Cryptocurrency

Ethereum 2.0 – Are we missing anything?

As ethereum (ETH) hodlers are now discovering how to stake their tokens and earn interest along the way, there is one subject they’ll eventually need to ask, and I hope there is a clear answer by then. Yes, it’s taxes. The only factual information is that there’s no regulatory certainty on how ETH stakers will be taxed (at least in the US).


CoinTracker’s Certified Public Accountant (CPA), Head of Tax Strategy, Shehan Chandrasekera, a cryptoasset portfolio tracker and tax calculator, stated even the US Internal Revenue Service (IRS) is working on wrapping its arms around what it all means for taxpayers. The tax rules are antiquated and “super generic,” Chandrasekera reckons that people can understand them separately.

Pointing to the rise of DeFi (decentralized finance) and staking developments that are coming up, he stated that,

“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.” 

Chandrasekera emphasized that the issue of staking surfaced when Tezos (XTZ) started its mainnet in 2018. The exception is that Tezos is the 19th largest cryptoasset based on market capitalization, while ETH is in the No. 2 spot.

He states that,

“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,” 

Staking Vs. Mining

mining

For now, staking income is governed by ordinary income taxes, based on Bitcoin mining’s existing administration from 2014.

Chandrasekera mentioned that,

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

He also continued that one could argue that mining-related tax guidance should not be utilized for staking, supposing that PoS is entirely distinctive from PoW.

In his view, it’s too quick to tell how this will play out “in the real world,” reflecting that there are several ways to transfer to ETH 2.0, such as going through an exchange like Coinbase or managing a validator node, etc.

Chandrasekera stated that,

“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.” 

Meantime, Ryan Berckmans, author of prediction markets Predictions Global, tried to clear up uncertainty on the matter, stating that there will only one ETH asset.

Sharon Yip, CPA at CoinTracking, a crypto tax consulting firm, analyzed 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. Income needs to be recognized for a hard fork coin 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. Non-Taxable Event

tax

In either case, according to Chandrasekera, the earning of ETH 2.0 staking rewards will 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 when 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 sell immediately, 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 described that the best practice is to be conventional, consistent, and flexible with your approach until the IRS released more guidance.

Meantime, CoinTracking’s Sharon Yip explained 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.”

She continued 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.”

Chandrasekera highlighted how the cryptocurrency scene 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 in the crypto space now — staking, Uniswap, DeFi, and stuff that likes. That’s the problem.

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