How IRS Tax Rules May Apply to Ethereum 2.0

In letter

  • Ethereum 2.0 has finally started.
  • However, this launch brings with it important questions about how participants in proof-of-stake networks are taxed.
  • The IRS has yet to clarify. Decrypt Some experts have reached out to them for answers.

Ethereum 2.0 is here, but IRS guidelines for taxation are not.

In the first phase of the 2.0 upgrade, which started earlier this week, Ethereum is officially beginning the transition to a proof-of-stake consensus mechanism known as proof-of-work.

The proof-of-work comprises the verification of transactions with pure computing power, while the proof-of-stake is based on “validators” that use tokens to enable the verification of blocks. As part of Ethereum 2.0, instead of “mining” coins, computers get ETH (the coin, not the protocol) because they check this in good faith (malicious auditors can have their ETH hiding places).slashed”From the system).

At this time, the IRS has not issued any guidelines on how stakers should report investments in Ethereum 2.0. And according to Roger Brown, the director of tax and regulatory affairs at Lukka, a blockchain data and software company, this is the best place we can try to identify some potential guidelines from the current iteration of tax law.

One thing you probably won’t be taxed for, Brown says, is transferring ETH to Ethereum 2.0’s deposit contract. This is a process that has been going on for some time. The start of Ethereum 2.0’s “Phase 0” earlier this week (it is the first of three planned phases) was made possible by community members who incorporated ETH into this deposit agreement. The contract provided for 524,288 ETH to lay the foundation for Ethereum’s proof of the future.

Under existing tax rules, Brown said Decrypt, deposited ETH is “not treated as a disposition because you still own it.”

But the ETH, which is actually awarded to examiners after They have put their money in and could very well be taxable, just like Bitcoin has been mining. “Reward setting is income for you because you are entitled to access the rewards,” said Brown. “That is treated as ordinary income, which is taxable at ordinary income rates.”

Brown also clarified that, in his view, rewards from a validation of proof of stake (not just Eth2) would likely qualify as decent income for tax purposes, unless those rewards were dilutive and split existing tokens rather than granting new ones awarded ones.

But since it’s not yet set in stone and there are no government guidelines on the subject as far as Ethereum 2.0 goes, some members of the crypto community are actually campaigning for Congress not to tax these rewards when they are generated.

Evan Weiss is the President and Co-Founder of the Proof of Stake Alliance, a group that does just that. Weiss told Decrypt that the group’s lobbying actually produced a result letter by the four heads of the Blockchain Caucus of Congress (Darren Soto [D-FL-9], Bill Foster [D-IL-11], Tom Emmer [R-MN-6]and David Schweikert [R-AZ-6]) to the IRS, essentially asking that rewards for demonstrating stake be taxed only when they are sold, as opposed to when they were originally created for the stakers.

“Similar to all other forms of property created (or discovered by the taxpayer) – such as grain, minerals, livestock, artwork, and even widgets off the assembly line – these tokens could be taxed when sold,” it said Letter.

This seems to be Weiss’ main concern when it comes to Ethereum 2.0 taxation. “POSA believes it would be a nightmare for both the IRS and taxpayers if the use of reward tokens were treated as income at creation time (rather than at sale), ”he said. “The wrong tax policies could really hinder the rollout of these networks and fuel growth in jurisdictions that take a sensible approach to this matter.”

Weiss also quoted a report by UVA law professor Abe Sutherland, who concludes that taxing proof-of-stake rewards at the time of its inception “would result in unequal taxation and discourage US taxpayers from participating in this new technology.”

Shehan Chandrasekara, head of tax strategy at crypto software company CoinTracker, reiterated Weiss’ concern that the issue is not whether the premiums are taxable but how they should be taxed. “Earned rewards are definitely taxable,” he said Decrypt. “The question is when should they be taxed (at the time of receipt versus the time of sale).”

Chandrasekara added that he did not expect any clarification from the IRS anytime soon. But in one blog entry On this subject, he pointed out another possible tax issue related to Eth2, namely whether or not ETH2 is different from ETH1. If they are indeed different, Chandrasekara claims, converting ETH1 to ETH2 (in the same way that you exchange one fiat currency for another) could be a taxable event.

But there isn’t much clarity here either. Per the official plan For the three phases of Ethereum 2.0, the pre-2.0 version of Ethereum is finally relegated to a shard chain that runs parallel to the other chains of Ethereum 2.0. But the question of whether or not a currency exchange actually takes place somewhere along the way has no clear answer for the time being.

Marta Belcher, a lawyer at Ropes & Gray and a blockchain specialist, pointed this out in an email on a more specific point Decrypt: “The lack of clarity on these types of issues, in my opinion, leads to unnecessary friction that harms innovation.”

Until the IRS emits a little more light, the Ethereum 2.0 stakers may have to fumble in the dark.