Crypto staking taxes: What investors need to know

Many traders hold cryptocurrencies anticipating future price increases, but some seek to profit from their tokens without selling them. Staking crypto offers a great way to earn rewards on otherwise idle assets. 

However, traders in the United States must report their staking income to the Internal Revenue Service (IRS) to ensure legal compliance.

In this guide, we’ll explore crypto staking taxes, how the IRS classifies these earnings, and how to report crypto staking rewards.

What is crypto staking?

Crypto staking allows traders to earn rewards on digital assets without selling them. Virtual currencies held as long-term investments often remain idle in a trader's digital wallet; while these investments may eventually provide significant returns, many traders attempt to earn staking rewards on their assets before selling them.

Staking requires traders to lock up their digital assets for a specified time in return for a profit. Smart contracts ensure the payment of rewards according to an annual percentage rate (APR), and validators distribute these rewards on a blockchain network.

Traders can stake crypto tokens through the same centralized exchange they used to purchase their crypto or directly through their digital wallet. Since the staking percentage can vary with market conditions, it’s beneficial to shop around for the best rate.

While staking is a popular way to earn returns on unused cryptocurrencies, not all crypto assets support staking. Some protocols rely on crypto mining to secure their blockchain network. Determining if a coin or token allows staking is as simple as checking its consensus mechanism. 

Understanding crypto staking requires distinguishing between the two main blockchain consensus mechanisms: Proof-of-work (PoW) and proof-of-stake (PoS).

Proof-of-work (PoW)

This consensus mechanism requires participants, known as miners, to compete for the right to authenticate transactions on a blockchain. Crypto miners use computers to validate network activity, and the protocol compensates them for their work. Miners earn a portion of the transaction fees charged to network users and a predetermined number of newly mined coins. While cryptocurrency mining allows anyone to validate network transactions for a reward, PoW coins like Bitcoin can't be staked. 

Similar to staking rewards, taxpayers must report crypto mining rewards to the IRS and pay taxes on their earnings. Traders should consult their local tax authorities to learn how to report crypto mining on taxes to adhere to regional regulations and avoid potential penalties.

Proof-of-stake (PoS)

With proof-of-stake (PoS) consensus mechanisms, the network randomly selects eligible validators to authenticate transactions; Ethereum (ETH) uses a PoS consensus mechanism.

Validators lock or stake a predetermined amount of cryptocurrency to be chosen for this task. When they successfully authenticate a block of transactions, they receive compensation for their work. Typically, the network selects validators with more crypto staked to complete more transactions.

Proof-of-history (PoH) and proof-of-activity (PoA)

Recently, other consensus mechanisms have gained appeal. Notable examples include proof-of-history (PoH) used by the Solana (SOL) network and proof-of-activity (PoA), which combines the security of PoW protocols with the efficiency of PoS. These innovations aim to address the limitations of traditional consensus mechanisms, offering enhanced scalability and reduced energy consumption.

What are crypto staking rewards?

Blockchain networks reward traders with crypto staking rewards for dedicating their assets to a decentralized network. Staking ensures the blockchain's core function – processing transactions. By participating in the authentication process, stakers help secure the network and receive crypto rewards in return.

The authentication process begins with several network validators using computers to run complex equations and authenticate transactions. To become eligible to authenticate transactions, validators must lock up or stake large amounts of crypto in a contract with the network. Typically, the more crypto a validator stakes, the better their chance of being chosen to validate a block of transactions.

Limiting the number of validators in a blockchain network can significantly reduce the energy required to process transactions, resulting in a much smaller carbon footprint than proof-of-work counterparts.

Validators earn crypto for successfully authenticating a block of transactions, but blockchain protocols also distribute crypto rewards through staking. Validators rely on everyday traders for support due to the staking requirement. By dedicating a portion of their holdings to a validator, traders earn a return on their investment, typically offered as an annual percentage rate (APR) paid in the same cryptocurrency.

Dedicating digital assets involves entering a contract with a validator, which locks a trader's crypto from transactions for a period of time. At the end of the staking period, traders can retake control of their assets or re-stake them to compound their returns.

The staking reward is the crypto a trader receives for dedicating a portion of their assets to a network validator. (Remember, crypto staking rewards are a taxable income source in the U.S.)

Crypto staking events

Traders must report capital gains and other income sources based on the timing of specific taxable events. A taxable event occurs upon receipt of staking rewards and at the point of their sale or disposition. Common tax events to consider when paying crypto taxes include:

• Transferring coins for staking: In the U.S., moving crypto between wallets does not constitute a taxable event. This includes sending crypto to a centralized exchange like Coinbase or Binance for staking. Traders won't need to report capital gains made up to the point of transfer. 
• Receiving crypto staking rewards: Once traders establish control over the reward, they must report the dollar amount of any crypto rewards they've received to the IRS. Complete control, or dominion, occurs when a trader can freely move or sell their earnings. These earnings are subject to cryptocurrency tax.

Crypto staking taxes in the U.S.

Crypto staking is taxable in the U.S., and in 2023, the IRS clarified the rules and outlined its expectations for taxpayers who receive crypto rewards. According to Rev. Rul. 2023-14, traders must report their rewards once they take control of them. The IRS considers control established when traders receive their crypto rewards in a digital wallet without restriction.

Crypto rewards are taxed as ordinary income. When traders gain dominion over the rewards, they must include the value of all rewards in their gross income for the tax year they were received.

Here’s an example of when to report earnings for crypto tax purposes:

Suppose a taxpayer staked some crypto tokens through a centralized exchange in August 2023. Their tokens were locked for six months and released back to them in February 2024. The taxable event occurs when they receive the staking rewards in their wallet, which means they will need to report this event in the 2024 tax return (filed in April 2025). 

If the same taxpayer sells these rewards later in 2025, they will need to calculate the cost basis and report any capital gains to the IRS in the 2025 tax return (filed in April 2026). The capital gains tax will be assessed based on factors including the asset's fair market value and the duration it was held before the sale.

Remember, beyond federal requirements, traders must also consider state and local tax implications. Taxpayers should research the rules of their specific jurisdictions to ensure compliance with local laws.

IRS forms to report crypto staking rewards

The IRS uses several tax forms to categorize different types of cryptocurrency transactions and can vary based on the type of taxable event and whether the entity reporting is a business or an individual.

Individuals 

The IRS taxes these rewards as ordinary income added to the gross income an individual reports for the tax year. Staking rewards are generally reported on Schedule 1, Line z. When a trader sells or disposes of crypto rewards, they must report the capital gains on Form 8949 and Form 1040 Schedule D. The capital gains are calculated by subtracting the cost basis (amount reported as staking rewards on Schedule 1) by the fair market value of the crypto when sold.

Keeping detailed records of every crypto transaction is crucial for calculating an accurate cost basis for tax reporting.

Optimize your crypto tax strategy with CoinTracker

Tax laws related to cryptocurrency continue to evolve as digital assets become more popular, and keeping up with these changes can be exhausting for traders. Fortunately, CoinTracker provides the latest tax information for all trading situations, including comprehensive guides on staking and crypto rewards.

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