Two federal court cases are serving as the testing grounds for when certain kinds of newly created cryptocurrency become taxable income, in an area where some legal observers say regulators haven’t yet established clear rules.
The cases, Jarrett v. United States and Rogovy v. Commissioner, are brought by cryptocurrency advocates challenging the IRS’s treatment of digital asset activity. The cases could sidestep current IRS guidance, said Omri Marian, a professor at the University of California, Irvine School of Law who focuses on taxation and blockchain technology.
“What they’re pursuing is tax exemptions in places where there is no tax exemption,” Marian said. “This is not different than the oil and gas industry pushing for oil and gas subsidies through the tax code; just an industry that’s trying to generate favorable tax treatment.”
Jarrett hinges on whether staking rewards—tokens earned for validating transactions on certain blockchain networks—should be taxed when received or when sold. Cryptocurrency investors Joshua and Jessica Jarrett argue these rewards are newly created property and shouldn’t be taxed until sold, much like a farmer growing crops or an artist creating a painting being taxed upon sale, not creation. Their 2024 suit in the US District Court for the Middle District of Tennessee comes after the IRS issued guidance stating that newly created staking rewards are taxable upon creation.
Rogovy involves how to tax cryptocurrency received during a hard fork—a blockchain protocol split that creates a new token. An April trial session in US Tax Court was held to determine whether the Bitcoin adopters had dominion and control—and therefore realized income. Although a judge denied Rogovy’s motion for summary judgment, which argued the pair’s hard fork transactions weren’t income realization events under IRC Section 611, an opinion hasn’t been issued yet.
Rogovy should be viewed narrowly because it addresses hard forks—a transaction more common in former, less developed iterations of blockchain technology, according to Jason Schwartz, a partner at Cahill Gordon & Reindel LLP. However, Rogovy can impact staking reward taxation because both transactions involve creating new tokens that the recipient first owns without any payment or realization event occurring, he said.
“The question of new tokens on a hard fork is directly analogous to the question of new tokens as staking rewards,” Schwartz said.
Newly Created Goods
Cryptocurrency earned from hard forks and staking should instead be taxed when sold, not received, because they’re newly created goods, according to some practitioners.
“When Shaquille O’Neal autographs a basketball card, he’s not taxed; he’s taxed when he sells it,” Schwartz said. “The first owner is not taxed on property because the Constitution doesn’t permit the federal government to tax property without apportionment—it’s the apportionment clause.”
Schwartz said existing IRS guidance on hard forks and staking are largely inadequate and “difficult to parse.” While the IRS has tried to provide relevant guidance, it lacks substantive reasoning and is at times contradictory, he added.
“Crypto truly presents fact patterns that we just haven’t seen before, that don’t have clear analogies in the off-chain world,” Schwartz said. “It’s very difficult for the IRS to know what to do here.”
The legal theory advanced in Jarrett, to tax received staking rewards only when they’re sold, is also the center of a legislative proposal that would defer taxation of staking rewards, among other provisions, Schwartz said. Supporters of the Digital Asset PARITY Act— a bipartisan proposal from two House Ways and Means Committee members which proposes deferring income recognition for up to five years and then taxing further appreciation only when staking rewards are sold or spent—say it will modernize the taxation of digital assets.
Patrick Wilson, general counsel for Solana Policy Institute, a nonprofit that aims to grow blockchain technology through regulation that filed an amicus brief supporting the Jarretts, said current tax treatment is a barrier to cryptocurrency adoption. When crypto tax treatment becomes overly complicated—requiring “hoops for engaging in otherwise ordinary transactions"—people choose to avoid engaging altogether, Wilson said.
The complexity of the technology and its current taxation may lead someone to say, “I don’t want to deal with that yet,” and postpone their involvement until the process becomes more manageable, he said.
“We’re just seeking the same tax treatment as any other product,” Wilson said.
Setting Precedents
Meanwhile, other legal observers say the current regulatory framework is clear, and characterize the litigation as a coordinated, aggressive campaign to change tax law.
The crypto industry frequently argues its technology is too complicated and novel for existing tax laws to apply, but their arguments are “overblown” and “advantageous to the advocates,“ according to Amanda Parsons, a professor at the University of Colorado Law School who studies taxation in the digital economy.
Federal regulatory agencies are better suited than the courts to decide how to tax crypto transactions because they can build technical expertise and view issues holistically within the tax code, Parsons said. Both cases could provide a significant win for taxpayers and result in courts diluting the power of agencies in the process, she added.
“They’re trying to create the guidance,” Parsons said of Jarrett and Rogovy. “They’re trying to set the precedent for how this technology will be taxed moving forward.”
Marian agreed the industry is trying to change the law through the courts, rather than filling any legitimate gap through legislation. After the Jarretts previously lost a similar case, there’s no question hard forks and staking rewards are taxable under current law, he said.
Rogovy is particularly aggressive because clear IRS guidance saying hard forks are taxable existed before the case was filed, Marian added.
“These arguments that are being put forward are very aggressive,” Parsons agreed. “It’s telling that the arguments are opposite what IRS guidance has indicated. If they win, it’s a huge win for crypto taxpayers in either instance.”
Fenwick & West LLP represents the petitioners in Rogovy. Consovoy McCarthy PLLC represents the Jarretts.
The cases are Rogovy v. Commissioner, T.C., No. 17513-24; and Jarrett v. United States, M.D. Tenn., No. 3:24-cv-01209.