It wasn’t long ago that virtual currency such as Bitcoin was considered a niche investment, but things have changed dramatically in recent years. Today, cryptocurrency transactions are common and investors at every level are using cryptocurrencies as a medium of exchange for goods and services.
If you have obtained digital currency through crypto mining, you should be thinking about the tax consequences of doing so. At CMP, a crypto tax CPA, our experienced team of tax pros has created this guide to help you understand crypto mining taxes, including how to report cryptocurrency income on your tax returns and minimize your taxes.
What is Crypto Mining?
Before you can understand crypto mining taxes, you must understand what mining is and how people earn income from mining; particularly if you're new to the world of digital currency and want to try your hand at mining.
People who have a crypto mining business or who mine cryptocurrency to earn extra money play a vital role in keeping cryptocurrencies such as Bitcoin secure. Just as a business expense is entered in a general ledger, any transaction completed with cryptocurrency in exchange must be logged in the distributed ledger, also known as the blockchain.
Since the ledger has no centralized authority, only verified miners are permitted to verify transactions. Their work, often as hobby miners, prevents any double-spending of digital currency. To prevent unverified miners from compromising the blockchain, there is a proof-of-work consensus protocol (PoW) that must be followed.
Crypto miners often compete with one another to verify a new transaction. As a reward for their work, new coins are minted and earned as payment.
Tax Implications of Cryptocurrency Mining
The tax implications of cryptocurrency mining are complex and may be confusing to people who are new to mining.
Let's start with the basics. You must report both cryptocurrency holdings and any cryptocurrency you earn to the IRS. Gains you make by buying cryptocurrency or mining it is all considered to be taxable, although the specific rules of how they are taxed vary depending on how they came into your possession. The cryptocurrency that you earn through mining is reported and taxed differently than the cryptocurrency you purchase as an investment.
How is Cryptocurrency Taxed?
Taxation of cryptocurrency is determined by how you obtained the crypto, and in some cases, how long you have owned it. The rules differ depending on whether you bought the cryptocurrency in question or obtained it through mining.
Cryptocurrency holdings are considered to be property and not income. In general, the money you earn as your holdings increase in value is a taxable capital gains when sold. The money you lose is a capital loss and is reported as such. Holdings are taxed as short-term capital gains if you have owned them for less than a year and as long-term capital gains if you have owned them for longer than a year.
The same rule does not apply to cryptocurrency mining. Hobby miners and business miners must report their earnings from mining as income. Any Bitcoin or other cryptocurrency that you earn for your work mining may be reported to the IRS on Form 1099-NEC by the payer or mining pool. The person who mined the crypto then reports this amount as business income, even if the payment is made in-kind rather than as a cash payment.
How to File Crypto Mining Taxes
Filing crypto mining taxes requires an understanding of what the IRS requires for cryptocurrency trades and mining. Understanding how to minimize the amount of taxes you pay then becomes important to your profitability. We'll address the first part of that statement in this section.
Let's start with crypto holdings, including crypto that you obtained through mining or that you bought. As we mentioned in the previous section, gains or losses from your holdings are considered capital gains for purposes of taxation. Remember, short-term capital gains are taxed at ordinary income tax rates, while long-term capital gains are taxed at lower capital gains tax rates.
To report capital gains or losses, you must first use Form 8949 to report the details of your cryptocurrency transactions. You will need the following information:
- A description of the property
- The date you acquired it
- The date you sold it
- The proceeds (sale price)
- The cost at the time of the purchase
The cost base at the time you purchased all forms of crypto is used to determine whether you realized a capital gain or a capital loss. The acquisition date is used to determine whether your holdings will be taxed as long-term or short-term capital gains.
After you have completed Form 8949, you will transfer your totals onto Schedule D, which should be attached to your federal income tax return.
Earnings from Crypto Mining
Any Bitcoin or other cryptocurrency you receive as the result of mining is considered ordinary business income by the IRS and taxed at the ordinary income rate in the year you earned it. In some cases, your mining transactions may be reported to the IRS on Form 1099-NEC. However, even if your earnings are not reported separately, you must report them and pay taxes on them.
The same rule applies if you receive cryptocurrency as a payment for goods or services. You will use the fair market value on the day of the transaction to report your income to the IRS.
If you did not receive Form 1099-NEC (business income) or a 1099-B (sale of investments), you can download a list of your cryptocurrency transactions from your cryptocurrency exchange platform. Keep in mind that the IRS now asks about cryptocurrency on Form 1040. If you answer “YES” to the question about cryptocurrency, the IRS will expect you to report your earnings and pay taxes on them.
