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Ethereum 2.0 Has Another Mystery – Taxes

As ethereum (ETH) holders are now learning how to stake their tokens and earn interest along the way, there is one question they’ll eventually need to ask, and hope there is a clear answer by then. Yes, it’s taxes. And the only thing that’s clear is that there’s no regulatory clarity on how ETH stakers will be taxed (at least in the US).

Shehan Chandrasekera, Certified Public Accountant (CPA), Head of Tax Strategy at CoinTracker, a cryptoasset portfolio tracker and tax calculator, said even the US Internal Revenue Service (IRS) is trying to wrap its arms around what it all means for taxpayers. The tax rules are outdated and “super generic,” Chandrasekera told Our, adding that people can interpret them in different ways.

“There is guidance on crypto taxes, that’s good. The problem is that the guidance came out in 2014, and during that time, we only had bitcoin (BTC) as the most prevalent cryptocurrency. Since 2014, things have changed drastically,” he said, pointing to the rise of DeFi (decentralized finance) and staking developments that are coming up.

Chandrasekera went on to explain that the issue of staking surfaced when Tezos (XTZ) launched its mainnet in 2018. The difference is Tezos is the 19th biggest cryptoasset based on market capitalization, while ETH is in the No. 2 spot.

“Now it’s a bigger problem with ETH — the second biggest crypto — going from [the proof-of-work (PoW) consensus algorithm to proof-of-stake (POS)]. So that’s why how it’s taxed and when it’s taxed are getting a lot of attention now,” he said.

Mining vs. staking

For now, staking income is subject to ordinary income taxes, based on the existing guidance for Bitcoin mining from 2014.

“In the absence of PoS guidance, we have to go with what we have,” said Chandrasekera.

But, he added, one could argue that mining-related tax guidance should not be applied to staking considering that PoS is completely different from PoW.

In his opinion, it’s too early to tell how this will play out “in the real world,” considering that there are different ways to migrate to ETH 2.0, such as going through an exchange like Coinbase or running a validator node, etc.

“Some exchanges say while ETH 1.0 is locked in the contract, they will provide liquidity using a different token. Until we see how it will play out in the world, it is hard to tell how it will get taxed,” said Chandrasekera.

Meanwhile, Ryan Berckmans, creator of prediction markets Predictions Global, attempted to clear up confusion on the matter, saying that there will only one ETH asset:

@dondaryl20 Yes.

— Ryan Berckmans (@RyanBerckmans)

Also, Sharon Yip, CPA at CoinTracking, a crypto tax consulting firm, speaking with Our, compared the migration from ETH 1.0 to ETH 2.0 to a hard fork, pointing out the key differences and saying:

“Hard forks are a different story. The reason that income needs to be recognized for a hard fork coin is because you have free access to the coin when it lands in your wallet (if even you don’t realize it because you didn’t check your wallet). In other words, the coin has a fair market value. ETH2 is in a different situation because its value will be locked up, so its tax treatment is not the same.”

Taxable vs. no taxable event

In either case, according to Chandrasekera, the earning of ETH 2.0 staking rewards will definitely be a “taxable event.”

In his recent blog post, he elaborated that “the controversial question is as to when they should be reported and taxed.”

According to him, the most conservative approach is to report ETH 2.0 staking income at the time you receive each reward into your wallet. Alternatively, you may recognize staking income at the time you gain dominion and control (not at the time when rewards get deposited into your account), because, in some cases, you can receive staking rewards but not have the right to immediately sell, trade, transfer, or withdraw the rewards.

“Say you receive 1 ETH as a staking reward on January 15, 2021. At the time you receive this in your wallet, it’s worth USD 500. Here, you would report USD 500 on Schedule 1. It will be subject to ordinary income tax rate depending on your tax bracket. If you later sell this for USD 800, you would pay capital gains taxes on USD 300 (USD 800 – USD 500),” Chandrasekera explained, stressing that the best practice is to be conservative, consistent, and reasonable with your approach until the IRS released more guidance.

Meanwhile, CoinTracking’s Sharon Yip argued that whether swapping ETH 1.0 for ETH 2.0 is a taxable event comes down to coin accessibility, saying:

“In general, crypto income needs to be recognized when the amount (i.e., the number of coins) is determinable, the asset is accessible, and there is a fair market value available. When a coin that you either purchased or is awarded to you is locked up (involuntarily) and you cannot get it until a certain date, I believe we can argue that there is no taxable event until we have free access to the coin.”

Also, she added that “when there is no market for us to trade/dispose of a coin, a case can be made that there is no fair market value available so there is no taxable event.”

Meanwhile, Chandrasekera emphasized the ways in which the cryptocurrency landscape has changed, especially in the past year as this nascent market continues to take shape, saying:

“So the problem is, we have cryptocurrency tax guidelines from 2014. But that general guidance doesn’t address these very complex situations that are happening in the crypto space now — staking, Uniswap, DeFi, and stuff that like. That’s the problem.”
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Learn more:
Banks Should Pay Interest on CBDCs to Reduce Tax Avoidance – Report
OECD Says It Is Working on Crypto Tax Reporting Standards for 2021
South Korean Crypto Tax May Be Delayed after Parliamentary Intervention
Russian Ministry Wants to Jail Citizens Who Don’t Declare Bitcoin Earnings
Venezuelan Authorities Clamp Down on Off-The-Books Crypto Pay Vendors

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