Overview: Cryptocurrency Mining as a Taxable Event
US taxpayers are obligated to accurately report all their cryptocurrency transactions when filing tax returns. The IRS has issued clear directives that cryptocurrency dealings which generate income (including cryptocurrency mining activities) qualify as taxable income.
Therefore, mining crypto is a taxable event that needs to be reported to the Internal Revenue Service. Most importantly, the reporting should be at par with the market value of mined coins or cryptocurrency at the time those coins are received. If the mined coins are sold or disposed of, this constitutes a taxable event, and reporting must be at par with the value of coins at the time of selling.
How Is Cryptocurrency Mining Income Treated? And, How Is Cryptocurrency Mining Reported?
Crypto mining income is viewed and taxed as ordinary income, which attracts a tax rate of 10–37%. When mined crypto is sold, it is treated as capital gains or losses depending on if the value of the coins has risen or fallen since being mined.
Mined income is reported in different forms depending on the nature of the mining – i.e., is it a hobby or a regular business activity? It's the responsibility of a US taxpayer who mines cryptocurrency to be compliant with IRS rules on crypto mining.
You should know which IRS forms to use when reporting, maintain accurate records on your mining activities, and report such activities accurately to avoid serious penalties and charges such as perjury, contempt, tax evasion, and possible jail time.
Since staying up to date with the latest IRS take on cryptocurrency can be a daunting task, you should consider seeking help from experts. Retaining an attorney with experience in legislation and guidelines on cryptocurrency mining is highly recommendable and the first step to protecting yourself.
Blockchain & Cryptocurrency Mining
Blockchain is simply a decentralized distributed public ledger that stores all transactions. This creates a permanent and secure record of transactions verifiable through peer-to-peer networks.
Crypto mining is a process characterized by verifying crypto transactions. Mining is done via computers which solve complicated mathematical problems (equations). Miners who solve the equation first get an award (cryptocurrency). Other miners verify the winning miner's solution before validated transactions form a “block" and move to the blockchain.
All transactions are public. However, individual parties responsible for the transactions aren't identified. This makes crypto transactions anonymous. Cryptocurrency mining requires substantial computing power. Besides incurring a huge power cost, it is also expensive to buy computers capable of mining profitably. Mining also has tax implications.
Crypto Mining Tax Implications
Many tax implications arise from crypto mining. What's more, all these must be reported to the IRS on specific forms. Tax obligations differ based on factors such as reasons for mining. Taxpayers must be aware of the tax implications of mining as a hobby and as a business.
The IRS is increasingly focused on crypto mining entities and individuals. Most importantly, the IRS does due diligence on crypto exchanges and utilizes other technology such as AI (Artificial Intelligence) and ML (Machine Learning) to monitor and capture “suspect" crypto transactions.
If you don't report your cryptocurrency mining activities or report false earnings, you can attract IRS audits or criminal penalties like jail time in serious cases.
“Criminal prosecution for crypto mining-related offenses can attract tax evasion, perjury contempt, and other serious charges. Criminal defense attorneys can defend persons against such charges and other crypto-related charges." – Dr. Nick Oberheiden (Founding Attorney, Blockchain Lawyer)
Crypto Mining as Taxable Events
Taxable Event 1: Mining and Receiving New Cryptocurrency
As mentioned above, this taxable event qualifies as ordinary income. This event is triggered when new cryptocurrency from mining is deposited into a miner's wallet, marking a successful crypto mining transaction. The miner (US taxpayer) owes taxes on the mined income immediately the income is earned whether the value of the new crypto increases or decreases going forward.
Taxable Event 2: Disposing New Crypto Acquired from Mining
As mentioned above, this taxable event qualifies as capital gains/loss thus is taxed as per capital gains tax rates. This event is triggered when you successfully sell, exchange, or dispose of your new crypto earned from mining. If the crypto rises in value by the time you sell, you will own capital gains tax. If the crypto falls in value, you will have a capital loss which you can offset with capital gains from other assets.
The time it takes before selling also matters. If you take less than a year to sell your new crypto, this results in short-term capital gains/losses. If you take over a year to sell, this translates into long-term capital gains/loss.
The IRS' Notice-2014-21 offers notable guidelines on crypto mining taxation. For instance, it states that income from crypto mining should be added to gross income. Most importantly, the taxpayer should use the fair market value during the time they receive the income.
The importance of keeping records on when crypto is mined, the amount mined, the time mined, and fair market value received can't be overemphasized.
Cryptocurrency Mining Tax Example
If you mine cryptocurrency (such as Bitcoin) and earn 1 Bitcoin valued at $42,000 as the fair market value, and you choose to sell at $60,000 two years later, you will have earned $18,000 in long-term capital gains. The fair market value minus cost results in a net capital gain which is subjected to the applicable long-term capital gains tax rate.
What Are the Tax Implications of Crypto Mining as a Hobby?
Cryptocurrency mined as a hobby should be reported as income (other income) in Schedule 1 (Form 1040). The specific tax rate will depend on a taxpayer's income bracket. While reporting your mining activities as a hobby is easy and fast, you aren't able to enjoy deductions applicable when mining as a business.
What Are the Tax Implications of Crypto Mining as a Business?
Since mining as a business is unique, there is usually no employer to give their employees W-2 forms. What's more, mining companies aren't obligated to issue Form 1099-MISC to independent contractors.
However, the IRS Notice 2014-21 gives special guidance on self-employed miners. These miners are subject to self-employment tax. Provided mining activities weren't done as an employee, and they were part of a business or trade, net earnings minus allowable deductions are subject to self-employment tax. Earnings from crypto mining as a business should be reported on Schedule C as income.
What Deductions Will I Enjoy When Mining Cryptocurrency as a Business?
The IRS (through Internal Revenue Code – Section 162) allows crypto miners to take several deductions when mining for business purposes. The deductions include all necessary and ordinary expenses incurred and paid during a taxable year due to business or trading.
A typical example would be electricity costs of mining, rent paid to house your crypto mining rig/computers, and money spent to buy mining computers and other equipment. What's more, if your cryptocurrency mining business loses money, you can deduct those losses from other income due.
Examples of deductions include electricity, repairs, rent, and equipment for mining. Also, if the mining business loses money within the tax year, it may be eligible to offset those losses against other income.
Summary: IRS on Crypto Mining
Cryptocurrency mining is an increasingly popular activity. If you are a US taxpayer who mines for fun or as a business, you have tax obligations that must be met. If you overlook these tax obligations or provide false information, you risk many negative consequences ranging from IRS investigations to facing serious criminal charges like tax evasion.
The IRS already has the resources to monitor cryptocurrency activities ranging from mining to individual transactions. The agency can also subpoena cryptocurrency exchanges and other institutions doing business with US taxpayers to uncover illegal cryptocurrency activities. Instead of waiting to be subjected to an IRS investigation, it's important to engage in compliant crypto mining activities. This calls for maintaining accurate records on all your crypto mining activities.
Since this can be a challenge, seek help from experts in tax matters relating to crypto mining and related activities.
Contact us today for help and representation on all crypto tax issues.
