Ethereum 2.0 Tax Guide

Dec 03, 2020

The long-awaited Ethereum 2.0 has finally launched, but the upgrade raises questions about Ethereum 2.0 tax treatment.

How will Ethereum 2.0 be taxed? In many ways, it will be taxed the same way as the original Ethereum cryptocurrency. However, those who participate in staking and earn staking rewards have complex tax issues to consider.

Our Ethereum 2.0 Tax Guide explains how the new Ethereum and its proof-of-stake rewards are likely to be treated by the IRS.

Is the ETH to ETH 2.0 conversion taxable?

General consensus in the crypto community says that Ethereum 2.0 is completely replacing the original Ethereum. In this case, there is no taxable event to report for the conversion of ETH tokens to ETH 2.0.

In general, when one cryptocurrency is exchanged or converted to another, it is considered a taxable event (akin to selling the first token for USD and using USD to purchase the second). In addition, the IRS has advised that if a “hard fork” occurs, followed by an “airdrop” of a new coin, that is a different type of taxable event (the airdrop is taxed as income rather than a capital gain).

For example, in 2017, Bitcoin Cash was introduced. Owners of Bitcoin received an equal amount of Bitcoin Cash in addition to their existing Bitcoin, and the 2 tokens have always been separate entities that trade at different prices. This is considered a hard fork resulting in a taxable event.

However, this is not the case with Ethereum 2.0 because the new token is replacing the old; you will not be able to own both ETH and ETH 2.0. The IRS has acknowledged that this type of “soft fork” does not result in the creation of a new cryptocurrency and thus does not create a taxable event.

If I sell my Ethereum 2.0, how will it be taxed?

The cost basis and purchase date of your original ETH coins will carry forward to corresponding ETH 2.0 coins. Any gain/loss on the sale of ETH 2.0 coins will be calculated as the difference between the sales price and the original cost basis, plus fees of the sale.

As with other cryptocurrencies, Ethereum 2.0 tax is based on capital gains; the tax rate depends on how long you held the coin. Learn more about how cryptocurrency taxes work here.

How are rewards on staked Ethereum 2.0 taxed?

In general, proof-of-stake rewards are treated as income to the recipient; they must be reported along with your other income and will be taxed according to your normal income tax bracket. Learn more about cryptocurrency as taxable income here.

ETH 2.0 rewards are recognized as income at the time of receipt (the amount of income you report is the fair market value in USD at the time of receipt).

However, the fact that proof-of-stake rewards from Ethereum 2.0 will be locked in the initial phase creates a thorny tax question.

Typically, cryptocurrency is considered “received” when you have dominion and control over the token. But in the initial phase of ETH 2.0, staking rewards may be treated a little differently.

What if my ETH 2.0 and staking rewards cannot be transferred and are locked up?

This Ethereum 2.0 tax question has been a hot topic of debate amongst our cryptocurrency tax lawyers, as well as the Ethereum community at large, and there is no official IRS guidance to provide an answer. However, we can make an educated guess based on other IRS rules.

At the launch of Ethereum 2.0’s Phase 0, validators (those who opt to stake their tokens to validate transactions on the blockchain) will contribute multiples of 32 ETH 2.0 that will be locked up until Phase 1.5, which is approximately 2 years away. During that time, the validators will accrue ETH 2.0 rewards every 6.5 minutes, but neither the principal nor the accrued rewards can be withdrawn until Phase 1.5 is launched.

When are Ethereum 2.0 rewards “received” for tax purposes? Does a taxable event occur when the rewards are given, or when you can actually move them?

One could make an argument that the staked ETH 2.0 is “locked” for 2 years as a result of the contract, and thus the income should not be reported until the 2-year term has expired and the coins can be withdrawn, exchanged, and sold.

But even if you follow this line of thinking, it’s likely the IRS would characterize the staking as a loan of ETH 2.0, and the accrued (but unpaid) rewards should still be reported and taxed annually under the Original Issue Discount rules.

This is similar to a multi-year Certificate of Deposit (“CD”) where the interest is only paid at maturity; however, the CD holder must report and pay taxes on accrued interest every year. When the CD holder is paid at maturity, they will not pay taxes on the full amount of interest received, as they have already paid taxes on phantom income in the prior year.

While there is no definitive answer yet, we expect the IRS will take the position that the same rules apply for ETH 2.0 validators, and that the staking rewards will be considered “received” when they are given, even if you can’t access or control them right away.

How will Ethereum 2.0 rewards be taxed if I sell them?

As we mentioned above, staking rewards are considered income at the time of receipt and taxed as such. The fair market value in USD at the time of receipt is the amount of income that you report. It is also the cost basis for any future sales.

When ETH 2.0 rewards are sold, the gain/loss is calculated as the difference between the sales price and the cost basis.

Can I just pay taxes on Ethereum 2.0 rewards when I sell?

Unfortunately, no. A similar argument had been made that hard forks should only be taxed when the resulting coins are sold; however, the IRS has specified that tokens received this way are considered income and are taxable upon receipt.

As a firm, we disagree with this tax treatment, and in fact have urged members of Congress to reconsider the law when it comes to proof-of-stake rewards. However, those are the rules at this time.

Have more Ethereum 2.0 tax questions? Call our experienced cryptocurrency tax attorneys for tax planning, filing, and any other crypto reporting needs!

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