Introduction:
Joshua Jarrett says his cryptocurrency “staking” activity is like baking. He commits some of his Tezos tokens to the blockchain to support a process of validating transactions, and he receives new tokens from the newly created “block.” These, he says, are like a cake he has baked, using “ingredients” and an oven. He should not be taxed, he says, until he sells the cake.
Or perhaps it is like writing. The analogies are not entirely clear. Others, even within the crypto industry, say “staking” is more like lending, and the newly created tokens are like interest on the loan, which would, of course, be taxable.
Jarrett likely suspected that the Internal Revenue Service might take something like the latter view, so when he filed an income tax return for 2019, he reported the new tokens he had received from “staking” that year as income, and then he filed an amended return taking the position that these were not income after all and requesting a refund.
After a few months passed, having heard nothing from the IRS on his refund claim, Jarrett filed suit [i] in federal district court in Nashville, Tennessee, asking for a declaratory judgment that the tax on his receipt of these tokens was wrongly assessed, and for an order directing the IRS to refund the tax, with applicable interest.
A brief aside
For the reporting year 2019, IRS Form 1040 did not yet include a question about whether or not the taxpayer had engaged in any transactions involving cryptocurrency, so it is unlikely that the IRS would have identified a failure to report this activity. Moreover, the IRS would likely not have issued a Statutory Notice of Deficiency – commonly referred to as a “90-day letter” — and Jarrett would not have had an opportunity to pursue this matter in the U.S. Tax Court.
His flagging the issue on an amended return might be seen as laying the groundwork for a “test case,” particularly in view of the modest amount of tax at issue. He was represented in the district court by attorneys from at least four high-powered firms, only one of which was local.
To date, the IRS has offered only limited guidance on the proper tax treatment of cryptocurrency transactions. [ii] Notice 2014-21, issued March 25, 2014 and published in the Internal Revenue Bulletin on April 14, 2014, [iii] consisted of 16 FAQs. The thrust of the Notice was that cryptocurrency is property, not currency, and that a transaction in cryptocurrency is per se a recognition event.
While three of the FAQs dealt with “mining,” none dealt with “proof of stake,” as this technology had not yet been widely adopted. According to Q&A 8, a taxpayer who successfully “mines” virtual currency realizes income in the amount of the fair market value of the mined currency on the date it is received. [iv] It is not self-evident why “staking” should be treated differently.
Returning to our story
The government answered Jarrett’s complaint with a general denial, forgoing the opportunity and/or avoiding the necessity of articulating a theory as to the taxation of crypto “staking” rewards.[v] The cause was set for a bench trial in March 2023.
Then, the government offered Jarrett a refund. The IRS did not say why, and they certainly did not commit to forgo taxing “staking” rewards as income in future years. So Jarrett declined the refund. The IRS tendered a check, including statutory interest, and Jarrett refused to deposit it.
The government then moved to dismiss the action as moot. [vi] Jarrett opposed the motion, [vii] citing the 2016 U.S. Supreme Court opinion in Campbell-Ewald Co. v. Gomez [viii] for the proposition that “an unaccepted settlement offer or offer of judgment does not moot a plaintiff’s case,” [ix] even if the offer would grant the full relief requested.
In its memorandum in support of its motion to dismiss, [x] the government cited several decisions to the effect that “[w]hen the United States tenders full payment of a refund – even during litigation – no case or controversy remains and the refund claim is moot.”
In his memorandum in opposition, [xi] Jarrett singled out one of these decisions, Christian Coalition of Florida, Inc. v. United States, [xii] arguing that the IRS had been compelled to refund the tax payment in that case because it had been made outside the limitations period, but that the 11th Circuit Court of Appeals had made a point of noting that the case might be different if the government had granted the refund “in response to pending litigation,” in order to “deprive the court of jurisdiction and without any independent basis [in the tax code] for granting the refund.”[xiii]
That characterization of the cited footnote in the 11th Circuit’s opinion in Christian Coalition omits some context. The appeals court was addressing the possibility that on some future occasion, if the same issue were to arise again, and the IRS issued a refund when it was not compelled by statute to do so, the taxpayer might be able to make the case that the IRS’s “voluntary cessation” should not moot the case. [xiv]
Inconclusive
While the motion to dismiss was pending, Jarrett was granted leave to file an amended complaint, [xv] adding to the prayer for relief a request for a permanent injunction, preventing the IRS from treating as income any “staking” rewards he might receive in the future.
