USA tax trap?

Hi everyone, USA staking taxes have me scratching my head. Can anyone help me out with a strange scenario that I see as a potential tax trap?

What if ADA accrued in value over the year, only to tank later? What if the staker found themselves underwater? What if the tax burden for the year was higher than the staking rewards’ value at the end of the year? Is there a tax work-around? What would happen if people unstaked ADA to protect themselves against this trap happening to them?

Let’s say that ADA really takes off-- $10/ADA, for example, with staking rewards for most/all of the year taxed at the rate of $10 per coin.

FOR EXAMPLE – Say Sam staked 10,000 ADA and over the year earned 500 ADA rewards worth $5,000. The tax burden on these rewards would be $1,250 (using a 25% tax rate as an example).

BUT what if, at the end of the year, the price of ADA plummets to $1. Sam would be stuck with a $1,250 tax burden while the value of their rewarded ADA dropped to $500. If Sam intended on selling earned ADA to cover income tax, they would have to sell all 500 earned reward ADA plus an additional 750 ADA, leaving them with a smaller bag at the end of the year.

In this scenario, is there a tax work-around that would lessen Sam’s tax burden?

I have a long-term outlook for Cardano, but if ADA really started mooning, I would be tempted to unstake some of my ADA to protect myself against a possible crash. After all, altcoins have a history of crashing hard after the bull cycle peak, and so many people seem ready to “cash out” at some point. The problem here is that unstaking would have a negative affect on the network.

Any thoughts? Thanks!

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I’ve been contemplating the same predicament too. One thought I had was if you didn’t do it by the book how would they know? At the same time, like you mentioned, you need to look at the long term view and set yourself up properly to cya.

If I’m not mistaken, ada earned through staking rewards are treated differently from ada that you purchase so it made me think about possibly cashing out my staking rewards every month or maybe even every epoch to get the proper ada values/tax bill, then from that put aside the estimated taxes from that sale, then use the remaining to purchase ada again immediately. Taxes deducted and you have your ada that u purchased, but lots of work though. What do you think?

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Sounds like a lot of work, I agree. Also have to keep in mind that the capital gains goes down a ton if you hold for a year. So the idea of cashing out every month makes most sense for people who have been holding for longer than 12 months.

Haha, I doubt they could know … but why risk it? I am going to dot every I and cross every T when it comes to taxes!

I’ve been wondering the same thing. I know there are people lobbying to have this changed/clarified, but that doesn’t help much in the mean time, since taxes are due soon. I’m certainly not a tax expert, but I would hope that the IRS would be lenient when auditing individuals with how they report their staking rewards, given how little sense some of the requirements are for crypto (I think they’re more concerned with getting people to report in the first place). For example, it’s a bit easier with ADA, but still a burden, to go through and calculate the USD price every 5 days. But what happens for things that continuously distribute rewards? You’re not going to create an infinite number of distributions for such a crypto. So in this scenario, it makes the most sense to treat it similar to a $0 cost basis buy and then pay the taxes once you sell; however, I’m not sure how you would define the holding period in this case. That sort of begs the question, “well if it would have to be done this way with rewards from X crypto, then why can’t I use the same method with ADA?”
I think that the suggestion that @gsxrboi600 gave would work well for your situation. I’m not sure what you mean by “the idea of cashing out every month makes most sense for people who have been holding for longer than 12 months.” From what I gather, if you’re reporting the ADA rewards you get every 5 days, then those allotments would be treated as short term capital gains regardless of how long you had been holding the rest of your ADA.

Thanks for the responses.

I agree that @gsxrboi600 has a solid idea with a monthly cash-out for taxes (or income + taxes). A bit more work, but a good hedge against a sudden loss of coin value. I’ve been giving it some thought and really like the idea.

@Serotonin If you’ve been holding your ADA for 12+ months, couldn’t you could claim long-term capital gains by First-In, First-Out? (I think that I’m using that term correctly). I would simply claim long-term gains by “selling” ADA from my original stack, and replacing them with rewards. The stack remains the same, but the old ones are “leaving” and being replaced by new ones. That was going to be my plan.

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I don’t know if you can claim it as long term or not, but I don’t think so. Maybe if staking rewards were treated like a dividend, but from what I can gather, they’re just treated as ordinary income.

As the article states, most people assume that staking is treated the same way mining is…see question 8 from the IRS website.

If done this way, you’d have the staking rewards counted as ordinary income and then it’s essentially a “buy” with a cost basis equal to the current market value at distribution and the holding period for those “pools” of ADA starting one day after you receive that distribution. This is extremely annoying given that this implies that you have to keep track of 365/5 = 73 different “pools” of ADA each year, each with a different cost basis and holding period.
The other wrench in the works is that I’ve heard of two different definitions for how the IRS defines “receipt” of funds. One is that it is once the funds are under your control and the other is once they appear in your wallet. These two actually aren’t quite the same, technically, because your staking rewards aren’t actually in your wallet until some time after they’ve been accumulated or if you initiate a transaction from your wallet. This is a way for Ouroborus to prevent having to keep track of “dust” (small amounts of ADA) all over the network.
It’s all very confusing and congress needs to be more informed and come up with a better way of defining/addressing taxation of crypto. Like I said, all you can do is give it your best effort and hope that IRS would be understanding. They don’t have much of a leg to stand on if they audit you and say “you did it wrong” when they didn’t concisely define how to do it in the first place.

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