Digital-asset rewards are taxable before a bankrupt platform freezes the account

Plain-English summary

A cash-method taxpayer received staking and other digital-asset rewards in an account before the platform froze customer accounts and filed for Chapter 11 bankruptcy. When credited, the rewards belonged to the taxpayer and could be sold, exchanged, or transferred. Chief Counsel advised that the taxpayer had dominion and control at that point and must include the rewards' fair market value at the date and time of receipt in that year's gross income, even though the account remained frozen on the last day of the year. The special frozen-deposit rule did not apply because the platform was not a qualified financial institution and the rewards were not deposit interest. Rewards that accrued but were not credited before the freeze would not be included that year because the taxpayer could not access them and had not received them actually or constructively.

Ruling snapshot

• Question: Must digital-asset rewards received before an account freeze be included in income for that year when the platform later enters bankruptcy?
• Outcome: Advice given, include credited rewards at fair market value when received
• Key authorities: IRC §§ 61, 451; Treas. Reg. §§ 1.61-1, 1.451-1, 1.451-2; Rev. Rul. 2023-14

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       memorandum
       Number: 202444009
       Release Date: 11/1/2024

       CC:ITA:B02:MELawrence
       PRENO-103305-24

UILC: 61.00-00; 451.00-00

date: October 10, 2024

 to:   Michael R. Fiore
       Area Counsel, 1 (Boston)
       (Small Business/Self-Employed)

from: Ronald J. Goldstein
Senior Technician Reviewer, Branch 2
(Income Tax & Accounting)

subject: Frozen Rewards Related to Bankrupt Digital Asset Platforms

               This memorandum responds to your request for advice regarding the proper year
       of inclusion of frozen digital asset rewards in gross income.

                                                 Issue

               Taxpayer A received rewards from staking and other activities during Year 1 in
       an account at Digital Asset Platform X (Platform X). Platform X froze the account and
       filed a Chapter 11 bankruptcy petition after the rewards were credited to Taxpayer A’s
       account but before the end of Year 1. Is Taxpayer A required to include the value of the
       rewards in gross income in Year 1 if the account remains frozen as of December 31st of
       Year 1?

                                              Conclusion

              Yes. Taxpayer A received the rewards in Year 1 prior to the account being frozen
       and must include the fair market value of the rewards, at the date and time of receipt, in
       gross income in Year 1 under Internal Revenue Code (Code) §§ 61 and 451 even
       though the account remains frozen as of December 31st of Year 1.

PRENO-103305-24 2

                                                Facts

   Taxpayer A is an individual cash method taxpayer who in Year 1 held digital

assets, including cryptocurrency, in an account at Platform X for investment purposes.
Pursuant to the user agreement between Platform X and Taxpayer A (“User
Agreement”), rewards, including those from staking, were periodically distributed to
Taxpayer A following any applicable lockup or waiting period. At the time the rewards
were credited to the account, Taxpayer A was able to sell, exchange, or transfer the
rewards. In addition, the User Agreement provided that the credited rewards were
property of Taxpayer A. Taxpayer A’s account included cryptocurrency received and
credited to Taxpayer A’s account in Year 1 as rewards from staking and other activities.

    During Year 1, Platform X froze its customers’ accounts and filed a Chapter 11

bankruptcy petition.1 As a result of the account being frozen, Taxpayer A was unable to
sell, exchange, or transfer any of the digital assets contained in the account, including
credited rewards, from the date the account was frozen through December 31st of
Year 1.

                                       Law and Analysis

   Digital assets are defined under § 6045(g)(3)(D) of the Code as digital

representations of value that are recorded on a cryptographically secured distributed
ledger.2 See also Treas. Reg. § 1.6045-1(a)(19)(i). Digital assets do not exist in
physical form and include, but are not limited to, property the Internal Revenue Service
has previously referred to as convertible virtual currency and cryptocurrency. Notice
2014-21, 2014-16 I.R.B. 938, as modified by Notice 2023-34, 2023-19 I.R.B. 837; Rev.
Rul. 2019-24, 2019-44 I.R.B. 1004. Notice 2014-21 provides that convertible virtual
currency is treated as property and that general tax principles applicable to property
transactions apply to convertible virtual currency.

   Cryptocurrency is a type of virtual currency that utilizes cryptography to secure

transactions that are digitally recorded on a distributed ledger, such as a blockchain.
Units of cryptocurrency are generally referred to as coins or tokens. Distributed ledger
technology uses independent digital systems to record, share, and synchronize
transactions, the details of which are recorded in multiple places at the same time with
no central data store or administration functionality. See Rev. Rul. 2019-24.

1 Section 451(i)(4) defines a “frozen deposit” for purposes of interest credited by a qualified financial

institution. Although this memorandum refers to frozen accounts and assets, § 451(i) is not applicable
because Platform X does not provide interest on deposits and is not a qualified financial institution as
defined by §§ 451(i)(5) and 165(l) of the Code.
2 The Infrastructure Investment and Jobs Act (“the IIJA”), Pub. L. 117-58, div. H, title VI, § 80603(b)(1)(B),

added new § 6045(g)(3)(D), which provides this definition of a digital asset for purposes of information
reporting by brokers, effective January 1, 2023. The IIJA provides the Secretary with the authority to
further define the term “digital asset.”