In the memorandum opinion accompanying its order granting the government’s motion to dismiss, [xvi] however, the district court observed that both the Declaratory Judgment Act [xvii] and the Anti-Injunction Act [xviii] precluded this kind of “forward-looking relief.” The question at hand was whether the tender of a refund check had rendered the present action moot. [xix]
The tender was not an “offer of judgment,” the court said, “The refund is simply issued upon determination of an overpayment.” [xx] So Campbell-Ewald did not apply.
There are two exceptions to the mootness doctrine, the court said. “Voluntary cessation” will not moot a case unless it is clear that the challenged conduct “could not reasonably be expected to recur.” And a case will not become moot if the injury is “capable of repetition yet evading review.” [xxi]
But neither of these exceptions applied here, the court said. There is no “conduct” that the IRS has “ceased.” The agency “has not changed the tax rules or regulations and does not claim to have changed its position.” It has simply issued a refund check. [xxii]
And with the issuance of that check, any dispute as to the taxpayer’s liability for the 2019 tax year is no longer “capable of repetition.” “Any subsequent claim for refund would necessarily apply to a different tax year,” the court said. [xxiii]
With respect to Jarrett’s argument based on the footnote in the appeals court opinion in Christian Coalition, the court noted this was his “first suit to seek a refund after paying income tax on Tezos tokens,” and it was “premature to speculate” whether similar refund claims in later years “will repeatedly evade review.” [xxiv]
The court was unpersuaded by the argument that the “public importance” of the question of the taxation of crypto “staking” should itself provide an exception to the mootness doctrine. [xxv]
At this writing, the time for filing a notice of appeal had not yet elapsed.
[i] Jarrett v. U.S., Cause No. 3:21-cv-00419 (M.D. Tenn.), doc. 1, filed 05/26/21.
Because the 2019 return was filed by Mr. Jarrett jointly with his spouse, she is also a named plaintiff in this matter. For convenience, we will refer here only to Mr. Jarrett, as it was he who engaged in the crypto “staking” activity.
[ii] The need for further guidance is argued at some length in an amicus brief submitted on behalf of Coin Center in the Jarrett litigation, doc. 49-1, filed 03/14/22. In its order granting the government’s motion to dismiss, the court also denied leave for this brief to be filed.
[iii] IRB 2014-16 (04/14/16).
[iv] Id.
[v] Jarrett, supra note 1, doc. 25, filed 08/27/21.
[vi] Id., doc. 41, filed 02/28/22.
[vii] Id., doc. 51, filed 03/14/22.
[viii] 577 U.S. 153 (2016). The substantive issues at stake in Campbell-Ewald are sufficiently remote from our concerns here that we will not take the trouble to summarize that case.
[ix] Id. at 165.
[x] Jarrett, supra note 1, doc. 42, filed 02/28/22.
[xi] Jarrett, doc. 51, supra note 7.
[xii] 662 F.3d 1182 (11th Cir. 2011).
[xiii] Id. at 1196 and note 13.
[xiv] Id. at 1196 note 13.
[xv] Jarrett, supra note 1, doc. 55-1, filed 04/27/22.
[xvi] Id., doc. 65, filed 09/30/22.
[xvii] 28 U.S.C. § 2201(a).
[xviii] 26 U.S.C. § 7421(a).
[xix] Jarrett, doc. 65, supra note 16.
[xx] Id. (citing 26 U.S.C. § 6402(a).)
[xxi] Id.
[xxii] Id.
[xxiii] Id.
[xxiv] Id.
[xxv] Id.