Crypto Couple’s Victory Against The IRS Comes At The Cost Of Regulatory Clarity

What Happened

In May 2021, a Tennessee couple, Joshua Jarrett & Jessica Jarrett (Jarretts), filed a complaint with the IRS arguing that Tezos staking rewards they earned should not be taxed at the time of receipt. The couple requested a tax refund of $3,793 by filing an amended tax return.

In December 2021, the US Department of Justice directed the IRS to issue the full refund. The Jarretts refused to accept the refund because the IRS didn’t acknowledge the true reasoning for issuing the refund. This reasoning was essential to create a precedent for other stakers and protect himself from IRS scrutiny in the future. The Jarretts decided to take this to the court to get a formal court ruling.

In a motion to dismiss dated February 28, 2022, the US Department of Justice dismissed the Jarretts’ attempt to take the case to the court because the case lacks merit.

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Key Concepts

Joshua Jarrett, Jessica Jarrett (plaintiffs) v. US (defendant) case.

During 2019, a Nashville couple (Jarrets) received 8,876 tezos (XTZ) staking rewards. These coins were worth $9,407 at the time of receipt. The Jarrets reported $9,407 as income and paid related taxes.

On July 31, 2020, the couple filed an amended tax return arguing that $9,407 staking income shouldn’t have been income in the first place. The amended return demanded a $3,793 tax refund from the IRS. The couple didn’t receive a timely response from the IRS.

In a complaint dated May 21, 2021, the couple argued that newly created property is taxed only at the time of sale, not at the time of receipt. For example, if you create a book, you pay taxes only when you sell it, not at the time you are done authoring the book. In response to this complaint, the Tax division of the US department of Justice ordered the IRS to issue a refund of $3,793 on a letter dated December 20, 2021. The Jarrets received a $4,001.83 ($3,793, plus $208.03 of interest under 26 U.S.C. § 6611(a) calculated to January 28, 2022) refund check on February 14, 2022.

Interestingly, the Jarretts refused to accept the refund because the IRS didn’t acknowledge the true reasoning for issuing the refund. This reasoning is essential to create a precedent for other stakers to protect themselves from IRS scrutiny in the future. The Jarretts decided to take this to the court to get a formal court ruling.

Motion to Dismiss dated February 28, 2022

In a court document dated February 28, 2022, the Tax Davison of US Department of Justice (DOJ) dismissed the Jarretts’ attempt to get an official ruling from the court on staking.

In the document, the DOJ argues that the Jarretts’ case is moot, in other words, there’s no issue that remains unsettled, open to argument or debatable because the IRS has issued a full refund including the interest, exactly what the Jarrett’s requested.

“Here, the United States granted a full refund of the amount the Jarretts asked for in the Complaint, with interest and without receiving anything in return. It was not an offer to compromise the case with each party giving up something. Thus, there is nothing left to adjudicate: Plaintiffs sued for a refund and received a full refund. When the United States tenders full payment of a refund – even during litigation – no case or controversy remains, and the refund claim is moot”

Moreover, the DOJ disagrees with the position that the Jarretts can seek to get a court ruling on staking income by refusing to accept the refund. The DOJ argues that the court can issue a refund for any reason other than the one raised by the taxpayer. The Jarretts also initiated this lawsuit to find out the reasons behind the IRS issuing a refund so they (and others) can use this as a basis to protect themselves from future IRS scrutiny on similar matters. The DOJ stresses that “prospective relief is unavailable in a refund suite”. Each tax year is unique, and a court ruling related to a certain tax year cannot be relied upon to get relief for future years.

In certain cases, there are exceptions to the concept of moot mentioned here. The DOJ also explains that the Jarretts’ case is not eligible for any of these exceptions to warrant a court case either. For all the above reasons, the DOJ believes that the court should dismiss the case.

Implications of the Motion to Dismiss

The Jarretts getting a refund check from the IRS was an exciting moment for the crypto community. The community appreciated the Jarretts’ attempt to take the case to the court (without just accepting the refund) to get an official ruling and set precedent for other stakers. Although this was an ongoing case with a pending resolution, by relying on facts presented in Jarrett’s complaint, some crypto users prematurely believed that staking income should not be taxed at the time of receipt.

Unfortunately, the new information presented in the motion for dismissal show that the Jarrett’s case is not strong enough case to rely on yet. It will also be interesting to see the Jarrett’s response to this motion of dismissal. Until the IRS issues further guidance, it is conservative to report staking income at the time of receipt. That said, some taxpayers could still decide not to report staking income by relying on the primary tax principle mentioned on Jarret’s’ complaint — newly created property is not taxed at the time of receipt; they are taxed only at the time of sale.

Next Steps

· Monitor the Jarretts’ response to the motion of dismissal.

Further Reading

· Quick Guide To Filing Your 2021 Cryptocurrency & NFT Taxes

· How The Infrastructure Bill Is Brewing A Crypto Tax Compliance Nightmare

· IRS May Not Tax Passive Income From Holding Crypto Right Away