Crypto mining has become one of the largest trends in the last couple of years, and a lot of countries have decided to impose taxes on this activity. Mining digital assets can be quite profitable, but it is also important to know what are the possible tax implications regarding the process. This is what we will cover today, and while the laws will mostly be those set by the IRS, the same might soon (or already) be true for the majority of other countries.
Tax Agencies' Views On Cryptos
Before we deal with the exact way that private crypto mining operations can be taxed, it's worth taking a look at how the tax agencies view cryptos in general.
Back in 2014, the IRS decided to make a framework for cryptos, and one part notice in it states how to apply the current tax codes to cryptocurrencies. Back then, the agency decided that cryptos should be seen as property. That means that crypto holders have to pay proper income taxes on them, no matter how they came to be in their possession. This, of course, also includes the cryptos received via mining activities, even the ones done at home.
Taxable Event is a term that those who have dealt with crypto transactions during trading might already be familiar with. One example of how this can be triggered is by making a profit while selling a cryptocurrency for fiat currency.
When it comes to mining, as soon as the coins hit the blockchain, the income that you receive by mining will trigger the same kind of taxable event. Additionally, the tax that you will have to pay will be in accordance with the crypto's price at the moment of reaching the blockchain. That same price is used as a benchmark when it comes to calculating capital losses or gains for the tax purposes.
So, if a cryptocurrency is bought at a certain price, and then sold for the higher price, the taxable gain is the profit earned by selling the coin at a higher price. Naturally, the process of calculating the taxes is a bit more complicated than that, especially when considering the volatility and illiquidity of some coins. The tax would also depend on the exchange used for the trade, and several other aspects.
Is it business, or is it a hobby?
Even though your earnings through crypto mining might remain the same, there is a significant difference in whether you consider it a business or a hobby. The difference comes since crypto mining can be viewed as both, the self-employment, as well as a wage, depending on how you think of it.
The income will be seen as a wage if you are mining cryptos as part of a hobby, and the tax around the process will be only half of the tax that would come for self-employment. The tax rate for self-employment is 15% as of this year. However, it might be better to report these activities as a business, since your itemized deductions would open up more options that way.
Still, the IRS won't view it as a business automatically, and your earnings need to meet certain criteria. For example, the mining must be done consistently, and with a purpose of making a profit. Also, your mining income needs to be over $400 per tax year in order for you to pay self-employment tax.
Explaining Tax Deductions
Mining cryptos can be profitable, true, but it is also a quite costly process. This is why it is important to mine cryptos as part of a business, rather than a hobby, since these expenses are then considered as a cost of doing business, which makes them tax deductible.
According to IRS, the tax-deductible expenses are all those expenses that cannot be avoided while conducting your business practices. In terms of crypto mining operations, those include things like electricity, capex on hardware and coin storage, broadband, business travels, fees imposed by mining pools, accounting expenses, and administrative expenses.
While these expenses fall under the category, there are some complications here as well. For example, if you are mining from home, only the electricity used for mining will be tax-deductible. The electricity spent on running the household doesn't fall under this category, which the IRS knows. Because of this, it might ask for a total breakdown of your expenses. This is where separate electricity-tracking meters come in handy, since you can use them for measuring how much electricity does the mining rig spend.
This is similar to business travels, and you will have to prove that the trip you took is actually business-related, and not just a vacation.
Limitations Of Deductions
It is important to be aware that there are limitations to which you can deduct various expenses, and those are directly influenced by the classification of the mining operation. This means that the limits are much smaller if your operation is seen as a hobby. If that is the case, the only expenses that you can deduct are those that are exceeding 2% of the adjusted gross income. Additionally, you cannot deduct losses that you experience by conducting a mining operation.
Not only that, but running a mining operation as a hobby only allows claiming deductions if the standard ones have not already been taken. Running a mining operation as a business, however, does not impose any limitations when it comes to deductions.
Despite the precision that the IRS usually values, the crypto mining, crypto holding, and anything else connected to cryptos is still new and not properly explored. This makes a lot of laws regarding crypto mining vague, and this is often the case even with simpler new technologies.
Since it is difficult to calculate these things and be sure what you do have to pay, it is highly advisable to hire a tax professional to help you out. No matter how you decide to classify your mining operation, you will still have to pay the tax for any amount that exceeds $400 per tax year.
Also, make sure to create a plan regarding when will you exchange your crypts for fiat currency. Selling the funds within a year from mining them might subject you to short-term capital gains. If the sale occurred after more than one year has passed, it would be considered as long-term gains, which applies different rates.
On top of all that, there is the already mentioned issue of classifying your operation, which also needs to be thought out carefully.
Making an additional income by mining digital coins from your own home can be quite profitable. Additionally, it is the best way to get new coins, especially if you are willing to place them in a cold storage and wait for a shift in the market. However, do not forget that you are still obliged to pay taxes for them, since the US government certainly won't.
Mining cryptos is a new way of earning, and it can be extremely profitable. Since that is the case, you can be sure that the taxmen would want in on your gains. So, to sum it up, educate yourself on your tax obligations, learn how to report the income you receive, and find out what you can or can't deduct. As long as you do that, you should not end up being in any trouble.