The growing popularity of cryptocurrencies has caught the attention of the IRS and other government regulators to levy Bitcoin mining taxes on miners. The Biden administration has made the “tax gap” a priority issue for the Treasury, and cryptocurrencies are a key area of focus with new rules that are making miners pay taxes on income.
Let's take a look at the most frequently asked questions regarding crypto mining taxes.
The following is a guest post by Bitcoin tax solution ZenLedger.
1) Are mining rewards taxed?
Yes. If you mine cryptocurrency, receive it as a promotion or as remittance for goods or services, it is considered as taxable income. The taxes will be levied upon you on the entire fair market value of the coins that you received on that day at a regular income tax rate.
According to IRS Notice 2014-21:
“If a taxpayer's "mining" of virtual currency constitutes a trade or business, and the "mining" activity isn't undertaken by the taxpayer as an employee, the net earnings from self-employment (generally, gross income derived from carrying on a trade or business less allowable deductions) resulting from those activities constitute self-employment income and are subject to self-employment tax.”
2) Are mining rewards taxed as income or capital gains?
Hobby income is treated as ordinary income upon the time of receipt by the IRS, which means that it's taxed at your personal marginal tax rate. These tax rates depend on your overall level of taxable income from your job, investments, and other sources. There are only a handful of deductions that you may be able to take for a hobby business, so most of that income is directly taxable. If you subsequently sell the mining rewards for profit, those profits must be reported as capital gains.
Business income is treated separately from ordinary income (e.g., income from wages or investments). The most significant advantage of setting up a business is that you can deduct many business-related expenses (see below). However, fees like computing resources and office space must be used exclusively for Bitcoin mining to qualify for a deduction.
3) Should I file my mining taxes as a hobby or business?
Bitcoin miners may choose to treat their activities as a hobby or a business. While treating it as a hobby may seem simpler on the surface, mining as a business has more deductions and benefits, and may reduce your overall tax liability. The key is determining if the added complexity of owning a company is worth the tax savings.
The legal difference between a hobby and a business depends on subjective factors like:
- The time and effort spent.
- Your intent to make a profit.
- Your dependence on mining income.
- Your mining profitability.
In short: If you're trying out small-scale crypto mining on your personal computer, you should treat it as a hobby for tax purposes. On the other hand, if you own your own rack server and rely on the income, you should treat it as a business and write off some of your mining taxes. If you have any questions, it’s best to ask a tax professional for specific advice.
4) If I file as a business, what mining expenses can I deduct?
Some of the most common deductions include:
There may be other deductions available as well depending on your business. Speak with your accountant or tax professional to discuss these deductions and balance the benefit of a deduction with the risk of an audit.
5) How do I file taxes for my mining activity?
The easiest way to keep detailed records is using an online transaction aggregator, like ZenLedger, that automatically tracks prices. ZenLedger makes it easy to calculate your crypto tax liability by aggregating transactions in wallets and across many popular exchanges. In addition, the software helps auto-populate many popular tax forms, such as Form 8949 and Form 1040 Schedule D, as well as FBAR and other regulatory forms.
All you have to do is simply import your wallet address where you are receiving mining rewards, and our software will automatically read these transactions and apply the necessary tax calculation.
Paying what you owe means avoiding many potential shortcuts that could trigger an audit. For example, you may not want to take a home office deduction for mining operations taking place with a shared room (e.g., a bedroom or living room). The lack of a dedicated space makes it difficult to prove that you only used the area for mining.
The Bottom Line
Bitcoin taxes, especially when it comes to mining rewards, can often be a daunting topic - but it doesn't have to be. As long as you keep in mind the basics, strategize your physical and legal framework, and use a Bitcoin tax prep software like ZenLedger, you’ll be headache free come tax season.
Use code COMPASS for 10% off all DIY ZenLedger plans! Sign up here
Image via the New York Public Library/Unsplash