The taxpayer pushback to the Internal Revenue Service’s growing interest in cryptocurrency transactions is underway.
Joshua Jarrett, a cryptocurrency investor, has filed suit against the IRS. He claims that taxing newly created tokens as income “is in direct contradiction of over 100 years of U.S. tax law.”
“Like any property, cryptocurrency tokens can be income when they’re received as payment or compensation,” said Jarrett in a press release announcing the suit. “But these newly created tokens are like crops harvested by a farmer—which are not taxed until they are sold.”
Jarrett and his attorneys argue that newly created crypto tokens are akin to a just-completed painting and are not considered income until they are sold—and warn that if people who harvest tokens of any digital currency are subject to taxation, they could move their operations to other countries with different tax codes.
Jarrett participates in Tezos, a blockchain system that earns people cryptocurrency rewards, similar to Bitcoin “mining.” Unlike Bitcoin, however, Tezos uses “staking,” a different method of securing the underlying blockchain that is less energy intensive.
Some tax experts say Jarrett might have a case.
“It is well-settled that the creation of property is not, in and of itself, a taxable event,” Phil Karter and Kevin Sweeney, shareholders at the Texas law firm Chamberlain Hrdlicka told Fortune in an email. “The government has all along presumed that the Blockchain should be treated as a third party that is providing the newly created token when in reality, it seems fair to treat the staking of tokens (or perhaps even mining of tokens for that matter) as property created by the taxpayer herself.”
“[Given] the complexities of cryptocurrency and the Blockchain, it is not surprising that issues such as this have likely not been carefully considered by the IRS,” Karter and Sweeney said.
Others experts, though say things aren’t quite so clear-cut.
“The IRS has a long-established policy that cryptocurrency is considered property, however as the industry continues to innovate, the IRS will have to revisit the implications of the innovations,” says Eric Hylton, former commissioner of the IRS’s small business and self employed division and current compliance director for alliantgroup, a business consultancy.
Jarrett says he has been “baking”—Tezos’s lingo for staking, which yields the associated cryptocurrency “XTZ”—since 2019. Those pursuits garnered him 8,876 new Tezos tokens that year, according to the suit. (At their current price, that puts the value of those at over $34,000.)
When the Jarretts filed their 2019 taxes, they reported $9,407 from the creation of new Tezos tokens as “other income” on their Schedule C form. They paid $3,293 in taxes on the tokens, and they have filed a refund claim on those taxes (and subsequent tax credits). They say the IRS has not responded to it.
“The United States here seeks to use the federal income tax law to do something unprecedented, which is tax creative activity rather than income,” the suit alleges. “Taxing newly created cakes, books, or tokens as income would have far-reaching and detrimental effects on taxpayers and the U.S. economy.”