Cryptocurrency Staking and its Tax Implications
The rapid popularity of cryptocurrency has brought several innovations in traditional financial systems by introducing concepts of decentralised finance (DeFi), staking, and yield farming. This brings many opportunities for investors to actively participate and invest in the growth of blockchain and earn hefty rewards from it.
While the potential benefits are there, tax implications on these earnings must also be kept in mind while investing. In this blog, we will understand and explore the tax implications crypto investors need to bear. We will highlight the risks, benefits, and taxation guidelines associated with yield farming, staking, DeFi, and crypto staking. Understanding this will allow potential investors to navigate their earnings while abiding by tax regulations.
What is cryptocurrency staking?
When a crypto investor locks a percentage of his digital tokens in a blockchain network to earn rewards, this is called Crypto Staking. Staking cryptocurrency also gives the holder the right to participate in proof-of-stake blockchains.
How Does Staking Work?
If you own a cryptocurrency that uses a proof of stake blockchain, you are eligible to stake your tokens. Staking locks up your assets to participate and help maintain the security of that network’s blockchain. In exchange for locking up your assets and participating in the network validation, validators receive rewards in that cryptocurrency known as staking rewards.
You can also set up a cryptocurrency wallet that supports staking
Here’s a simple example: Suppose a blockchain network offers a 5% reward for a staking period of, say, a month. You decide to lock up and stake 100 tokens in the network. After a month, you’re able to access your staked tokens and you receive 5 additional tokens as your reward.
How are staking returns computed?
The percentage of return provided by a validator each year APR (Annual Percentage Rate) determines profits from staking.
Assume you wish to stake 100 BTC to a validator that offers a 10% APR. Every year, you will receive 10% interest on your asset. This means that after one year, your net asset will be 100+(100×10%) = 110. This implies you will receive 10÷12 months = 0.833% interest per month.
What are the taxations concerning staking rewards/income?
In the Union Budget 2022, the government introduced a flat tax of 30% on the income generated through VDAs (cryptocurrency/NFTs). Additionally, a TDS of 1% will be deducted on the transfer of any VDA.
However, the income generated through crypto staking is taxed per individual slab rates.
For example, Mr A is a salaried individual with a total taxable income of ₹20,00,000 in the previous year, 2022-2023. Additionally, he has received staking rewards of 5 ETH worth ₹7,50,000. Will the staking rewards be taxed at 30%?
NO – The staking rewards will be taxed as per the slab rates applicable to Mr A. Additionally, if Mr A sells 5 ETH for ₹10,00,000 in the future such a tax of 30% will be levied on gains of ₹2,50,000.
Overview of tax treatment for cryptocurrency transactions
If you’re holding crypto, there’s no immediate gain or loss, so the crypto is not taxed. Tax is only incurred when you sell the asset, and you subsequently receive either cash or units of another cryptocurrency: At this point, you have “realized” the gains, and you have a taxable event.
IRS guidance on cryptocurrency taxation
The proposed section 6045 regulations, which are open for public comment and feedback until October 30, taxpayers owe tax on gains and may be entitled to deduct losses on digital assets when sold, but for many taxpayers, it is difficult and costly to calculate their gains.
These proposed rules require brokers to provide a new Form 1099-DA to help taxpayers determine if they owe taxes, and would help taxpayers avoid having to make complicated calculations or pay digital asset tax preparation services to file their tax returns. These regulations align tax reporting on digital assets with tax reporting on other assets, and, as a result, avoid preferential treatment between different types of assets.
Tax Implications on Crypto Staking
The moment you receive staking rewards, they are subject to income tax. The value of the reward is calculated based on its fair market value at the time of receipt. This means that the value, in U.S. dollars, of the crypto reward you receive needs to be reported on your tax return as ordinary income. For the holders, they must maintain up-to-date records of their rewards when the receipt is generated so that this income is accurately reported
Though many holders may not know, when staking rewards are sold, the transactions carried on are also taxable. Upon receiving the cryptocurrency, in case its value increases during the time of staking, then the holder will pay capital gain tax on the difference between the original and sale value when the receipt is generated. The gains upon staking the crypto tokens can be short-term or long-term, depending on how long they were held before being sold. However, there is a clear difference between the tax rate application on long-term and short-term crypto staking. This is why it is important to keep track of each staking reward period.
In short, the tax implications for both the sale and receipt of staking rewards are different. One needs to fully understand and adhere to these guidelines to efficiently manage their crypto taxation obligations and also to stay compliant with IRS rules.