Node Staking (Costly Tax Issues)
We’ve seen a rise in the popularity of Proof-of-Stake (POS) systems where users become validators of blocks with a POS blockchain network. As these transactions have increased in popularity, tax questions realted to the uncertain tax regulatory landscape has created unique tax issues and concerns for investors.
We’ll go over the current tax regulatory landscape realted to staking and how to navigate uncertainty related to tax regulations for these transactions. This will help you to remain in compliance with IRS regulations when participating in these systems and help to pay the least amount of tax as legally possible.
Does Staking Rise to Level of Trade or Business?
One of the top questions we get from people staking on POS blockchains are realted to the deductibility of expenses realted to the staking operation. The IRS has not provided clear guidance regarding staking activities like they have for mining on POW blockchains.
The deductibility of expenses realted to the staking operation will be dictated by how you classify your staking activities. You need to determine if the activities you conduct for staking rise to the level of a trade or a business. If your activity rises to the level of a trade or a business, you can deduct expenses that are related to the staking operation that are ordinary and necessary.
The standard considerations to determine if an activity rises to the level of a trade or business include:
- Time, attention and effort spent
- Does activity constitute livelihood or profit
- Continuity and regularity of the activities
- Profit motives
If the activity does not rise to the level of a trade or business, then this will be viewed as an investment activity or a hobby. If this is viewed as a hobby, staking related expenses are disallowed. If this is viewed as an investment activity only a very limited set of investment-related expenses are deductible and cannot be deducted against ordinary income.
Currently, many tax professionals believe that minting, validating transactions and updating the blockchain, is a trade or business while staking income is an investment activity. This would mean that taxpayers operating master nodes could consider themselves a trade or business. Stakers who delegate their tokens to others would not likely rise to the level of a trade or a business. Similarly, taxpayers that use ‘nodes-as-a-service’ would not likely rise to the level of a trade or a business since they are essentially renting or purchasing a node that is maintained by a third party.
It’s imperative to understand the nature of transactions that you participate in and the associated tax consequences. Over the past couple years, we have seen many taxpayers incorrectly categorize node, staking and mining transactions. This can lead to overlooked tax opportunities and also create large tax issues when selecting a tax entity structure for your operations. If you apply the incorrect judgment and treatment, this can lead to tax issues down the road that will impact several tax years.
If you are mining, managing masternodes, nodes as a service, yield farming, or staking Camuso CPA will help you determine the correct tax treatment for your transactions, establish the best tax structure for your operations, maximize your related tax deductions, and accurately report your business and At Camuso CPA, we have established a well-tested process to deliver clients with crypto assets and digital businesses accurate cryptocurrency accounting, proactive tax advisory and timely tax filings.
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