By Seun Gbri

Compiled by: 0x11, Foresight News


Stephen Covey once said that there are three constants in life: change, choice, and principles. However, we want to add a fourth: taxes. Almost everyone in the crypto world is talking about mergers. How do mergers affect ETH holders? What does it mean for the environment? Another key question is, will you have to pay more taxes after the merger? We will examine the taxability of ETH after the merger and its impact on stakers.

How does incorporating affect your income and taxes?

We’ll look at this question for different scenarios: What happens to the unstaked ETH in your wallet before the merge? What happens when you stake your ETH?

No country or region has specific tax regulations or guidelines for how your ETH is treated after a merger. A merger may be classified as a soft fork for tax purposes. US tax law has rules regarding what defines a soft fork, and according to IRS FAQ 30, a soft fork occurs when there is a protocol update (such as a merger) but no new cryptocurrency is created.

According to IRS guidelines, a "soft fork" occurs when the distributed ledger is updated through a protocol that does not result in a ledger transfer or the creation of a new token. You will not receive any new cryptocurrency as a result of a soft fork; instead, you will remain in the position you were in before the fork, which means you will not be paid anything. The fact that a soft fork leaves you in the same position as before and does not generate more income means it is not a taxable event. This is exactly what happened during the Ethereum merge, which did not form a new Ethereum chain. It made Ethereum faster, more scalable, and less harmful to the environment. The old chain will be combined with the Beacon chain; no new income is created; all transaction history is preserved.

Suppose you have 5 ETH in your wallet and no new income is generated; instead, the Ethereum ecosystem converts your PoW ETH to PoS ETH after the merger.

What happens if ETH is staked before the merge?

You might be wondering how you could stake ETH before the merge. Wasn't the purpose of the merge to introduce a staking mechanism? Before the merge, some exchanges offered staking services; however, the merge completely eliminated the PoW mechanism and converted all ETH to PoS ETH, requiring you to lock up your ETH to receive rewards, thus staking your PoW ETH (pre-merger ETH). To lock up your ETH, you must convert it to "ETH 2" or "ETH 2.S", which are names that represent staked ETH.

Note that different exchanges give different names to staked ETH. Coinbase, Binance, and many other exchanges call them "ETH 2", while Kraken calls them "ETH 2.S". Because "ETH 2" is just used as a "label", this kind of stake before the merger is also a soft fork. The tokens are essentially the same, just distinguished by a new name, and no new cryptocurrency is generated. For example, suppose you bought 5 ETH for $200 in 2019, and then a year later you staked them on Binance by converting them to ETH 2. The converted ETH is worth $5,000. Regardless of the price, this transaction is not taxable because it does not generate new income.

How do differences in pledge types and jurisdictions affect taxation?

Until the Ethereum 2.0 network supports it, stakers will not be able to access the original ETH deposited or the staking rewards. This means that ETH 2 rewards are illiquid.

Should these illiquid rewards be taxed?

There are no clear rules defining the nature of PoS ETH staking income, so we will use the closest guide to determine how staking taxes are calculated. We will refer to some jurisdictions, but countries have different tax laws and guidelines.

The closest guide for the US is the Mining Tax Guide: Notice 2014-21. Although receiving staking rewards on ETH 2 is a taxable event, you do not need to file an income tax return until you can use, manage, and redeem your rewards. If you stake 5 ETH on Binance this year, and receive 0.5 ETH as a staking reward a month later. You do not need to report income because it cannot be spent yet. But suppose Binance allows you to receive 0.5 ETH in staking rewards in 2025, the price of 0.5 ETH is now $350, you are now entitled to handle this $350, so you can report it as income (you can spend it). Until such features are enabled for PoS ETH, most stakers will generally not be able to receive rewards.

The closest guide for Canada is the Mining Tax Guide: Guide for Cryptocurrency Users. Generally speaking, in Canada, unless you are mining on a commercial scale, you don’t have to pay taxes on it. What does this mean for Canadians on illiquid staking rewards? As in the US, you don’t pay taxes until you have full control of the funds, and as mentioned before, you don’t have to file an income tax return until you can use, manage, and exchange your rewards. The main difference is that if this staking is done as a “hobby” or “fun”, then you don’t have to file any income tax, even if you can spend your staking rewards.

