Executive Summary: IRS Bulletin No. 2026–43 Highlights

The October 19, 2026 edition of the Internal Revenue Bulletin (IRB 2026–43) delivers a sweeping array of regulatory updates, administrative guidance, and enforcement priorities that collectively reshape the compliance landscape for financial institutions, fund managers, and digital asset stakeholders. At the heart of this bulletin lies a coordinated effort by Treasury and the IRS to refine existing frameworks while addressing emerging tax-avoidance strategies in high-stakes sectors. The issuance arrives amid heightened congressional scrutiny over tax compliance in private investment funds and digital asset markets, with legislative proposals such as the One, Big, Beautiful Bill Act (OBBBA) looming on the horizon to further tighten oversight.

Among the most consequential developments is the extension of the phase-in period for Section 871(m) regulations, which govern the taxation of dividend equivalent payments made to foreign investors through notional principal contracts and equity-linked instruments. Originally slated for full enforcement in 2025, the IRS—through Notice 2026-61—delays the applicability of certain provisions and extends the transition relief first granted in Notice 2022-37. This move reflects ongoing industry pushback over the operational complexity of delta-based identification systems and the compliance burden on withholding agents, particularly brokers and custodians who must now navigate a staggered regulatory timeline.

In parallel, the IRS advances its regulatory agenda for Qualified Opportunity Funds (QOFs) and Qualified Opportunity Zone Businesses (QOZBs) through proposed regulations (REG-116506-25). These rules introduce annual information reporting requirements, mandating that QOFs disclose operational details to the IRS and furnish statements to investors regarding disposition events. The proposed regulations also clarify self-certification procedures, including mechanisms for revoking inadvertent certifications or voluntarily decertifying a fund—a response to widespread concerns over erroneous or fraudulent QOF filings that have proliferated since the enactment of Section 1400Z-2 under the Tax Cuts and Jobs Act of 2017. The IRS’s emphasis on transparency aligns with broader legislative efforts, such as the OBBBA, which threatens to impose stricter sunset provisions and community impact reporting on QOFs within the next decade.

The bulletin also marks a pivotal moment in the taxation of digital assets, particularly through Revenue Procedure 2026-20, which establishes a safe harbor for grantor trusts engaged in digital asset staking. This guidance resolves long-standing uncertainty over whether staking activities—where validators lock cryptocurrency to secure network operations and earn rewards—would jeopardize a trust’s classification as an investment trust under Section 301.7701-4(c) or a grantor trust. The safe harbor, which includes a limited window for existing trusts to amend governing instruments, reflects the IRS’s recognition of the growing institutionalization of digital asset staking while attempting to balance innovation with tax integrity.

In a direct challenge to perceived abuses in the investment fund industry, the IRS issues Notice 2026-62, which identifies novel strategies employed by certain funds to generate tax results inconsistent with the intent of the Internal Revenue Code. The notice invites public comment on transactions that exploit loopholes in partnership allocations, basis shifting, and related-party rules, signaling the agency’s intent to deploy legislative or regulatory tools to curb such practices. This development follows a series of high-profile audits and court cases targeting abusive fund structures, including the Tax Court’s decision in CRI-Leslie, LLC v. Commissioner (T.C. Memo. 2021-135), which upheld the IRS’s interpretation of the 30-month substantial improvement rule for QOZBs.

Rounding out the bulletin is Revenue Ruling 2026-20, which provides critical guidance on the tax treatment of appreciated securities transferred to newly formed exchange-traded funds (ETFs) when some or all of those securities are subsequently distributed to redeem shares held by other investors. The ruling addresses the interplay between Sections 351 (nonrecognition of gain on transfers to controlled corporations) and 852(b)(6) (taxation of regulated investment companies), clarifying that such transactions do not trigger immediate recognition of gain under Section 361(c), provided the ETF maintains its status as a regulated investment company under Section 851. This guidance shores up longstanding ambiguities in ETF formation and redemption mechanics, offering practitioners a clearer path to structuring compliant transactions.

Collectively, these updates underscore the IRS’s strategic pivot toward enhanced transparency, stricter enforcement, and adaptive regulatory frameworks in response to the evolving tax landscape. The agency’s actions are situated within a broader political and economic context marked by bipartisan calls for greater accountability in private investment and digital asset markets, as well as the lingering effects of the OBBBA’s proposed reforms. For tax practitioners, the bulletin serves as both a warning and a roadmap: a warning of heightened scrutiny in areas ripe for abuse, and a roadmap for navigating the increasingly complex intersection of tax law, financial innovation, and regulatory compliance.

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Deep Dive: Extension of the Phase-In Period for Section 871(m) Regulations

The Internal Revenue Service’s latest extension of the phase-in period for Section 871(m) regulations—formalized in Notice 2026-61—represents a deliberate pause in enforcement, not a retreat from compliance. This two-year reprieve, running through 2029, builds on a decade of regulatory evolution that has struggled to reconcile the IRS’s statutory mandate to tax "dividend equivalents" with the practical realities of modern derivatives markets. The extension arrives amid bipartisan pressure to close loopholes exploited by foreign investors and financial intermediaries, even as the IRS acknowledges the administrative burdens of policing synthetic dividend transactions. For practitioners, the notice is both a reprieve and a warning: relief is temporary, but the anti-abuse rule remains a sword hanging over transactions that appear to skirt the spirit of the law.

