Cryptoasset ‘staking’ challenge dismissed as moot after government’s concession

The Sixth Circuit affirmed a district court’s dismissal of a taxpayer’s case in which he contended that he did not realize gross income in the year of cryptocurrency “staking,” leaving the underlying issue unresolved.

Facts: In 2019, Joshua Jarrett engaged in a cryptocurrency staking activity in which he used his existing Tezos cryptocurrency and computing power to create new cryptocurrency on the Tezos public blockchain.  Tezos tokens are a form of cryptocurrency as defined by Notice 2014-21. Jarrett received 8,876 Tezos tokens created by his staking activity in 2019 but did not sell, exchange, or otherwise dispose of them during that year.

Jarrett did not think the value of the tokens he received was taxable in 2019; however, he was aware that the IRS took the position that it was.  He was also aware that under Secs.  7421 and 7422, to contest the IRS’s position, he was required to pay the tax first and then file a refund suit.  Therefore, he and his spouse timely filed their 2019 tax return, including the value of the staked Tezos tokens ($9,407) in income on Schedule C, Profit or Loss From Business, and paid tax of $3,793 on the income.  Later, in summer 2020, they filed a Form 1040-X, Amended U. S. Individual Income Tax Return, requesting a refund of the tax paid.

The IRS had six months to respond to the refund claim (Sec.  6532(a)(1)), but it did not do so.  The Jarretts, having not received a response to the claim, filed a refund lawsuit in district court requesting: (1) a refund; (2) costs and attorneys’ fees; and (3) a permanent injunction barring the IRS from treating tokens they created as income.

After the lawsuit was filed, the IRS issued Jarrett a refund check for $4,001.83, the amount of the taxes paid on the Tezos tokens created and statutory interest.  The IRS sent the check to Jarrett with a notice of adjustment indicating the refund was made in accordance with a concession authorized in the district court case by the U.S. attorney eneral.

Jarrett did not cash the check, preferring to litigate his case to judgment.  The IRS moved to dismiss the district court case as moot because it had already conceded that Jarrett was not liable for tax on the cryptocurrency he received in 2019 and had paid him a full refund of the tax he paid.  The court granted the IRS’s motion and dismissed the case (Jarrett, No.  3:21-cv-00419 (M.D. Tenn.  9/30/22)). The Jarretts appealed the district court’s decision to the Sixth Circuit.

Issues: On appeal, Jarrett argued that his refund claim remained a live dispute, that the refund issued by the IRS did not make the case moot, and that it should not be dismissed.  Jarrett argued that his case was analogous to Campbell-Ewald v. Gomez, 577 U. S 153 (2016), where the Supreme Court refused to dismiss a case where the plaintiff in a class action was offered the maximum amount he could receive by statute and refused the offer.  Jarrett also argued that the government had not admitted liability or agreed to an entry of a judgment and that his alternative relief requests, including his request for a permanent injunction preventing the IRS from treating created tokens as taxable income in the year of creation, remained unaddressed.

The Sixth Circuit noted that in Rev. Rul. 2023-14, the IRS held that new tokens created by staking are included in income when the tokens are received.  (The revenue ruling states that validation rewards a cash-method taxpayer receives from staking activities are income as of the tax year in which the taxpayer gains dominion and control over them.)  For that reason, the IRS might not issue similar refunds arising after the revenue ruling’s 2023 issuance, the court found. But, it added, considering the government’s concession and refund in Jarrett’s case, the revenue ruling had no bearing on his 2019 taxes, for which any controversy had been terminated.

The Sixth Circuit distinguished Campbell-Ewald from Jarrett’s situation in several ways.  The court noted that the IRS paid Jarrett, as opposed to the defendant in Campbell-Ewald, who made the plaintiff an “unaccepted settlement offer,” and stated that “[o]ffers differ from tenders, just as words differ from deeds.” The court also observed that in Campbell-Ewald, the court “refused to ‘decide whether the result would be different’ for actual payment … (distinguishing cases where ‘the plaintiffs had received full redress’)” (quoting Campbell-Ewald v. Gomez, 577 U.S. at 166).

Further, the Sixth Circuit held that “mootness arises when a plaintiff receives all the relief she requested or could receive in the case.” The fact that Jarrett refused to cash The check did not change the mootness of the case.  The court closed the loop on Jarrett’s first argument by stating, “Refund lawsuits exist for a single purpose.  … The IRS satisfies its repayment obligation when it issues and mails a refund check to the taxpayer for the full amount of the overpayment.”

The Sixth Circuit also rejected Jarrett’s argument that the IRS’s failure to admit liability or the lack of an entry of judgment against the IRS prevented mootness. The court stated that mootness “arises even though the parties ‘continue to dispute the lawfulness of the conduct that precipitated the lawsuit’” (quoting Already, LLC v. Nike, Inc., 568 U.S. 85, 91 (2013)).

Finally, the Sixth Circuit rebuffed Jarrett’s claim that his alternate requests for relief should keep his case viable.  The court held that his request for a permanent Injunction did not suffice “to avoid mootness in a tax refund lawsuit.” Under Sec. 7422 (which prevents the filing of a tax recovery suit until an administrative claim for refund or credit has been filed) and 28 U.S.C. Section 1346(a)(1) (which gives district courts and the Court of Federal Claims jurisdiction over civil actions to recover any internal revenue tax erroneously or illegally assessed or collected), refund suits “determine the propriety of a previously assessed and previously paid tax, not future tax years.” In the court’s view, Jarrett’s request for prospective relief in the form of an injunction was inconsistent with these provisions.

Jarrett also argued that a court may award prospective relief in a refund lawsuit so long as it is ancillary to the refund claim. The court, however, found the relevant issue to be “not whether a court may award prospective relief alongside a refund request.  It is whether prospective relief alone may sustain a refund case after the refund claim itself drops out.” The court stated that the Eleventh Circuit, the only circuit to address this specific issue, had disagreed with Jarrett’s position.  That court held that “Absent a live refund claim,” a court lacks ‘jurisdiction to entertain a suit containing solely forward-looking claims seeking declaratory and injunctive relief from the IRS’” (Christian Coal. Of Florida, Inc., 662 F.3d 1182 (11th Cir.  2011)).

Holding: Finding none of Jarrett’s arguments sufficient to show that any live case or controversy remained, the Sixth Circuit affirmed the district court’s holding that Jarrett’s claim for relief was moot and granted the IRS’s motion to dismiss the case.  Because the court did not reach the merits of Jarrett’s claims, taxpayers still have no judicial guidance on the underlying tax issue of whether cryptocurrency received by a taxpayer through staking or mining is taxable income when the cryptocurrency is created or upon its sale or exchange.

∎ Jarrett, 79 F.4th 675 (6th Cir.  2023), aff’g No.  3:21-cv-00419 (M.D. Tenn.  9/30/22) .  

— Jeffrey R. D’Amico, J.D., LL.M., and Linval Frazer, CPA, CGMA, Ph.D., CFE, E.A., are both associate professors at the State University of New York at Old Westbury. To comment on this column, contact Paul Bonner, the JofA’s tax editor.