Miss-Stake By IRS: Proof-of-Stake's Underinclusive Regulatory Guidance

Jack H. Duncan (J.D. 2024, USC), Miss-Stake By IRS: Proof-of-Stake's Underinclusive Regulatory Guidance, 97 S. Cal. L. Rev. 537 (2024):

Death and taxes are the two certainties of life, and for some, the former may be more conceptually pleasant than the latter. To allay some of that unpleasantness, this Note uses the IRS’s guidance (or lack thereof) on the taxation of new types of digital currencies to provide a basic conceptual understanding of how tax law is formed. “Staking rewards,” which is income derived from new types of digital currencies, have sparked debate over when it should be taxed. However, such ambiguity has failed to elicit a clear response from the IRS.

It is understandable why this area of law feels convoluted to many. Unlike other disciplines, tax law is not judge-made law. Therefore, tax law often lacks clear natural-language holdings from case law. Instead, it is applied either statutorily (under the Internal Revenue Code) or administratively (through regulations, notices, and letters from the IRS). This Note illustrates that in many instances, our tax system is not as convoluted or ambiguous as it is appears.

This Note looks at the IRS’s non-response up until the Revenue Ruling on July 31, 2023, to argue that such silence regarding income from staking rewards was not only deliberate but also necessary, at least during that time. This argument analyzes the taxation of staking rewards in three parts. Part I explains the background and mechanics of staking rewards and how those traits factor into questions of how it should be taxed. Scholarship on taxing staking rewards is growing yet scarce, and typically published either by advocates or adversaries of digital currencies. Accordingly, Part I of this Note also provides a consolidation of arguments and analyses from both sides of the debate. Part II outlines what is left unclear by the Internal Revenue Code, the IRS, and case law. Part III explains what the IRS had ruled up until the recent Revenue Ruling, and what guidance may be expected to follow. Here, in Part III, is this Note’s novel contribution. Part III uses the debate on staking rewards as a lens to justify non-guidance by the IRS to balance the risk of stifling innovation in new technology sectors and avoid commitment to “unfair” tax guidance. These considerations draw on tort law to illustrate the need to allow for development of a sufficient “background of experience” before regulating developing technology into the ground. 

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