Mining for cryptocurrency can be a major money-maker. It can also leave a miner scratching their head wondering just how much their tax bill will be at the end of the year. Use this guide to help you avoid any nasty surprises when it comes to the taxation of mining income.
What is Cryptocurrency Mining?
Mining is a process used by Proof-of-work (PoW) blockchains to verify transactions, maintain network security, and generate coins which are paid as rewards to miners.
Using powerful computers running complex mining algorithms, miners compete to be first to validate and verify a set of transactions called a block. Once each block is verified it is added to the blockchain.
The first miner to verify the block is rewarded with coins as a reward for their services. This acts as a financial incentive for miners to continue supporting the blockchain, i.e. maintaining the network and ensuring security.
Do You Have to Report Crypto Mining on Taxes?
Yes, cryptocurrency miners are required to report the results of their mining activity on their tax returns. The market value of the mined coins at the time of receipt will be treated as income. Furthermore, when the mined coins are sold or disposed of at a later date, capital gains or capital losses are incurred.
In other words, both of these trigger a tax event that results in tax owed to the government on the income earned.
Let’s better understand this with the help of an example:
Alex obtained 1 bitcoin as a reward on April 01, 2021. The market value of 1 bitcoin on April 01, 2021 was $50,000. Alex sold the 1 Bitcoin on April 15, 2021 when the market price of 1 Bitcoin was $60,000
This is what the income reported on Alex’s tax return for FY 2021 would look like:
Next let’s see how this would be taxed.
How Are Crypto Mining Rewards Taxed?
Income from mining of cryptocurrencies are subject to two tax events:
- Ordinary Income - based on the market value of coins at the time of receiving the rewards.
- Capital Gains - when the coins are sold or disposed of at a later date.
Mining rewards are taxed as Ordinary Income based on the market value of the coins on the date of receipt.
The tax rate charged on the said income will be according to the applicable slab rates. The slab rates for FY 2021 federal income taxes are below.
Note 1: Mining income reported as business income will also trigger a 15.3% self-employment tax.
Note 2: Income may be subject to additional state income taxes based on residence.
In the above example, Alex had a tax event on April 01, 2021 of receipt of 1 bitcoin as a mining reward. As a result, his income of $50,000 will be taxed as per his applicable federal tax slab rate.
On the subsequent sale or disposal of mining rewards, capital gains or capital losses are incurred. The amount of capital gains made or losses incurred is dependent on the movement of price between the date of sale and the date of receipt of the mining rewards.
The formula to calculate gains/losses is simple:
Capital gain/loss = Sale price - Cost basis
In case of a favorable movement, meaning the sale price is higher than the cost basis, you will result in a Capital gain.
In case of an adverse movement, meaning the sale price is lower than the cost basis, you will result in a Capital loss.
It’s important to note that your tax rate for capital gains depends on the period of holding and amount of income.
Crypto assets held for equal to or less than 365 days will be classified as short term and those held for more than 365 days will be classified as long term.
The tax rate for short term capital gains is the same as ordinary income slab rates (refer to the above table).
The tax rate for long term capital gains varies between 0% to 20% (refer to the below table).
How Should Crypto Miners Report Income?
When reporting income from crypto mining on your taxes, you’ll need to first make a determination on whether your mining was a hobby or a self-employed business. Mining income can be reported either as hobby or business income and this affects whether you can claim deductions to lower your taxes and whether you need to pay additional self-employment tax.
The IRS provides a list of factors which can be used to determine if mining activity is a hobby or business income. Some of the factors are:
- Whether accurate and complete books of accounts and records are maintained
- Expertise of taxpayer or advisors
- Time and effort invested in the activity indicates an intention to make profit
- Expectation of appreciation in price
- Success in making a profit in similar activities in the past
- Amount of occasional profits earned
To summarize, operating a mining farm on a large scale will be classified as business income. Mining from an old computer or on a personal level will be classified as a hobby.
Reporting for Mining as Hobby
The value of coins received as mining rewards should be reported in Point 8z - Other Income of Form 1040 Schedule 1 Part I. Ensure you report the nature of income as “Mining rewards”.
No expenses deduction will be allowed if income is reported as a hobby.
Reporting for Mining as Business Income
Business income and expenses will be reported in Schedule C (Profit or loss from Business) of Form 1040 or other business returns depending on the nature of the business entity (Form 1065, Form 1120, Form 1120S).
In case of business income, self-employment taxes will also be payable at 15.3%. Remember to maintain your books of accounts and records in case of an IRS audit.
The upside of reporting mining as business income though is that it will provide deductions of business expenses from your taxable income.
What Tax Deductions Are Available for Mining Businesses?
Reporting mining as business income will allow you to write-off expenses associated with the business. This will help reduce your overall tax liability.
Some of the expenses that mining businesses can write-off are:
This is one of the biggest expenses of a miner. It is important to maintain proper records of electricity used solely for mining purposes. If mining from home, it’s best to use a separate meter to maintain a track of units of electricity used.
Proper documentation will ensure deduction for electricity is allowed and can be used to justify the cost in case of an IRS audit.
2. Equipment used to mine:
There are two opinions on claiming expense deduction for mining equipment:
- Option 1: Section 179 deduction
Section 179 allows companies to deduct tangible assets directly as expenses in the year of purchase rather than capitalizing it and charging depreciation.
This can be used as an option where the amount of equipment purchased in a year is up to $2.7 million.
- Option 2: Depreciation
You can capitalize the cost of mining equipment purchased and claim depreciation as per modified accelerated cost recovery system (MACRS) as expense deduction.
Hardware equipment used for mining can break down and require repairs. All expenses incurred during the year for repair could be claimed as an expense deduction.
Ensure you keep all invoices as records to avoid disallowance of expense in case of an IRS audit.
The five most important things to remember about reporting income from crypto mining on your tax returns are:
- Mining income is taxed at two tax events. First, when the mining rewards are received as Ordinary income. Second, when such mining rewards are disposed of, as Capital gains.
- Ordinary income and Short term capital gains are taxed at applicable federal Income tax slab rates (additional self-employment tax and state income taxes may also apply).
- Long term capital gains are taxed between 0-20% based on the quantum of gains.
- Mining income can be reported either as Hobby or Business income. In case income is reported as a hobby, no deduction can be claimed for expenditure.
- Mining businesses can claim expenses as a deduction. However, proper documentation has to be maintained to justify the expenses in case of an IRS audit.
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