IRS Maintains Stance on Taxation of Cryptoasset Staking: Interpreting Jarrett v. USA

深度 | 作者 | TaxDAO

In 2022, the Jarretts filed a lawsuit against the U.S. government for a refund of the federal income tax they requested, and the case focused on the dispute over whether the Jarretts realized income when they staked new cryptocurrencies. That same year, the District Court for the Central District of Tennessee dismissed the Jarretts lawsuit on the grounds that the IRS had issued a check to the Jarretts for a full tax refund plus statutory interest. The Jarretts then sued the Sixth Circuit, which upheld the verdict on August 18 of this year. The case of Jarrett v. USA reflects the differing positions of the IRS and cryptoasset investors on the timing of the realization of income from staking cryptocurrencies, which directly affects the recognition of taxable income for personal income tax and thus the amount of tax paid. Through the analysis of this case, this paper attempts to sort out the thinking of the U.S. government on the taxation of crypto asset pledge income, and provides a reference for the tax compliance practice of crypto assets. ### 1 Facts of the case and focus of the dispute

1.1 Facts ascertained during two trials

Joshua Jarrett sued the IRS for a refund after claiming she overpaid her taxes in 2019. Jarrett produces Tezos tokens (a cryptocurrency) through a process called "staking". According to Jarrett, the essence of staking is to use existing Tezos tokens and computing power to produce new tokens, so he should only recognize revenue when selling or transferring tokens, and thus be taxable. But the IRS sees the process differently. Similar to payments, wages, compensation, and other sources of income, pledges involve the exchange of goods and services, and increase gross income when taxpayers receive "incentives" from regular investment (2023-14). At the same time, the IRS's Digital Asset Issues Update published on its website classifies receipt of "new digital assets resulting from mining, regular investing, and similar activities" as taxable transactions). Based on this, Jarrett realizes income when it receives each token, which is included in the taxable income for the current year. The timing of revenue recognition is critical to accounting for taxable income, and it is often beneficial for taxpayers to delay realization. Jarrett's tax bill is determined by the value of Tezos at the time he realizes his income. Since 2018, Tezos has been worth anywhere from 70 cents to more than $8. Jarrett reported in 2019 that his staking activity generated 8,876 Tezos, but he did not dispose of them. The IRS counts the Tezos he receives as the realized revenue he earned when he produced the tokens. Although Jarrett disagreed, federal law prohibits him from contesting his tax liability in advance — Jarrett must pay his taxes before asking the IRS for a refund. As a result, the Jarretts declared the tokens they received in 2019 as income in their joint tax return and paid taxes on them. Thereafter, they asked the IRS for a refund of $3,793 on the grounds that the income was not realized. Because the IRS did not respond within the six-month time required by law, Jarrett filed a tax refund lawsuit in federal district court, requesting: (1) a judgment that Jarrett is entitled to a refund for 2019, (2) costs and attorneys' fees, and (3) a permanent injunction preventing the IRS from "treating the tokens created by Jarretts as income." After receiving the subpoena, the U.S. government approved Jarrett's refund and statutory interest. On January 28, 2022, the U.S. government issued a refund check to the plaintiff in the amount of $4,001.83, which included a federal income tax refund of $3,793.00 and interest of $208.83. The U.S. government then filed a motion under Rule 12(b)(1) of the Federal Rules of Civil Procedure to dismiss Jarrett's lawsuit on the grounds of lack of subject matter jurisdiction on the grounds that the refund claim was no longer moot — the government had refunded the overcharged taxes and interest. Jarrett did not cash the check and proceed with the lawsuit, while he still claimed that he was entitled to a permanent injunction against the IRS prohibiting the IRS from recognizing revenue from future tokens earned through stake, instead recognizing them when the tokens are realized. He argues that it is necessary for mining industry practitioners to obtain stable tax expectations through the permanent ban. #### 1.2 The focus of the case

At issue in this case is whether the court retains subject matter jurisdiction over the case after the U.S. government issues the tax refund check. In other words, whether the check Jarrett received resolved the dispute between him and the U.S. government. According to Jarrett, on the one hand, he received the check, but he refused to accept it (did not cash), so he was able to sue for the tax refund. On the other hand, even if his claim for money is moot, his arguments for other forms of relief remain valid. The application for a permanent injunction is itself a dispute that needs to be resolved independently, and it should therefore be heard by the court. However, the Government of the United States believes that Jarrett's petition is moot under the relevant provisions of the Federal Constitution and the Anti-Injunction Act and that the court should not rule against him. ### 2 Analysis of the legal relationship between the tax involved in the case

