US Tax Considerations – Tax Guidelines for Mining Cryptocurrencies (Bitcoin, Ethereum, STEEM, etc.)
Mining Virtual Convertible Currencies (Cryptocurrencies)
Recent enforcement action and "John Doe" record demands issued by the Internal Revenue Service have placed a focus on tax compliance in the cryptocurrency community which has not existed until recently. The US Income Tax questions a virtual convertible currency miner has are similar in scope to traders (such as tax rules related to sale and exchange rules), and different as it refers to earning block rewards for mining cryptocurrency. The guidance provided by the Internal Revenue Service on March 25, 2014, in Internal Revenue Notice IR-2014-36 provided guidelines on tax treatment for activities related to mining cryptocurrency.
For purposes of this article, the terms virtual convertible currency, cryptocurrency and crypto will be used interchangeably.
Let’s take a look at the issues related to mining cryptocurrencies…
But First, the Required Legalese…
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.
Earning the Block Reward is a Taxable Event
According to the Internal Revenue Service guidance issued on March 25, 2014 (Internal Revenue Notice IR-2014-36 IRS Virtual Currency Guidance), when a taxpayer earns a block reward of virtual convertible currency (Bitcoin, Ethereum, STEEM, etc.) for successfully mining a new block on the Blockchain, the taxpayer has earned taxable income. The taxable income earned is the determinable fair market value (in USD) of the virtual convertible currency earned from the block reward.
Imagine we decide to set up a cryptocurrency mining rig in our basement to mine some STEEM (or another cryptocurrency). Also, consider our mining rig has successfully generated block rewards which earn 100 STEEM on the first day of operation, and the USD value of STEEM at the close of trading on our preferred cryptocurrency exchange values STEEM at $0.20 per token. Based upon the guidance issued by the IRS, we would have (100 STEEM x $0.20 per STEEM token) = $20 of taxable income to report.
Now suppose on the second day of mining for blocks, our mining rig successfully generates block rewards which earn 50 STEEM, and the USD value of STEEM at the close of trading was closer to $0.30 per token. Calculating our cumulative taxable income would be:
- Day 1: (100 STEEM x $0.20 per STEEM token) = $20.00
- Day 2: (50 STEEM x $0.30 per STEEM token) = $15.00
Our total taxable income to report would be $35.00.
An earlier installment in the US Tax Considerations series (US Tax Considerations When Blogging for Magic Internet Money (Part I) touched on the topic of how to value cryptocurrencies earned for Author Rewards and Curation Rewards on Steemit. Those same valuation techniques are applied in valuing block rewards earned for mining.
Selling the Virtual Convertible Currency is a Taxable Event
Internal Revenue Notice IR-2014-36 IRS Virtual Currency Guidance set forth virtual convertible currencies are treated as property for US Federal Income Tax purposes, and cryptocurrency transactions are governed by the same general tax principles associated with property transactions. As a result, all sales and exchanges of cryptocurrency have realized capital gains/losses which must be reported for US tax purposes.
If we continue to expand upon the example from the section above, imagine we decide to sell off the tokens earned from the first day of operation (100 STEEM valued at $0.20 per STEEM token) and suppose we sell them for a $0.30 per STEEM token.
- Basis of STEEM tokens (Original Value): $0.20 per STEEM token
- Sale Price of STEEM Tokens: $0.30 per STEEM token
(Sale Price of STEEM token – Basis of STEEM Token) = Reportable Capital Gain/(Loss)
$0.30 - $0.20 = $0.10 Capital Gain per STEEM token
Capital gains realized from the sale or exchange of STEEM tokens held longer than one year and one day are taxed at potentially favorable Long Term Capital Gain rates. An earlier installment of the US Tax Considerations series (US Tax Considerations When Blogging for Magic Internet Money (Part II)) touches on this topic in greater detail.
What to Report
Based upon the guidance issued by the Internal Revenue Service in Internal Revenue Notice IR-2014-36 IRS Virtual Currency Guidance, and for purposes of the example in the above sections, we would have two taxable events to report:
The first taxable event is $35 of taxable income earned in block rewards related to mining. The tax treatment of this first event is to tax the rewards earned as ordinary income.
The second taxable event is $10 of capital gain realized from the sale or exchange of STEEM tokens. The tax treatment of this second event is to tax the capital gain from the sale of STEEM as a capital gain.