The Rule: What the IRS Is Updating

Section 871(m) of the Internal Revenue Code imposes a 30% withholding tax on "dividend equivalent" payments made to non-U.S. persons under notional principal contracts (NPCs) or equity-linked instruments (ELIs) that reference U.S. equities. The provision was designed to prevent tax avoidance by foreign investors who structure dividend-like payments as derivatives to avoid U.S. withholding tax. The IRS has struggled to enforce this rule effectively, leading to a series of phased-in enforcement periods and transition relief notices.

Notice 2026-61 extends the phase-in period for delta-one and non-delta-one transactions through 2029, delaying the applicability of certain provisions in the final Section 871(m) regulations issued in T.D. 9734 (2015) and T.D. 9815 (2017). The notice explicitly ties this relief to the continued applicability of the anti-abuse rule under §1.871-15(o), which allows the IRS to recharacterize transactions that, while technically outside the scope of Section 871(m), are structured to achieve the same economic effect as a dividend equivalent. The IRS retains the authority to apply this rule during the phase-in period, ensuring that taxpayers cannot exploit the extension to engage in abusive tax avoidance.

The relief provided in Notice 2026-61 is not a blanket exemption but a continuation of the "good faith effort standard" and the "simplified standard for determining combined transactions." The good faith effort standard allows withholding agents to rely on reasonable interpretations of the regulations while the phase-in is in effect, while the simplified standard for combined transactions reduces the administrative burden of aggregating multiple derivatives referencing the same underlying security. These measures are designed to ease the transition for financial institutions, brokers, and custodians who must implement systems to identify and withhold on Section 871(m) transactions.

The IRS’s notice also clarifies that the anti-abuse rule under §1.871-15(o) will continue to apply during the phase-in years, meaning that transactions that would not otherwise be treated as Section 871(m) transactions may still be recharacterized as such if they are structured to achieve the same economic effect as a dividend equivalent. This rule is a critical tool for the IRS to prevent taxpayers from exploiting the phase-in period to engage in abusive tax avoidance. Practitioners must therefore document the economic substance of transactions and ensure that they are not structured in a way that could be deemed abusive.

The extension also reiterates the good faith effort standard and the simplified standard for combined transactions. The good faith effort standard allows withholding agents to rely on reasonable interpretations of the regulations while the phase-in is in effect, reducing the risk of penalties for non-compliance. The simplified standard for combined transactions reduces the administrative burden of aggregating multiple derivatives referencing the same underlying security, making it easier for practitioners to comply with the regulations.

For withholding agents, the notice provides additional time to implement systems for identifying and withholding on Section 871(m) transactions. However, the IRS has made it clear that it expects progressive compliance during the phase-in period. Withholding agents must therefore begin preparing for full enforcement by 2029, including implementing delta calculation systems to identify Section 871(m) transactions, training staff on the requirements of the regulations and the anti-abuse rule, and documenting transactions to demonstrate compliance with the good faith effort standard.

For taxpayers, the notice provides temporary relief from the full enforcement of Section 871(m) regulations. However, practitioners must remain aware of the continued applicability of the anti-abuse rule and the potential for recharacterization of transactions. Taxpayers should therefore review their derivative transactions to ensure that they are not structured in a way that could be deemed abusive under §1.871-15(o).

The IRS has also indicated that it will continue to evaluate the Section 871(m) regulations and welcomes additional comments on tax policy considerations, legal authority, and administrative feasibility. Practitioners should therefore monitor future guidance from the IRS, including any proposed amendments to the regulations that could further extend or modify the phase-in period.

The Context: Politics, Industry, and Historical Precedents

The regulatory journey of Section 871(m) has been marked by political pressure, industry pushback, and administrative challenges. The provision was first introduced in 2010 under the Foreign Account Tax Compliance Act (FATCA), which aimed to curb tax evasion by U.S. persons holding assets abroad. However, foreign investors quickly adapted by using derivatives to replicate dividend payments without triggering withholding tax. The IRS responded with Notice 2010-46, which provided temporary relief for securities lending and repurchase agreements but also laid the groundwork for the eventual Section 871(m) regulations.

The 2015 final regulations (T.D. 9734) and 2017 final regulations (T.D. 9815) introduced the "delta test"—a threshold of 0.80 or higher—to determine whether a derivative is a Section 871(m) transaction. The delta test was intended to simplify compliance by focusing on transactions that closely track the underlying stock’s price movements. However, the industry argued that the delta test was overly rigid and failed to account for hedging transactions or market-making activities. The IRS responded with a series of transition relief notices, including Notice 2016-76, Notice 2018-5, Notice 2018-72, Notice 2020-2, Notice 2022-37, and Notice 2024-44, each extending the phase-in period to allow for the orderly implementation of the regulations.

The political context of these extensions cannot be ignored. The Tax Cuts and Jobs Act (TCJA) of 2017 and subsequent legislative efforts have focused on closing loopholes exploited by foreign investors and financial intermediaries. The One, Big, Beautiful Bill Act (OBBBA), a hypothetical omnibus tax reform bill proposed in 2023–2024, includes provisions that would tighten compliance requirements for QOFs and QOZBs and increase penalties for abusive investment strategies. While OBBBA has not been enacted, its draft provisions signal a broader trend toward greater scrutiny of tax-advantaged investment structures, including those involving synthetic dividends.

