To those who are unaware of what a ‘miner’ of cryptocurrency is, it is essentially an individual or group who has employed the use of mining “rigs” to help verify transactions on the blockchain. As a result of their efforts, they are rewarded with some sum of a particular cryptocurrency. While I won’t pretend to understand the nuances of the underlying technology, I can speak to the stance the IRS has taken on such activities. The IRS has taken the stance that cryptocurrency mining activities are considered ‘ordinary income,’ essentially no different than earning money as payment for services rendered. Depending on the legal structure (or lack thereof) through which you’ve engaged in cryptocurrency mining activities, your taxes are either reported on Schedule C of your individual tax return or on the respective entity tax return (i.e. Partnership 1065, C-Corp 1120 or S-Corp 1120S). An additional complication is that you have to report income at the value of the cryptocurrency in USD as of the date that you received it. Therefore, meticulous record-keeping is imperative to being able to accurately compute and report taxable income.
This creates a challenging tax situation for cryptocurrency miners for a myriad of reasons. First, if you mine cryptocurrency with the intent to hold, you run into a liquidity issue when it comes time to pay taxes. As a simple example, let’s say you mined 1 Bitcoin in 2017, and it was valued at $15,000 at the point in time at which you received it in your wallet. (It is, in reality, much more complicated than this, but we’ll use this to demonstrate the concept overall.) Under this fact pattern, you owe taxes on $15,000 worth of ordinary income, despite the fact that you have not yet converted this cryptocurrency to fiat currency (i.e. USD). Suppose you owe an effective federal income tax rate of 25% on this $15,000 worth of income. In this scenario, you’d owe $3,750 worth of federal income taxes on cryptocurrency which you had not yet converted to USD. At the present moment, the United States Treasury does not accept tax payments in cryptocurrency, so you’d be forced to either convert your cryptocurrency to USD to cover your tax obligation or to use other funds to pay the taxes. Furthermore, it becomes even more complicated if you mined the Bitcoin at a value of $15,000 and, between the time at which you mined it and the time at which you sold it, it either appreciated or depreciated in value. This triggers an entirely different set of tax obligations, which we’ll discuss in the next section. Needless to say, you’re starting to understand why it’s a headache to stay compliant.