Case Study 7-1: Taxation of Cryptocurrency - Mining (Disregarded Entity - Inventory - Tax Liability)
Index - https://steemit.com/tax/@alhofmeister/tax-blog-index
To complete my earlier examples, I've decided to calculate the tax due on each one. To identify the tax impact of the transaction, I have excluded income from other sources as well as the standard deduction/personal exemptions.
Note that I am treating cryptocurrency mining as an activity which would qualify for the 20% deduction for pass through entities for 2018. The activity might not qualify under IRC 199A as it might fall into the definition of dealing in commodities which will hopefully be clarified by IRS regulations this year.
Problem
Taxpayer A decides to mine Bitcoin in January. To accomplish this task, Taxpayer A acquires mining hardware for $500, purchases software for $50 and joins a mining pool that distributes earnings net of a 5% surcharge. Each month, the mining operation increases the electricity bill by $100. In addition, Taxpayer A manages the website the mining pool uses to advertise and is paid $50 a month. Taxpayer A uses a personal computer that is also used for personal reasons (40% personal/60% business). The personal computer was acquired in a prior year and converted to it's current use. The computer cost $600 when it was originally purchased but it's current fair market value is $300. Over the course of the year, Taxpayer A receives the following payouts from the mining operation:
- In February, Taxpayer A is awarded 0.05 Bitcoins when it is valued at $13,000.
- In April, Taxpayer A is awarded 0.08 Bitcoins when it is valued at $14,000.
- In May, Taxpayer A is awarded 0.04 Bitcoins when it is valued at $10,000.
- In August, Taxpayer A is awarded 0.02 Bitcoins when it is valued at $16,000.
- In November, Taxpayer A is awarded 0.10 Bitcoins when it is valued at $12,000.
Additionally, Taxpayer A engages in the following transactions throughout the year:
- In March, Taxpayer A sells 0.05 Bitcoins when it is valued at $15,000. Transaction fees totaled $50.
- In May, Taxpayer A sells 0.08 Bitcoins when it is valued at $10,000. Transaction fees totaled $50.
- In June, Taxpayer A sells 0.04 Bitcoins when it is valued at $12,000. Transaction fees totaled $50.
- In September, Taxpayer A sells 0.02 Bitcoins when it is valued at $16,000. Transaction fees totaled $50.
- In December, Taxpayer A sells 0.10 Bitcoins when it is valued at $13,000. Transaction fees totaled $50.
Solution
2017
2018
Disclaimer
Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.
Great example, very comprehensive. Just to be clear, this is under the fact pattern that mined cryptocurrency is inventory thus ordinary income? I think that makes logical sense as a conservative position (inventory is mentioned in the Notice 2014-21, albeit apparently without bright-lining mined crypto as an ordinary income asset). The position a taxpayer chooses for mined crypto (ordinary versus capital) has significant implications on the profitability of mining in the U.S. at a larger scale.
For my examples, I wanted to look to the taxpayer's selling patterns to try and determine if the property should be treated as inventory or capital. Does the taxpayer hold onto the property as an investment or do they immediately turn around and sell it? Treating it as inventory would clearly be the more conservative approach, but I feel that looking to how the taxpayer treats the property is a reasonable approach.
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