The industry response to Section 871(m) has been mixed. Financial institutions, particularly brokers and custodians, have invested heavily in systems to identify and withhold on Section 871(m) transactions. However, the complexity of the regulations has led to compliance gaps, particularly for non-delta-one transactions (e.g., options, swaps) and combined transactions that reference the same underlying security. The IRS has acknowledged these challenges, stating in the preamble to the 2017 regulations that the "QSL regime was administratively more convenient for taxpayers than the QI regime, but it created administrability problems for the IRS." The IRS has since replaced the QSL regime with the Qualified Derivatives Dealer (QDD) regime, which integrates the rules for pooled reporting on Form 1042-S and the QI requirements for compliance review and certification.

The IRS’s focus on Section 871(m) enforcement has intensified in recent years, with the agency targeting hedge funds and foreign financial institutions for non-compliance. In 2021, the IRS issued a directive focusing audits on Section 871(m) compliance, signaling a shift toward more aggressive enforcement. The IRS’s willingness to challenge transactions under the substance-over-form doctrine and the step-transaction doctrine further underscores its commitment to closing loopholes in the derivatives market.

The Implication: What Practitioners Need to Know

For tax practitioners, Notice 2026-61 is a double-edged sword. On one hand, the two-year extension provides breathing room to implement systems and processes for identifying and withholding on Section 871(m) transactions. On the other hand, the continued applicability of the anti-abuse rule under §1.871-15(o) means that practitioners must remain vigilant in structuring transactions to avoid recharacterization.

The notice explicitly states that the anti-abuse rule will continue to apply during the phase-in years, meaning that transactions that would not otherwise be treated as Section 871(m) transactions may still be recharacterized as such if they are structured to achieve the same economic effect as a dividend equivalent. This rule is a critical tool for the IRS to prevent taxpayers from exploiting the phase-in period to engage in abusive tax avoidance. Practitioners must therefore document the economic substance of transactions and ensure that they are not structured in a way that could be deemed abusive.

The extension also reiterates the good faith effort standard and the simplified standard for combined transactions. The good faith effort standard allows withholding agents to rely on reasonable interpretations of the regulations while the phase-in is in effect, reducing the risk of penalties for non-compliance. The simplified standard for combined transactions reduces the administrative burden of aggregating multiple derivatives referencing the same underlying security, making it easier for practitioners to comply with the regulations.

For withholding agents, the notice provides additional time to implement systems for identifying and withholding on Section 871(m) transactions. However, the IRS has made it clear that it expects progressive compliance during the phase-in period. Withholding agents must therefore begin preparing for full enforcement by 2029, including:

• Implementing delta calculation systems to identify Section 871(m) transactions.
• Training staff on the requirements of the regulations and the anti-abuse rule.
• Documenting transactions to demonstrate compliance with the good faith effort standard.

For taxpayers, the notice provides temporary relief from the full enforcement of Section 871(m) regulations. However, practitioners must remain aware of the continued applicability of the anti-abuse rule and the potential for recharacterization of transactions. Taxpayers should therefore review their derivative transactions to ensure that they are not structured in a way that could be deemed abusive under §1.871-15(o).

The IRS has also indicated that it will continue to evaluate the Section 871(m) regulations and welcomes additional comments on tax policy considerations, legal authority, and administrative feasibility. Practitioners should therefore monitor future guidance from the IRS, including any proposed amendments to the regulations that could further extend or modify the phase-in period.

In the broader context of tax enforcement and compliance, Notice 2026-61 is a reminder that the IRS is balancing enforcement with administrative feasibility. The extension of the phase-in period reflects the IRS’s recognition of the complexity of Section 871(m) regulations and the challenges faced by withholding agents in implementing them. However, the continued applicability of the anti-abuse rule underscores the IRS’s commitment to closing loopholes and ensuring that taxpayers do not exploit the phase-in period to engage in abusive tax avoidance. For practitioners, the notice is a call to action: prepare for full enforcement by 2029, but remain vigilant in structuring transactions to avoid recharacterization.

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Deep Dive: Proposed Regulations for Qualified Opportunity Funds and Businesses

The IRS’s latest proposed regulations under REG-116506-25 mark a significant expansion of the agency’s enforcement tools for Qualified Opportunity Funds (QOFs) and Qualified Opportunity Zone Businesses (QOZBs), introduced as part of the One, Big, Beautiful Bill Act (OBBBA). These rules—enacted under Section 70421(d)(1) and (2) of the OBBBA—establish new annual information reporting requirements for QOFs and QOZBs, while also clarifying penalties for non-compliance and procedures for certification and decertification. The changes reflect Congress’s growing skepticism toward the effectiveness of Opportunity Zones in delivering tangible economic benefits to distressed communities, as well as the IRS’s determination to close perceived loopholes in the program’s administration. For practitioners, these proposed regulations represent a paradigm shift in how QOFs and QOZBs must operate, moving from a largely self-certified regime to one with rigorous IRS oversight, public disclosure obligations, and stiff penalties for failure.

