Crypto Appeal Tests Ability to Challenge IRS Positions in Court

An appeals court will consider Wednesday whether the IRS had the power to end a couple’s lawsuit over cryptocurrency tax policy by sending them a refund check.

Joshua and Jessica Jarrett want the US Court of Appeals for the Sixth Circuit to revive their lawsuit after a Tennessee federal court ruled in 2021 that the refund check eliminated any case or controversy on which to rule. The pair argue that cryptocurrency tokens created through “staking"—where someone uses existing tokens and computing power to validate cryptocurrency transactions and create new tokens—shouldn’t be taxed as income until they’re sold or exchanged.

But the government has so far successfully argued that the Jarretts can’t get a ruling on that issue because the IRS sent them a check for the staking-related taxes they paid for 2019, plus interest—totaling a little over $4,000. The Jarretts’ appeal centers on whether they could decline that check to maintain their pursuit of a court ruling on tax law.

“For those interested in taxpayer rights and access to justice, the resolution of the case on appeal could have far-reaching practical consequences,” said Garrett L. Brodeur of Kostelanetz LLP, who practices tax law.

In a friend of the court brief supporting the Jarretts’ fight for court access, the Center for Taxpayer Rights, which is headed by former IRS National Taxpayer Advocate Nina Olson, argued that a tax refund suit is about more than just the money.

Allowing the government to unilaterally issue a check during active refund litigation “will hamper the pursuit of justice in tax controversy cases and abrogate taxpayer rights in refund suits, which will particularly burden low- and middle-income taxpayers seeking correction of wrongful IRS collection practices,” the nonprofit said.

Caitlin Tharp, a tax attorney at Steptoe & Johnson LLP, noted that the Treasury Department included staking in its 2022-2023 Priority Guidance Plan as a regulatory issue it intended to prioritize, and said there’s no other instance in which the receipt of self-created property is taxed as income.

“There certainly is a need for guidance on the tax treatment of staking,” Tharp said. “Even if the receipt of staking tokens is included in income, there are many questions regarding the character and valuation of such income,” she added.

‘Uphill Battle’

In arguing that the IRS’s refund check didn’t moot the case, the Jarretts said principles of contract law dictate that a government’s rejected refund offer can’t deprive a court of the power to hear a case. They also emphasized that they’re not only seeking money, but also a judgment that will make the government’s offer “certain and irrevocable,” and protect them going forward.

“Even if this case were otherwise moot, it would fall within the exception for issues that are capable of repetition but evading review,” they added. Joshua Jarrett faces the same tax problem annually, and the government could continuing sending refund checks to evade review, they said.

The government responded that five federal appeals courts, including the Sixth Circuit, “have held that where, as here, the Government concedes a plaintiff’s entitlement to a tax overpayment and grants a refund of the amount of the refund claim, the plaintiff’s refund suit is moot.”

“I just see it as a difficult issue,” said Victor Jaramillo of Caplin & Drysdale, who specializes in tax matters. He gave the hypothetical of a taxpayer who sues for a refund based on deductions the IRS blocked, only to have the court declare the case moot when the IRS issues a refund.

“What’s stopping this from now leading to an audit of year two, and the same denial of deductions, and me having to fight again, and then ultimately ending up in tax court or district court?” he said.

But although Jaramillo said he understood the Jarretts’ frustration, he added that keeping their case alive is “an uphill battle.”

‘Nationwide Importance’

“Jarrett is not the only time the IRS has quashed attempts to litigate an issue of nationwide importance,” Tharp said.

Tharp noted her client’s challenge to an IRS reporting requirement in 35 N. Fourth Street, Ltd. v. United States, in an Ohio federal district court. The IRS issued a refund of the $10,000 penalty the client paid to satisfy its alleged violation of the requirement, and then government lawyers asked the court to dismiss the case as moot. Her client has opposed the request, and the parties are awaiting a ruling.

Melissa Wiley, a tax partner at Lowenstein Sandler LLP, pointed to a 2021 US Tax Court ruling in Puglisi v. Commissioner, in which taxpayers challenged an IRS bill tied to a micro-captive insurance arrangement—an area of heightened tax enforcement scrutiny for the IRS. Wiley’s former firm, Caplin & Drysdale, represented those taxpayers.

During litigation, the IRS dropped its bill, but the taxpayers still wanted a ruling from the court that would “give clear guidance” going forward, Wiley said. The court denied the request.

Wiley said she believes IRS trial attorneys concluded the Puglisis weren’t bad actors, and the agency’s move may have been part of a strategy of bringing cases with bad actors to the court first, in the hope of favorable rulings that pressure other taxpayers to settle.

“What the Jarrett case is telling us is that it may not actually work in the refund posture, which is a really positive sign, I think, for taxpayer rights,” Wiley said.

Judges Jeffrey S. Sutton, Stephanie Dawkins Davis, and Andre B. Mathis will hold oral arguments Wednesday morning.

The Jarretts are represented by Consovoy McCarthy PLLC, Fenwick & West LLP, and J. Abraham Sutherland of Black Mountain, N.C.

The case is Jarrett v. United States, 6th Cir., No. 22-6023, oral arguments 7/25/23.