Mining Virtual Convertible Currency as a Trade or Business
While a business created for the purpose of mining virtual convertible currency is beyond the scope of this article, a brief discussion on this point will be covered.
It is possible a taxpayer could decide to form an entity engaged in the trade or business of mining virtual convertible currency, where the entity (rather than the taxpayer) engages in the mining activity as a for-profit activity. In this scenario, it is feasible the tax treatment of the mining and sale of virtual convertible currencies would be different, and all profits generated would be taxed as ordinary income and subject to self-employment tax. The primary questions to determine this would be are you engaged in a trade or business as defined by the Title 26 The Internal Revenue Code, and should your virtual convertible currency be treated as inventory instead of property?
Should you find yourself in this scenario, contact a tax professional for more guidance related to for-profit businesses engaged in cryptocurrency mining activity.
Wrapping it up
Based upon guidance issued by the Internal Revenue Service on March 25, 2014, earning block rewards related to mining a virtual convertible currency is a taxable event which must be reported for income tax purposes. Generally speaking, sales and exchanges of cryptocurrency earned from block rewards related to mining are subject to a second taxable event from the realized capital gain/loss at the time of the exchange or sale. With the most recent enforcement actions aimed at Coinbase, every cryptocurrency miner should focus on the quality of their record keeping and income tax reporting to remain in compliance and avoid costly penalties.
Have a tax question? Please feel free leave a question in the comment section below, and I may feature it in a future blog post.
Please follow me on my blog @lpfaust if you enjoy my content.
how enforceable is that?
Since cryptocurrency doesn't go by account numbers linked by your personal number. But they will try to get people to consent to resulting USD credits that show up in banking systems and call them income. But it is energy not money...
@virtualgrowth my personal opinions on whether or not STEEM mined should be taxed aside, the Internal Revenue Service guidance issued on March 25, 2014 (Internal Revenue Notice IR-2014-36 IRS Virtual Currency Guidance) already laid out regulatory guidance that virtual convertible currency (cryptocurrencies) are considered to be property and are subject to the general tax rules associated with property. Also, Title 26 Internal Revenue Code specifies the income subject to the tax code is the taxpayer's worldwide income. There are some extensive sections on the taxation of property, receiving compensation in the form of property and how to value it for tax purposes.
Unfortunately legal precedent in the US Tax courts would disagree with your position.
Of course. I have no need to continue further.
@everittmickey Thanks for checking out the article and the question.
If the question of enforcement feasibility is focused on whether or not they have legal jurisdiction, the answer is they do have jurisdiction and moreover, the government body responsible for their oversight (TIGTA) released two scathing reports in September about their negligence with enforcement actions related to illegal transactions and illegal tax evasion with cryptocurrencies. This is what caused the John Doe record demand with Coinbase.
If the question of enforcement is do they have the resources, the answer is not really, but they will make this a priority. In response to the three general concerns raised by the auditors, the IRS couched every reply with a limited resources caveat. I think crypto has become the flavor of the day for enforcement for a number of reasons which would be an excellent subject for a later topic, but not really relevant here.
How would they enforce this action? By systematically hitting the crypto exchanges (on ramps and off ramps) with record demands. In my earlier piece US Tax Considerations – IRS Warned by TIGTA to Focus on Illegal Use of Virtual Currency | IRS Demands Coinbase Records, I specifically laid out how I think the enforcement actions will proceed. In it I speculated Steemit will probably get a record demand fro the IRS sometime next year after Poloniex and some other exchanges receive theirs and comply in various ways (I suspect they will).
I hope that answers your question.
Youre welcome
Back in the day...it was said.
"Never give an order that you KNOW won't be obeyed.".
just saying.
Cruz said he'd eliminate the IRS
Will Trump?
I've been audited twice by the IRS and it's been a pain in the behind. But each time they were wrong and we did our taxes correctly.
I've been audited once..
Same thing..you're right.
The auditor was a moron.
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Extremely useful! Thank you!!
@liquidsolomon I have been meaning to get some guidelines out for miners. I'm glad you find some value in it.
Shared on twitter
Disclaimer: I am just a bot trying to be helpful.
@virtualgrowth thanks for the share on Twitter. I appreciate it.
Would you expect some difference with how this is handled with steem power vs steem? With payments in steem power, the miner or writer would only have access to the funds after a set date or schedule.