The proposed regulations under REG-116506-25 amend Sections 1400Z-2, 6011, 6037, 6039K, 6039L, 6045, 6722, 6724, and 6726 of the Internal Revenue Code, introducing three primary compliance obligations:

First, QOFs must file annual information returns under Section 6039K, detailing their investments, asset composition, and compliance with the 90% asset test required by Section 1400Z-2(d)(1). Second, QOZBs must furnish statements to QOFs under Section 6039L, providing data on their operations, employment metrics, and compliance with the 70% tangible property test under Section 1400Z-2(d)(3). Third, brokers must report transactions involving QOF interests under Section 6045, mirroring the reporting requirements for securities transactions. The IRS has explicitly tied these changes to Section 7805, asserting that the OBBBA’s amendments to the Opportunity Zone program necessitate new regulatory authority to ensure transparency and prevent abuse. The proposed regulations also codify penalties for non-compliance under Section 6726, which imposes $280 per failure for incorrect or untimely filings, with a maximum annual penalty of $3.4 million for large QOFs.

The regulatory overhaul arrives amid growing bipartisan criticism of the Opportunity Zone program, which was established by the Tax Cuts and Jobs Act (TCJA) of 2017 under Sections 1400Z-1 and 1400Z-2. While the program was designed to spur investment in low-income communities, studies—including a 2023 Government Accountability Office (GAO) report—have found that only 20% of designated Opportunity Zones saw measurable economic improvement, with many investments flowing into luxury real estate and gentrifying neighborhoods rather than underserved areas. The OBBBA’s amendments, signed into law on July 4, 2025, reflect Congress’s response to these concerns by mandating annual reporting and public disclosure of QOF activities, a provision codified under Section 70421(e). This public reporting requirement forces QOFs to disclose their holdings, investment strategies, and community impact metrics in a searchable IRS database, a stark departure from the program’s original self-certified, opaque structure. The IRS’s proposed regulations under REG-116506-25 operationalize these statutory changes, providing the mechanisms for compliance, enforcement, and transparency that the OBBBA envisioned.

The proposed regulations also clarify and expand the certification and decertification processes for QOFs, addressing longstanding ambiguities that have led to abusive structures and fraudulent claims. Under Section 1400Z-2(e)(4), the IRS has delegated authority to prescribe regulations governing QOF certification, including procedures for self-certification, voluntary decertification, and revocation of inadvertent certifications. The proposed rules introduce three key procedural innovations:

First, QOFs must now file Form 8996 annually to self-certify compliance with the 90% asset test, replacing the prior one-time certification model. Failure to file or incorrect filings trigger automatic penalties under Section 6726, with the IRS reserving the right to revoke certification if a QOF fails to meet the test for three consecutive years. Second, the regulations establish a voluntary decertification process, allowing QOFs to exit the program if they no longer meet eligibility requirements, such as when a QOZ designation expires or a fund’s investment strategy shifts. Third, the IRS introduces a procedure for revoking inadvertent certifications, providing a 90-day cure period for QOFs that discover non-compliance due to administrative errors. These changes are designed to prevent "zombie QOFs"—funds that remain certified despite no longer meeting program requirements—a problem that has plagued the program since its inception.

For practitioners, the most immediate and consequential aspect of the proposed regulations is the expansion of penalties for non-compliance, particularly under Section 6726, which now applies to QOFs, QOZBs, and brokers involved in QOF transactions. The IRS has explicitly linked these penalties to the OBBBA’s transparency goals, stating in the preamble that "failure to comply with information reporting requirements undermines the statutory framework of the Opportunity Zone program." The penalties are structured as follows:

• Section 6721: Imposes a $280 penalty per failure for incorrect or untimely Form 6039K (QOF annual return) or Form 6039L (QOZB statements), with a maximum annual penalty of $3.4 million for large funds.
• Section 6722: Applies a $280 penalty per failure for failure to furnish investor statements under Section 6039K(c), with the same $3.4 million cap.
• Section 6724: Provides reasonable cause relief for failures due to inadvertent errors, but the IRS has narrowed the scope of this relief in the proposed regulations, requiring documented evidence of due diligence.
• Section 6726: Introduces a new penalty regime for brokers who fail to report QOF transactions under Section 6045, mirroring the $280 per failure structure but with a lower maximum penalty of $1.1 million for small brokers.

The IRS’s aggressive penalty framework underscores its commitment to enforcing the new reporting requirements, particularly as the OBBBA’s public reporting mandates take effect. Under Section 70421(e), the IRS must publish aggregated data on QOF investments, including geographic breakdowns, asset classes, and community impact metrics, by January 1, 2027. This public disclosure regime is intended to shame non-compliant QOFs and encourage transparency, but it also creates reputational risks for funds that fail to meet reporting standards. Practitioners must advise clients that even minor errors—such as misclassifying an asset as QOZ property or failing to file Form 8996 on time—can trigger audits, penalties, and potential decertification.

The proposed regulations also address the intersection of Opportunity Zones with other tax regimes, particularly Section 1031 like-kind exchanges and Section 163(j) interest deduction limitations. The IRS has clarified that QOF investments do not qualify for like-kind exchange treatment, a change that eliminates a common tax planning strategy for deferring gains into QOFs. Additionally, the regulations prohibit QOZBs from deducting interest expenses under Section 163(j) if the debt is used to finance non-QOZ activities, a restriction designed to prevent "double-dipping" on tax benefits. These clarifications are critical for practitioners structuring transactions in Opportunity Zones, as they eliminate ambiguity but also reduce the attractiveness of certain strategies.

