Bitcoin Mining Is Not a Tax Free Exercise
Bitcoin mining is not a tax free exercise – no matter if its a hobby or for business. Knowing how taxes play a role in your bottom line is key to realizing all the benefits of dedicating your expensive hardware to secure a decentralized cryptocurrency network.
The IRS highlights the tax implications of bitcoin mining in Notice 2014-21, Q-9. The regulatory agency defines an individual who “mines” virtual currency as a “trade or business subject to self-employment tax on the income derived from those activities.”
So long as not done by the taxpayer as an employee, Bitcoin received through ‘mining’ for trade or business often constitutes self-employment income. Net earnings in self-employment is equal to gross income from trade or business, less allowable deductions.
Individuals generally work as employee or independent contractor. On behalf of their employees, employers account for, and collect via payroll employment taxes. Individuals work as 1099 independent contractors and account for their own taxes.
If you mined your bitcoins, as IRS Notice 2014-21 elaborates, miners have to recognize income for each bitcoin mined during the taxable year. The amount of income equals the market price of bitcoin on the day it is awarded on the blockchain, which is also then the miner’s basis in the bitcoin going forward and is used to calculate gain/loss in the future. The IRS illustrates an example for taxpayers.
“…[A]ssume you mine 1 bitcoin in 2013,” the government tax agency writes. “On the day it was mined, the market price of bitcoin was $1,000. You have $1,000 of taxable income in 2013. Going forward, your basis in the bitcoin is $1,000. If you later sell the bitcoin for $1,200, you have a taxable gain of $1,200 – $1,000 = $200.”
It adds: “Your mining expenses, such as electricity, would not be included into basis. Instead, they would be deductible in the taxable year as an expense. Miners will need to determine if their mining activity rises to the level of a trade or business, which is a highly factual determination.” The Agency also outlines what sorts of expenses a miner can deduct.
“If your mining operation is substantial and continuous enough to be considered an actual business, then you can deduct all of your ordinary and necessary expenses,” writes the IRS. “This would include the cost of electricity and depreciation on your mining rig, among others. If your mining operation is not substantial or continuous, you would deduct expenses like an ordinary investor.
The tax treatment of Bitcoin mining is “uncertain”, the IRS admits. “So, its important that you obtain the advice of a tax professional with regards to whether or not your activity rises to the level of a trade or business.”
https://www.irs.gov/pub/irs-drop/n-14-21.pdf
Miners must pay bitcoin mining taxes whether it is a business or a hobby. Self-employment tax must be paid when your net self-employment income is more than $400 in any tax year. Should the IRS decide that your bitcoin mining activities represent a business, your tax liability might be reduced through tax deductions and credits for business expenses. If the IRS sees your mining as a hobby, these options are not available.
Mining bitcoins, the process of which which is considered income, constitutes a taxable event, and expenses can be deducted if the IRS determines your operations to be a business. When miners sell their bitcoin, they can be taxed on the capital gains based on the amount the holding’s value had increased since the time of mining.
When this amount represents a loss, then it could be declared as such for tax purposes. (The IRS sees mined bitcoins as immediate income at market value of the mined coins mining date) Therefore, it is important miners know the price of bitcoin at the time of the coins having been mined.
The above information applies generally to alternative cryptographic assets and mining pools alike. Many independent contractors are required to make quarterly tax payments or face a penalty for a failure to make timely payment.