2.1 Does the court have ratione materiae jurisdiction over Jarrett tax refunds

2.1.1 Judgment of the District Court

Subject-matter jurisdiction refers to the power of a court to adjudicate a particular type of matter and provide the remedies requested. The court must have jurisdiction in order to make a valid judgment on the claim. The Government of the United States argues that, under article III of the Constitution of the Federal Republic of America, jurisdiction is limited to "cases" and "disputes", and that the courts have no jurisdiction ratione materiae because the tax refund is no longer in dispute. The District Court endorsed this view and argued that a case is meaningless when it is impossible for the court to provide any effective relief to the prevailing party. Since the U.S. government has completed the tax refund action, the court can no longer provide relief to Jarrett by satisfying his tax refund request. With regard to Jarrett's argument that "they have the right to refuse a refund and obtain a judicial decision," the court held that Jarrett erred in relying on Campbell-Ewald v. Gomez to support this argument. As the circumstances of the case were that the defendant made a settlement offer (offer), the settlement offer was not sufficient to close the case. In the present case, the U.S. government issued a check directly to Jarrett, not an offer, and whether or not Jarrett deposited the check did not affect the existence of the dispute. In summary, the District Court held that there was no dispute over the tax refund case and denied their jurisdiction. 2.1.2 Federal Circuit Decision

The Federal Circuit said it had adopted a "fresh lens" to examine the district court's frivolous ruling, which turned to whether the government had sufficiently demonstrated that the case was moot. After an extensive review of prior jurisprudence and Supreme Court cases, the Circuit Court found that the defendant's "offer" for relief did not result in full relief for the plaintiff, but the actual payment would. The Circuit Court added that there is no reason to use how Jarrett handles the check to determine whether a check is invalid, and 26 U.S.C. § 6611(b)(2) provides that "the IRS's obligation to pay interest and the refund check terminate at the same time," regardless of whether the taxpayer accepts the check. At the same time, the circuit court also denied the similarity of the Campbell-Ewald case to the present case. During the appeal process, the IRS issued Tax Ruling 2023-14 (Rev. Rul. 2023-14), the tax ruling holds that token rewards earned from staking should recognize revenue at the time of gaining dominance. The circuit court held that the ruling had no impact on tax payments in 2019. #### 2.2 Whether Jarrett's application for a permanent injunction is an independent dispute

2.2.1 Judgment of the District Court

In response to the dispute over the permanent injunction, the Court held that there were two statutes that precluded Jarrett's application for "forward-looking relief". The first is that federal tax actions under the Internal Revenue Code (IRC) are excluded from declaratory relief under 28 U.S.C. § 2201(a). The second is that the Anti-Injunction Act prohibits litigation "for the purpose of restricting the assessment or collection of taxes." On the other hand, the plaintiff's lawsuit was based on 26 U.S.C. § 7422, "Civil Action for Refund," which necessarily looked to the past rather than to the future. The claim under this provision "is for the recovery of any internal tax allegedly wrongfully charged", which means that Jarrett cannot pursue an action that relates only to anticipated tax relief. Further, Jarrett argued that their claim was a "moot" exception, which the court countered did not apply in the present case. There are two exceptions to "moot": (1) voluntary cessation of the challenged conduct, and (2) the possibility of recurrence of the damage but evading scrutiny. In the first case, the court held that the U.S. government's tax refund was not a "voluntary cessation" because the U.S. government did not change its own tax rules and regulations, but only refunded Jarrett's taxes. In the second case, the court stated that the "ability to repeat principle" applies only if the plaintiff can reasonably show that he will be affected again by the alleged wrongdoing. Since the question of whether Jarrett's Tezos is taxable income "will never be conclusive" and any subsequent claims for refunds are based on different tax years, the circumstances in question "cannot be repeated". In summary, the District Court held that the tax injunction should not be subject to jurisdiction either. 2.2.2 Federal Circuit Judgment

The general attitude of the Federal Circuit to a permanent injunction is that statutory confirmation is retroactive. They determine the appropriateness of previously assessed and previously paid taxes, rather than future-oriented tax years. In this regard, the circuit court argued similarly to that of the district court, holding that "a judgment that is favorable only for tomorrow would violate the law's prohibition on declaratory judgments in tax cases." Another important point of the Circuit Court is that after the refund request itself has been denied, the prospective relief alone cannot support a refund case. The Court's argument was weak, citing only the Christian Coal case to illustrate that "in the absence of an actual claim for refund, the Court has no jurisdiction to entertain an action containing only a forward-looking claim". ### 3 U.S. Attitude to Crypto Assets

Although the legal relationship in this case is relatively simple, it reflects the attitude of the federal court and the IRS towards the taxation of crypto assets, and in particular, the overall regulatory direction of the IRS. On the basis of combing through the facts and legal analysis of the case, this article attempts to interpret the possible views of the federal court and the IRS on the taxation of crypto assets. #### 3.1 General Attitude of the Federal Court