The political and industry context of these proposed regulations cannot be overstated. The Opportunity Zone program has faced relentless criticism from progressive lawmakers, watchdog groups, and economic researchers, who argue that the program has failed to deliver on its promise of economic revitalization. A 2024 Brookings Institution study found that only 3% of Opportunity Zone investments went to projects in the poorest 25% of designated zones, with the vast majority flowing into high-income areas or luxury developments. In response, the OBBBA included provisions to sunset QOZ designations after 10 years (currently indefinite) and require annual reporting on job creation and wage growth, a change that directly informs the IRS’s proposed regulations. The IRS’s enforcement posture—evidenced by the proposed penalties and public reporting requirements—suggests that the agency is preparing for a wave of audits as the 2026 deadline for deferred gains approaches. Practitioners should expect heightened scrutiny of QOFs that fail to meet the 90% asset test or report dubious community impact metrics.

For QOFs and QOZBs, the proposed regulations represent a fundamental shift in compliance obligations, moving from a voluntary, self-certified regime to a highly regulated, IRS-monitored system. The annual reporting requirements under Section 6039K will force funds to maintain detailed records of their investments, including appraisals, transaction logs, and asset classifications, to avoid penalties. QOZBs, in turn, must adapt to the new furnishing requirements under Section 6039L, which mandate quarterly statements to QOFs detailing employment numbers, wage levels, and tangible property usage. The public reporting mandates under Section 70421(e) will also expose QOFs to greater reputational risk, as their investment strategies and community impact will be scrutinized by the media, investors, and policymakers.

For investors, the proposed regulations introduce new risks and opportunities. On one hand, the expanded reporting requirements may increase confidence in the program, as investors can verify a QOF’s compliance before committing capital. On the other hand, the stricter penalty regime and public disclosure rules may deter some investors, particularly those seeking anonymity or tax arbitrage. The 10-year sunset provision in the OBBBA—if enacted—would also limit the long-term benefits of QOF investments, forcing investors to reassess their holding periods. Practitioners must advise clients that Opportunity Zone investments are no longer a "set-and-forget" tax strategy but rather a high-compliance, high-scrutiny endeavor.

The IRS’s timeline for implementation is aggressive, with comments due by October 26, 2026, and a public hearing scheduled for November 5, 2026. The agency has signaled its intent to finalize the regulations by mid-2027, in time for the 2026 deferred gains deadline. Practitioners should begin preparing clients now, particularly those with existing QOF investments, as the new reporting requirements will apply retroactively to the 2026 tax year. The IRS’s proposed penalty structure—with $280 per failure penalties and $3.4 million annual caps—means that even minor errors can result in significant financial exposure. Funds should conduct internal audits of their compliance systems, train staff on the new reporting requirements, and consult with tax advisors to avoid inadvertent non-compliance.

In summary, the proposed regulations under REG-116506-25 represent a watershed moment for the Opportunity Zone program, transforming it from a loosely regulated tax incentive into a highly monitored compliance regime. The IRS’s expansion of information reporting, public disclosure, and penalty enforcement reflects Congress’s growing impatience with the program’s lack of transparency and uneven economic impact. For practitioners, the regulations demand immediate action: review client QOF structures, implement new reporting systems, and prepare for heightened IRS scrutiny. The 2026 deferred gains deadline looms large, and the OBBBA’s transparency mandates ensure that non-compliance will no longer go unnoticed. The Opportunity Zone program is no longer a tax planning backwater—it is now a frontline enforcement priority, and practitioners must adapt accordingly.

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Deep Dive: Guidance on Digital Asset Staking for Grantor Trusts

The Internal Revenue Service’s issuance of Revenue Procedure 2026-20 marks a pivotal moment in the taxation of digital assets held in grantor trusts, particularly those engaged in staking activities. This guidance arrives amid a regulatory vacuum where the IRS has historically struggled to classify staking rewards for tax purposes, leaving practitioners in a state of uncertainty. The revenue procedure introduces a safe harbor under which trusts may stake digital assets without jeopardizing their classification as investment trusts under §301.7701-4(c) or grantor trusts for Federal income tax purposes. This development is not merely technical—it reflects the IRS’s belated recognition of the economic reality of proof-of-stake (PoS) consensus mechanisms, where staking rewards are not mere passive income but an integral part of the asset’s yield generation.

The Rule: What the IRS Is Updating

The background of digital asset staking is rooted in the proof-of-stake (PoS) consensus mechanism, a protocol used by blockchains such as Ethereum (post-Merge), Cardano, and Solana to validate transactions and secure the network. Unlike proof-of-work (PoW), which relies on computational power, PoS requires validators to lock up (stake) their holdings as collateral to propose and attest to new blocks. In return, validators receive staking rewards—typically denominated in the native cryptocurrency—proportional to the amount staked and the network’s inflation schedule. The IRS has long grappled with the characterization of these rewards: Are they ordinary income upon receipt under §61(a)(3)? Are they capital gains deferred until disposition? The agency’s silence has forced practitioners to rely on general principles of tax law, leading to inconsistent treatments and aggressive tax planning.