@lafona Thanks for taking the time to read and comment. I appreciate it
Block rewards, author rewards and curation rewards all have a dual tax component to them regardless of how the reward is paid (STEEM, STEEM Power or STEEM Based Dollars). The first component is income tax on the reward component on the determinable fair market value of the reward received when awarded- essentially it is treated as income. The second component is capital gains tax on any sale or transfer of STEEM, STEEM Power or STEEM Based Dollars upon exchange or transfer.
Bearing that in mind, the question asked is would the tax treatment be different if awarded with STEEM Power as opposed to STEEM, and if so, how?
The first tax component (income tax) would not any different. When a block reward is awarded to a miner in STEEM Power, at that point in time, the award has a determinable fair market value, the same as being awarded in STEEM tokens. Per the Internal Revenue Service guidance issued on March 25, 2014 (Internal Revenue Notice IR-2014-36 IRS Virtual Currency Guidance), this determinable fair market value must be reported as ordinary income.
The second component (capital gains tax) would not be different either.
Something which should be considered and was not touch upon in the article is, according to the March 25, 2014 guidelines, all inflation awards (interest) awarded to both STEEM Power and STEEM Based Dollars held by the taxpayer are subject to these same reporting and taxation rules.
Is there a way to change the tax treatment?
The answer is yes. It was alluded to in the article in the very brief discussion of a for profit entity whose business is mining crypto. The entity would have to satisfy the definition and guidelines of a for profit business as outlined in the Internal Revenue Code or it could be reclassified as a Passive activity or a Hobby, eliminating many tax deductible expenses.
I hope that answers your question.
Wow, thanks for the response. For the first tax component (income tax) could the fair market value be affected by the ability to sell the property? The reason I ask is because it is impossible to sell steem power on the day you receive it and in a bear market you could be forced to sell it much lower than the value on the day it was received as payment. In an extreme scenario, someone could owe more taxes than the property was worth by the time they had the chance to sell it. Thanks
@lafona no problem as far as the response goes. I'm glad to help the community with their tax questions related to cryptocurrencies as a whole.
In terms of your question as to whether or not determinable fair market value would be affected by the ability to sell the virtual convertible currency, the short answer is it would not.
The guidance provided by the IRS on this subject reads:
For U.S. tax purposes, transactions using virtual currency must be reported in U.S. dollars. Therefore, taxpayers will be required to determine the fair market value of virtual currency in U.S. dollars as of the date of payment or receipt.
The ordinary income portion of the first tax component is time independent, meaning the tax event is triggered by accepting the reward because a fair value can be determined at the time when goods or services are exchanged for the crypto.
So where do we get to recapture that loss to offset the value lost when we sell?
That is captured and recognized when the sale of the crypto occurs at a loss because a determinable fair value exists when the sale completes and the loss can be quantified and reported. This would be the second tax component (the capital gain/loss). This component is time dependent.
Regarding your question asking if someone could owe more tax than the property was worth by the time they had a chance to sell the property, I think the wrong question is being asked. I think the question which should be asked is in an extreme situation, is it possible a person could have to pay tax for the full value of the earned rewards (first tax component) before recognizing the full tax deduction associated with the loss of value (second tax component)? The answer to that question is yes due to rules regarding limitations related to capital losses being used against ordinary income. If the total capital loss exceeds $3,000, then it will take multiple tax periods to "use up" that capital loss. In the end, you will still receive all of it, just not all in the same period.
I hope that answers your question.
Good heads up, thanks
@munteanu thanks for taking the time to check out the article and to leave a comment. I appreciate it. I'm glad you found some value in it.
I followed and upvoted. Please follow, upvote and comment back steemit.com/@affltr
"While a business created for the purpose of mining virtual convertible currency is beyond the scope of this article."
If one person were to start mining a virtual currency today (with the potential of earning a five fig a year income). Would it be beneficial to pay taxes as a business/LLC or file personal income? What are the benefits filing as an entity in this scenario?
This is the most undervalued article that I have found on steemit...thankyou kind Sir.
I want to form an LLC, but then again I may have to end up paying quarterly taxes and self employment tax on top of that Federal and State taxes have to be figured out, I have to report my earnings and that is taxed and then I'm taxed again on my gains when I sell the coins. Dear lord, after noting this all down I just feel a little overwhelmed.
Mining in UE is not considered yet as an activity to be taxed. In addition, as long as, you keep your crypto-currency in your crypto-account (without convert it in FIAT currency) there is no tax to be report.
I believe for US citizens, the life is harder, since it has been specifically defined that "mining" is an activity subject as taxable income.