PRENO-103305-24 3

    A consensus mechanism is a set of protocols by which nodes reach agreement

on updates to the blockchain. In a proof-of-stake consensus mechanism, persons who
hold cryptocurrency may participate in the validation process by staking their holdings
themselves or may stake their holdings indirectly through a digital asset platform,
referred to as a cryptocurrency exchange. See Rev. Rul. 2023-14, 2023-33 I.R.B. 484.
In general, digital asset platform user agreements specify the timing for when staking
rewards will be credited to a customer’s account and made available to the customer to
sell, exchange, or transfer.

    Section 61(a) provides the general rule that, except as otherwise provided by

subtitle A of the Code, gross income means all income from whatever source derived.
Specifically, gross income includes, but is not limited to, compensation for services,
income derived from business, and gains from dealings in property. Under § 61,
"instances of undeniable accessions to wealth, clearly realized, and over which the
taxpayers have complete dominion," require inclusion in gross income. See
Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955). "Gross income
includes income realized in any form, whether in money, property, or services.” Treas.
Reg. § 1.61-1(a). In general, the receipt of property constitutes gross income in the
amount of its fair market value at the date and time at which it is reduced to undisputed
possession. See, e.g., § 61(a); Koons v. United States, 315 F.2d 542 (9th Cir. 1963);
Rooney v. Commissioner, 88 T.C. 523, 526-527 (1987); Treas. Reg. § 1.61-2(d)(1).

    Section 451(a) provides that the amount of any item of gross income shall be

included in gross income for the taxable year in which it is received by the taxpayer,
unless, under the taxpayer’s method of accounting used in computing taxable income,
such amount is to be properly accounted for as of a different period. Individual
taxpayers generally use the cash method of accounting, pursuant to which gains,
profits, and other income are included in gross income in the taxable year in which they
are actually or constructively received.3 Treas. Reg. § 1.451-1(a).

    Rev. Rul. 2023-14 provides that if a cash-method taxpayer stakes cryptocurrency

native to a proof-of-stake blockchain and receives additional units of cryptocurrency as
rewards when validation occurs, the fair market value of the validation rewards received
is included in the taxpayer's gross income in the taxable year in which the taxpayer
gains dominion and control over the validation rewards. The fair market value is
determined as of the date and time the taxpayer gains dominion and control over the
validation rewards. The same is true if a taxpayer stakes cryptocurrency native to a
proof-of-stake blockchain through a cryptocurrency exchange and the taxpayer receives
additional units of cryptocurrency as rewards as a result of the validation.

3 Income, although not actually reduced to a taxpayer’s possession, is constructively received by the

taxpayer in the taxable year during which it is credited to the taxpayer’s account, set apart for the
taxpayer, or otherwise made available so that the taxpayer may draw upon it at any time, or so that the
taxpayer could have drawn upon it during the taxable year if notice of intention to withdraw had been
given. Treas. Reg. § 1.451-2(a).

PRENO-103305-24 4

    In Year 1, prior to Platform X freezing customers’ accounts and filing its

bankruptcy petition, Taxpayer A was in actual receipt of cryptocurrency representing
staking and other rewards when the cryptocurrency was credited to the account.
Pursuant to the User Agreement, Taxpayer could sell, exchange, or transfer the
rewards when credited, thereby establishing dominion and control over the rewards and
resulting in gross income to Taxpayer A. See § 61; Rev. Rul. 2023-14. The proper year
for inclusion of the reward income is Year 1, when the rewards were received by
Taxpayer A, notwithstanding subsequent events such as the account being frozen.
Treas. Reg. § 1.451-1(a). Accordingly, Taxpayer A must include the fair market value of
the rewards received prior to the account being frozen in gross income in Year 1 even
though A’s account was frozen as of the last day of the year of receipt.4 The fair market
value of the rewards is determined at the date and time the rewards were credited to
Taxpayer A’s account. See § 61; Rev. Rul. 2023-14; and Treas. Reg. § 1.451-1(a)

    If you have any questions, please contact Morgan Lawrence at (202) 317-7011.

                                        Sincerely,


                                        /s/ Ronald J. Goldstein
                                        _________________________________
                                        Ronald J. Goldstein
                                        Senior Technician Reviewer, Branch 2
                                        (Income Tax & Accounting)

4 In contrast, any rewards that accrued but were not credited to Taxpayer A’s account before the account

was frozen, for example during a lockup period, would not be includible in income in Year 1 because
Taxpayer A could not sell, exchange, or transfer the rewards prior to the account being frozen. Thus,
these rewards were not actually or constructively received, and Taxpayer A did not have dominion and
control over the rewards, in Year 1.