On July 26, 2023, during oral arguments in the Circuit Court, the Chief Justice acknowledged that there is some merit in allowing the government to postpone (consider) the case if it needs more time to determine its position on difficult or novel issues. However, less than a week after oral arguments, the IRS issued a 2023-14 tax ruling making it clear that they disagreed with Jarrett. Jarrett was quick to point this out to the Court of Appeals and insisted that they had the right to a hearing in their case and seek injunctive relief as they could be subject to similar taxes in the future. Federal courts have generally taken a conservative approach to cryptoasset taxation, and instead of making legal confirmation of the timing of the stake's income, they have refused to proceed with a corresponding hearing on the grounds of jurisdiction. In its judgment, the district court stated: "The plaintiff asked the court for an advisory opinion on whether it was entitled to a refund under the current tax law, but the court did not provide an advisory opinion." In response to the IRS2023-14 tax ruling, the court held that "this may mean that a subsequent refund similar to Jarrett's will not be granted," but it did not comment on the ruling. Combined with the previous statements of the Chief Justice of the Circuit Court, the court believes that the taxation of crypto assets is still an emerging field, and it is obviously premature to recognize the timing of its legal income. #### 3.2 IRS Views on Related Issues

3.2.1 Timing of Pledge Revenue Recognition

The IRS explicitly disagrees with Jarrett's argument, arguing that staking revenue should be determined at the time of gaining control of the token. There is a question of chronology here. The IRS levied taxes on Jarrett for the 2019 tax year, while Jarrett filed the lawsuit in the district court in 2022, but the IRS2023-14 tax ruling was issued on July 31, 2023, which means that the IRS only clarified the timing of the recognition of staking income in 2023. But in any case, the IRS (at least since 2019) has been arguing that staking income should be determined at the time of gaining control of the token. Since the IRS's tax ruling does not have legal effect, in order to avoid the possible risk of the tax ruling being denied by the court, the IRS adopted a jurisdictional denial strategy in this lawsuit, so that they can avoid the issue of the timing of the recognition of the pledged income from being substantively heard by the court. The IRS's litigation strategy was successful, and Jarrett's litigation did not pose a legal challenge to the 2023-14 tax ruling and the IRS's previous tax practices. This means that for some time to come, it is foreseeable that the IRS will still judge the timing of the recognition of staking income based on the criterion of "gaining control of the token". 3.2.2 Possible Directions for Taxation of Staked Income

As mentioned in the previous section, the IRS's tax ruling, although not legally enforceable, has the effect of providing guidance on taxation, allowing it to be taxed at the same rate under similar circumstances, and the IRS believes that each tax year will have different tax causes depending on the circumstances. Therefore, even investors who have received tax refunds in the past few years or staked tokens have not recognized income due to non-withdrawals must be wary: in future tax years, staking income is likely to be recognized when they take control of the tokens. However, as the 2023-14 tax ruling is based on only 2 cases, there are few precedents accumulated in the current practice, and investors are advised to communicate further with professionals to determine their future tax strategies. #### 3.3 Discussion of other legal issues in this case

3.3.1 Jurisdictional issues

Jarrett v. United States provides an important precedent for jurisdiction in tax refund cases. On the one hand, it confirms that the IRS settles a refund dispute when it issues a refund check, which means that it is difficult for taxpayers to seek a substantive review of the IRS's tax provisions through litigation. In his appellate brief, Jarrett argued that the government could strategically mail refund checks and suspend refund proceedings at any time for a variety of reasons. Undoubtedly, the IRS can use this strategy to circumvent controversial tax policies from entering the substantive review stage and in fact implementing them. However, the court took a different view, holding that meeting all the demands of citizens in individual lawsuits could be a strategy of the government, but such a strategy would not normally raise concerns about government abuse. The government must pay a full refund and interest for non-controversial purposes, and only if the lawsuit triggers a public opinion of the government's concessions. This means that the IRS's strategy will still come at a cost, and will be subject to public opinion and other forms of scrutiny. These restrictions make it impossible for the IRS to abuse its powers, but to keep them within their limits. 3.3.2 Nature of Tax Refund Proceedings

On the other hand, this case further confirms the "past-oriented" nature of tax refund litigation, and the litigation strategy of filing a permanent injunction against future tax revenue through tax refund litigation seems to be difficult to obtain recognition by the court in the context of this case. In fact, one of the purposes of Jarrett's lawsuit is to challenge the IRS's timing of revenue recognition (as reflected in the 2023-14 tax ruling) and to seek to recognize that staking income should be at the time of "withdrawal". Unfortunately, the court did not uphold Jarrett's request. Through the analysis of the case of Jarrett v. USA, this article attempts to sort out the thinking of the U.S. government on the taxation of crypto asset pledge income, and provide reference for the tax compliance practice of crypto assets. This case reflects the Federal Court's conservative approach to cryptoasset taxation, which did not legally confirm the timing of the recognition of pledged income, but refused to proceed with the corresponding hearing on the grounds of jurisdiction. At the same time, the IRS's new tax ruling reminds investors of the uncertainty and complexity of cryptoasset taxation, and also shows the future development and trend of cryptoasset taxation, which deserves investors' close attention.