The safe harbor in Revenue Procedure 2026-20 resolves this ambiguity for grantor trusts that otherwise qualify as investment trusts under §301.7701-4(c). The IRS explicitly acknowledges that staking rewards are not dividends or interest but rather compensation for services rendered—namely, the validation of transactions and maintenance of network security. The revenue procedure clarifies that the receipt of staking rewards does not, by itself, cause a trust to fail the investment trust test, provided the trust adheres to strict operational and structural requirements. This is a critical concession, as prior guidance (such as Revenue Procedure 2025-31) had left trusts in limbo, risking reclassification as non-grantor trusts or even associations taxable as corporations under §7701(a)(3).

To qualify for the safe harbor, a trust must satisfy several exacting requirements. First, the trust must use a qualified custodian to hold the digital assets being staked. The custodian must be independent of the trust and regulated under applicable state or federal law, ensuring that the assets are not commingled with the trust’s other property and that the trust retains no beneficial interest in the staked assets beyond its right to receive rewards. The IRS’s insistence on a qualified custodian reflects its broader crackdown on self-custody arrangements, which the agency views as high-risk for fraud and tax evasion. Second, the trust must engage a qualified staking provider—an entity that operates the staking infrastructure on behalf of the trust. The staking provider must be unrelated to the trust and must not have discretion over the disposition of the staked assets or the rewards generated. This requirement is designed to prevent the trust from being treated as a dealer in digital assets under §1221(a)(1), which would subject the trust to ordinary income treatment on staking rewards.

The revenue procedure also mandates that the trust maintain a liquidity reserve equal to 10% of the fair market value of the staked assets, measured at the time of staking. The reserve must consist of cash or cash equivalents and must be held in a separate account from the staked assets. The purpose of the reserve is twofold: to ensure the trust has sufficient liquidity to cover unbonding periods (the time required to withdraw staked assets from the network) and to demonstrate economic substance, thereby avoiding IRS assertions that the staking activity is a sham transaction. The IRS’s focus on the liquidity reserve is consistent with its broader enforcement priorities in the digital asset space, where it has repeatedly challenged structures that lack economic substance or substantial business purpose.

The Federal income tax consequences of staking under the safe harbor are straightforward. Staking rewards are treated as ordinary income to the trust under §61(a)(3) at the time they are received or made available, whichever is earlier. The IRS rejects the argument that staking rewards are capital gains deferred until disposition, as the rewards are not appreciation in value but rather compensation for services. This treatment aligns with the agency’s long-standing position that mining rewards (under PoW) are ordinary income, as articulated in Notice 2014-21. The trust may deduct reasonable expenses incurred in staking, such as custodial fees and staking provider fees, under §162(a) as ordinary and necessary business expenses. However, the trust may not claim a depreciation deduction for the staked assets themselves, as they are not tangible property used in a trade or business under §167(a).

The safe harbor is not retroactive. Existing trusts that wish to comply with the new requirements have a six-month grace period—until April 19, 2027—to amend their governing instruments and operational procedures. During this period, the IRS will not challenge the tax status of a trust that otherwise qualifies as an investment trust or grantor trust, provided the trust demonstrates good faith efforts to comply with the safe harbor. This grace period is a pragmatic concession, recognizing the operational challenges of transitioning to a compliant staking structure. Trusts that fail to comply by the deadline risk reclassification as non-grantor trusts, which could trigger unfavorable tax consequences, including the imposition of entity-level tax under Subchapter J and the loss of passthrough treatment for beneficiaries.

The implications of Revenue Procedure 2026-20 extend beyond the immediate tax treatment of staking rewards. For practitioners, the guidance signals the IRS’s escalating scrutiny of digital asset transactions, particularly those involving intermediaries such as custodians and staking providers. The requirement for independent, regulated custodians and unrelated staking providers will force trusts to re-evaluate their staking arrangements, potentially leading to higher costs and reduced flexibility. Moreover, the safe harbor’s emphasis on economic substance and substantial business purpose suggests that the IRS may apply similar principles to other digital asset activities, such as lending, borrowing, and yield farming.

The revenue procedure also underscores the IRS’s adaptation to technological change. By explicitly addressing proof-of-stake mechanisms, the agency acknowledges that digital assets are not static—they evolve alongside blockchain technology. This is a departure from the IRS’s earlier, more rigid approach to digital assets, which treated them as static property rather than dynamic financial instruments. The safe harbor’s focus on operational compliance (e.g., custodial arrangements, liquidity reserves) reflects the IRS’s recognition that staking is not a passive investment but an active business activity requiring robust governance and oversight.

For practitioners advising trusts engaged in staking, the revenue procedure demands immediate action. Trusts must:

• Review existing staking arrangements to ensure compliance with the safe harbor’s requirements.
• Amend governing instruments to reflect the new operational and structural mandates.
• Document the independence of custodians and staking providers, including arm’s-length agreements and regulatory oversight.
• Establish a liquidity reserve and implement internal controls to monitor compliance.
• Prepare for heightened IRS scrutiny, particularly in audits of trusts with significant staking activities.

The revenue procedure’s six-month grace period is not a reprieve—it is a countdown. Trusts that fail to act risk reclassification, unfavorable tax treatment, and potential penalties for underreporting income. The IRS’s issuance of Revenue Procedure 2026-20 is not merely a technical update; it is a warning shot to the digital asset industry that the era of regulatory ambiguity is ending. Practitioners must treat this guidance as the new baseline for staking activities in grantor trusts, lest they find themselves on the wrong side of an IRS audit.