Note: Both “hobby miners” and “commercial miners” pay capital gains tax, but income tax is different.

Suppose you staked 5 ETH on Binance this year and received 0.5 ETH next month, it cannot be spent yet, but it is in your wallet. Now it is 2025, Binance allows you to withdraw 0.5 ETH, its price is now $350, you do not need to pay income tax on this $350, because you cannot be called a "commercial staker".

Now imagine Almorok ventures stakes 300 ETH and gets rewarded 30 ETH. It’s 2025 now, Binance has allowed Amorok ventures to receive staking rewards, and they have to pay taxes on the staking rewards because they are staking for “business purposes”.

Note: The terms "business purpose" and "pleasure" are often determined by a variety of factors.

Australia has regulated staking rewards guidelines, and the ATO specifies how staking rewards should be reported: Staking Rewards and the Roles of Forgers. In Australia, you receive staking rewards completely without having to report them for tax. Once you have access to the funds, you must report other taxes on the rewards you have available to you and capital gains tax (upon sale).

In the UK, there are also staking reward rules set out by HMRC: Crypto Assets Manual. The specific facts will depend on whether such staking constitutes a taxable transaction (the crypto asset as trading income), taking into account various variables, including:

  • Activity scale

  • organize

  • risk

  • Commercial

You do not need to file a tax return until you have fully received your staking rewards. Once you have received your staking rewards, you must file an income tax return for your staking rewards, CGT, or CGTC.

Liquidity Staking

Staking protocols such as Lido, RPL, and Marinade Finance also offer liquidity staking derivative tokens. Liquidity staking not only provides the ability to earn rewards by staking cryptocurrencies, but also allows stakers to continue to use their locked assets for investment and income in other activities. Therefore, you have control over both the staked ETH and the staking rewards received and can invest them in other activities. Rewards earned in liquidity staking are taxable income.

This means that you don’t have to wait for a while to get full access to your staking rewards. Therefore, once you have earned your staking rewards, you can dispose of (sell, exchange, etc.) them.

Converting ETH to stETH is a taxable event because it is different from ETH you own, it allows you to receive staking rewards that you can use and control, and the stETH price is not completely pegged to ETH. stETH should be taxed when received. After you receive the reward income, it should be reported immediately. In addition, when you sell stETH, another taxable event is triggered.

For example, you exchange your 5 ETH for 5 stETH worth $5500 (cost is $5000). In the following year, you will receive 0.5 stETH worth $500. Your taxes will be $500 (5500 - 5000) of capital gains and $500 of ordinary income (subsequent rewards for stETH).

How does this differ from the illiquidity pledge taxes in each of the jurisdictions mentioned?

In the above jurisdictions for illiquid staking rewards, you have to wait to gain access before filing taxes, but in liquid staking, you file income taxes on staking rewards when you receive them (you receive them immediately) and when you sell them, you also trigger another taxable event and file it in the US.

In Canada, you have to be a "business" stakeholder to file income tax, and everyone files capital gains tax (CGT) on dispositions.

In Australia, every (business and recreational) stakeholder reports other income when received and CGT when disposed of.

An Australian example of how your taxes work after receiving liquidity staking rewards

The situation in the UK will depend on factors such as the commercial nature, risk, scale and organisation of the activity. Any crypto-asset rewards given for mining and staking are generally taxed as income (when received), and if the mining activity does not constitute a transaction, any necessary expenses will reduce the taxable amount.

If the activity qualifies as a transaction, the income must be determined under applicable tax laws. If the staker retains the reward, he will be subject to CGT or CGTC when he disposes of the reward.

in conclusion

Proof of Stake has significantly changed the Ethereum ecosystem. However, from a tax perspective, there is no reason to be afraid. While this article does not discuss what combined staking rewards will constitute tax revenue, it answers questions about how to value them.