (cash them in, sell them, etc.), you’re liable for capital gains taxes.

Are There Specific IRS Rules for Staking?

No, there are currently no rules that pertain specifically to staking. The rules used to tax staking actually come from Notice 2014-21, which covers how mining proceeds are taxed. It lays the groundwork by defining new tokens as income at the time they are created, and since staking results in the creation of new tokens (interest to the coin owner), this rule applies.

How Will You Know Your Tax Liability?

It can be challenging to track your tax liability, particularly in the crypto world. Thankfully, exchanges can help. When you stake crypto, you’ll be provided with a 1099-MISC if you earn over $600. With this information, you can track your earnings and report them to the IRS.

Limiting Your Liability

As an ordinary citizen, you have few ways to limit your liability regarding staking. However, if your staking activities are on the trade or business level, you may be able to claim certain deductions, such as “ordinary and necessary expenses” related to staking. If your activities are only on the hobby level, though, no such deductions exist. Those using staking as an investment are limited to investment-related expense deductions and are not allowed to claim business deductions.

Why This Matters?

Staking offers a way to earn passive income with your crypto assets. However, it also means additional tax liabilities. Please understand these concepts before deciding to stake your assets.

Please contact Hugh Meyer or Richard Barnett with any questions.

Source:
https://freemanlaw.com/the-taxation-of-staking/
https://support.taxslayer.com/hc/en-us/articles/360059949532-How-is-my-crypto-mining-income-and-staking-rewards-taxed-
https://koinly.io/blog/how-is-staking-taxed/
https://www.berdonllp.com/crypto-staking-what-is-it-and-what-are-the-tax-implications/

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The information above is provided for general informational purposes only and does not constitute financial advice or an offer to purchase securities. Individuals should not apply information to a specific situation and should consult their financial professional. Highline Wealth Partners is not responsible for any errors in or omissions to this information, or for any consequences that may result from the use of this information. Please read the full disclaimers and disclosures here.

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