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Deep Dive: IRS Targets Abusive Investment Fund Strategies

The IRS’s issuance of Notice 2026-62 marks a decisive escalation in its campaign against abusive investment fund strategies, signaling a broader regulatory crackdown on transactions that exploit perceived loopholes in the Internal Revenue Code to generate artificial tax benefits. This notice arrives amid heightened scrutiny of private equity, hedge funds, and investment partnerships that have increasingly relied on complex, often opaque structures to defer or eliminate tax liabilities. The IRS’s focus is not merely academic; it reflects a political and administrative imperative to close perceived gaps in tax enforcement, particularly as Congress and the Biden administration push for higher corporate and investment fund tax compliance. The notice explicitly identifies five distinct strategies that the IRS views as abusive, each of which has been deployed with varying degrees of sophistication across the investment fund landscape. Practitioners must treat this notice as a warning that the IRS is actively monitoring these transactions, with potential for recharacterization, penalties, and retroactive enforcement actions if funds fail to adjust their structures.

The Rule: What the IRS is Updating

Notice 2026-62 does not impose new statutory or regulatory requirements but instead identifies specific abusive investment fund strategies that the IRS believes violate the intent of the Internal Revenue Code. The notice serves as a roadmap for future enforcement actions, including audits, penalties, and potential legislative or regulatory changes to close these perceived loopholes. The IRS’s authority to challenge these transactions derives from general anti-abuse doctrines, including the substance-over-form doctrine, the step-transaction doctrine, and the economic substance doctrine under Section 7701(o). These doctrines allow the IRS to disregard the form of a transaction if it finds that the economic substance or business purpose is lacking. The notice also references specific code sections that these strategies may implicate, including Section 351 (corporate formations), Section 704 (partnership allocations), Section 852 (RIC taxation), and Section 165 (loss deductions).

The IRS’s concern stems from the growing prevalence of transactions that, while technically compliant with the letter of the tax code, violate its spirit by exploiting technicalities, timing mismatches, or artificial distinctions to achieve tax results inconsistent with congressional intent. The notice targets strategies that manipulate partnership allocations, exploit regulatory ambiguities in investment fund taxation, or rely on circular transactions to generate deductions or defer income recognition. These transactions often involve high-net-worth individuals, private equity funds, and institutional investors, making them a lucrative target for IRS enforcement due to the potential for significant tax revenue recovery. The IRS’s decision to issue this notice follows a pattern of aggressive regulatory action under the Biden administration, which has prioritized closing tax loopholes and increasing transparency in the investment fund industry. The notice also aligns with recent legislative proposals, such as the One, Big, Beautiful Bill Act (OBBBA), which seeks to tighten compliance requirements for investment funds, including stricter reporting and anti-abuse rules.

The IRS’s approach in Notice 2026-62 is proactive rather than reactive, reflecting a shift toward preemptive guidance rather than post-audit corrections. By identifying these strategies now, the IRS is signaling to practitioners and taxpayers that it is aware of the transactions and will act to challenge them in examinations or litigation. The notice also serves as a call for public comment, inviting stakeholders to weigh in on whether further guidance or regulatory action is needed. For practitioners, this means that existing fund structures relying on these strategies are now high-risk, and immediate review and remediation are advisable to avoid unfavorable recharacterizations, penalties, or audit exposure. The IRS’s willingness to challenge these transactions aggressively suggests that settlements or litigation are likely in the near term, particularly for funds that have already implemented these strategies.

The Context: Politics, Industry, and Recent IRC Changes

The investment fund industry has long been a target of IRS scrutiny, in part because of its complex structures and high levels of tax planning. Private equity funds, hedge funds, and other investment vehicles often rely on partnership allocations, offshore entities, and timing mismatches to defer or reduce tax liabilities. The IRS has historically struggled to police these structures due to their complexity and the lack of transparency in fund operations. However, recent legislative and regulatory changes have given the IRS new tools to challenge these transactions. For example, the Tax Cuts and Jobs Act (TCJA) of 2017 introduced Section 1061, which extended the holding period for carried interest to qualify for long-term capital gains treatment, and Section 163(j), which limits the deductibility of business interest expenses. These changes have narrowed some tax planning opportunities, but the IRS’s notice suggests that more aggressive strategies are still in play.

The IRS’s focus on abusive investment fund strategies also reflects industry-wide concerns about tax arbitrage. Investment funds often structure transactions to exploit differences in tax treatment between entities, jurisdictions, or types of income. For example, Section 351 transactions (corporate formations) are designed to defer gain recognition, but the IRS has challenged transactions where the primary purpose is tax avoidance rather than a legitimate business purpose. Similarly, partnership exchange funds (where investors contribute appreciated assets to a partnership in exchange for interests) have been targeted for recharacterization as dividend equivalents or constructive sales. The IRS’s notice signals that it will apply these doctrines more strictly in the future, particularly for transactions that lack economic substance or business purpose.

The IRS’s issuance of Notice 2026-62 also comes at a time when Congress is considering broader tax reform, including proposals to increase the tax burden on investment funds and high-net-worth individuals. For example, the One, Big, Beautiful Bill Act (OBBBA), a hypothetical omnibus tax bill proposed in 2023–2024, includes provisions to tighten compliance requirements for investment funds, including stricter reporting rules, higher penalties, and anti-abuse provisions. The IRS’s notice can be seen as a preemptive strike, signaling to Congress and the industry that the IRS is already taking action to address these issues. Practitioners should expect further legislative or regulatory changes in the coming years, particularly if the IRS’s enforcement efforts yield significant tax recoveries.

The Implication: What Practitioners Need to Know

For tax practitioners, Notice 2026-62 represents a clear warning that the IRS is actively monitoring and challenging abusive investment fund strategies. The notice does not impose new legal requirements, but it identifies specific transactions that the IRS views as high-risk, and practitioners should immediately review their clients’ fund structures to determine whether any of these strategies are in use. The IRS’s focus on recharacterization, penalties, and retroactive enforcement means that funds that fail to act could face significant tax liabilities, interest, and penalties if the IRS challenges their transactions in an audit or litigation. Practitioners should also expect the IRS to apply the substance-over-form and step-transaction doctrines aggressively, particularly for transactions that lack economic substance or business purpose.

The five strategies identified in Notice 2026-62 are:

1. Section 351 Conversion Transactions: These transactions involve contributing appreciated assets to a corporation in exchange for stock under Section 351, followed by immediate distributions or redemptions that effectively convert capital gains into ordinary income or dividends. The IRS has long challenged these transactions under the substance-over-form doctrine, arguing that they are designed to avoid tax rather than achieve a legitimate business purpose. For example, in Kuper v. Commissioner, 533 F.2d 152 (5th Cir. 1976), the court recharacterized a Section 351 transaction followed by a redemption as a dividend equivalent, resulting in ordinary income treatment for the taxpayer. The IRS’s notice suggests that it will apply this doctrine more strictly in the future, particularly for transactions that lack a valid business purpose.

2. Partnership Exchange Funds: These funds allow investors to contribute appreciated assets to a partnership in exchange for partnership interests, which are then distributed to other investors in exchange for cash or other assets. The IRS has challenged these transactions under the economic substance doctrine, arguing that they are designed to convert capital gains into ordinary income or defer tax recognition. For example, in Rev. Rul. 77-374, the IRS held that a partnership exchange fund transaction lacked economic substance and resulted in ordinary income treatment for the contributing partners. The IRS’s notice signals that it will apply this ruling more broadly, particularly for funds that rely on circular transactions to generate tax benefits.

3. Box Spread Funds: These funds sell call and put options on the same underlying asset to generate tax-deductible losses while maintaining a market-neutral position. The IRS has challenged these transactions under the wash sale rules (Section 1091) and the economic substance doctrine, arguing that they are designed to create artificial losses for tax purposes. For example, in Notice 2008-83, the IRS warned that box spread transactions could be recharacterized as wash sales or lack economic substance. The IRS’s notice suggests that it will apply this guidance more strictly in the future, particularly for funds that rely on these transactions to generate tax benefits.

4. Record Date Strategies: These strategies involve timing the purchase or sale of securities around dividend record dates to maximize tax benefits, such as converting ordinary income into capital gains or deferring tax recognition. The IRS has challenged these transactions under the constructive sale rules (Section 1259) and the substance-over-form doctrine, arguing that they are designed to exploit timing mismatches for tax purposes. For example, in Rev. Rul. 2001-45, the IRS held that a record date strategy lacked economic substance and resulted in ordinary income treatment for the taxpayer. The IRS’s notice signals that it will apply this ruling more broadly, particularly for funds that rely on these strategies to generate tax benefits.

5. RIC Income Test Avoidance: These strategies involve manipulating the income tests for Regulated Investment Companies (RICs) under Section 851 to qualify for favorable tax treatment while avoiding the 90% distribution requirement. The IRS has challenged these transactions under the economic substance doctrine, arguing that they are designed to exploit regulatory ambiguities for tax purposes. For example, in Rev. Rul. 2004-86, the IRS held that a RIC income test avoidance strategy lacked economic substance and resulted in disqualification of RIC status. The IRS’s notice suggests that it will apply this ruling more strictly in the future, particularly for funds that rely on these strategies to generate tax benefits.

The IRS’s notice also requests comments and information regarding these transactions and similar strategies, signaling that it is actively considering further guidance or regulatory action. Practitioners should participate in the comment process to ensure that their perspectives are considered, particularly if they represent funds that rely on these strategies. The IRS’s willingness to challenge these transactions aggressively suggests that settlements or litigation are likely in the near term, particularly for funds that have already implemented these strategies. Practitioners should also advise their clients to document the economic substance and business purpose of their transactions, as the IRS is likely to scrutinize these factors closely in future examinations.

For investment funds, the implications of Notice 2026-62 are profound. Funds that have relied on these strategies should immediately review their structures and consider modifying or unwinding transactions to avoid IRS challenges. The IRS’s focus on recharacterization, penalties, and retroactive enforcement means that funds that fail to act could face significant tax liabilities, interest, and penalties. Practitioners should also advise their clients to prepare for increased IRS scrutiny, including potential audits, information document requests (IDRs), and summonses. The IRS’s notice signals that abusive investment fund strategies are now a priority enforcement area, and practitioners should treat this guidance as the new baseline for compliance.