How to File Crypto Mining Taxes
The method for filing crypto mining taxes depends both on how the cryptocurrency came into your possession, as noted in the previous section, as well as whether you engage in crypto mining as a business or as a hobby.
Crypto Mining as a Hobby
If you mine cryptocurrency as a hobby, filing your crypto mining taxes is simple. You will need to report your cryptocurrency income as "Other Income", with a brief description of the income source. Keep in mind that this reportage only applies to cryptocurrency earnings as a result of mining, which is taxed at the regular income tax rate, and is also subject to self-employment tax.
Once you have cryptocurrency holdings, regardless of how they came into your possession, you will report any crypto gains or losses on Schedule D, as noted above. Taxation will be based on the length of your holdings. Holdings you have had for over a year are taxed at the lower capital gains tax rate.
Crypto Mining as a Business
Engaging in crypto mining as a business opens up some tax advantages that aren't available to hobby miners. You must report business income from crypto mining on Schedule C (if you are operating as a sole proprietor) or as a more formal entity type, such as a partnership/LLC or an S-Corporation.
From a tax perspective, there are some advantages of reporting crypto mining as a business. Several crypto mining-related deductions may be used to reduce your tax burden and we’ll discuss those deductions later in this post.
Crypto Miners IRS Reporting Rule for Transfers
There has been an ongoing debate about whether crypto miners should be subject to IRS reporting rules that require crypto brokers to report their clients' crypto transactions to the IRS. As of February 2022, this issue seems to have been resolved to the benefit of crypto miners, crypto-stakers, and ancillary participants in the crypto market.
It has been determined that the reporting rule applies only to crypto brokers and was never meant to capture the work done by crypto miners. The reason is that crypto miners are usually not in a position to identify whether a transaction is a sale and do not have access to the personal information that would be required for proper reportage.
Crypto Mining Tax Deductions
In the section about filing crypto mining taxes, we noted that there are several deductions available to those who operate crypto mining businesses. These deductions include the following:
- Electricity expenses. All crypto miners use electricity for purposes of mining, and you may deduct the cost of electricity that is used exclusively for mining. If you have a place of business, you can use the meter there to calculate deductions, but if you work from home, you may want to get a separate meter for business to ensure accuracy.
- Equipment costs. Any equipment that you use for mining may be deducted against the mining income on your tax return. Equipment may include mining hardware, mining software, and the cost of maintaining crypto wallets.
- Repairs. Any money you spend to repair your mining equipment may be deductible.
- Rented space. If you rent an office space that is used exclusively for your crypto mining business, then you may be able to deduct some of your rent. Crypto miners who work from home should keep meticulous records of how much space is used exclusively for mining because that may qualify for the business use of home deduction to reduce their tax burden.
There are several other expenses that may also be income tax deductible for crypto miners, which are beyond the scope of this post to explain. As is the case with any business deduction, it is essential to keep careful records. The IRS is likely to flag any large deductions and a lack of proper documentation can be problematic in the event of an audit. Working with an experienced crypto tax professional can help you maximize your deductions while minimizing the risk of an audit.
Tips for Minimizing Your Crypto Mining Tax Liability
At Cook Martin Poulson, we always want our clients to save money on their taxes. You already know about crypto mining business tax deductions. Here are some additional tips to help you minimize your crypto mining tax liability.
Find Ways to Lower Your Taxable Income
If you're a hobby miner, anything you do to reduce your taxable income will save you money. For example, you might contribute to a retirement plan such as a 401(k) or an IRA or open a health savings account. You'll be taxed on your withdrawals from a retirement plan, but if you're retired, your taxable income is likely to be lower than it is now.
Gift Your Cryptocurrency to Family Members
The IRS allows taxpayers to make gifts up to $16,000 annual exclusion amount to family members (or others) each year. Keep in mind that the cost basis of any cryptocurrency you gift to others will transfer to the new owner, meaning that they will need to pay taxes on any gains they realize when they sell the crypto.
Sell Older Cryptocurrency First
Since any cryptocurrency holdings you have had for more than a year are taxed at the capital gains rate, you can reduce your taxes by selling your older holdings first and allowing the newer acquisitions to age before you sell them.
Partner with a Cryptocurrency Tax Expert
One of the best ways to be sure that you take advantage of every possible method to reduce your crypto mining taxes is to partner with an experienced cryptocurrency accountant. Our crypto team has the knowledge and experience to walk you through the finer points of crypto taxation and ensure that you never pay more than necessary.
Let Our Tax Pro Solve Your Complex Crypto Tax Situation
Navigating the ins and outs of crypto mining reporting and taxation requires in-depth knowledge of the tax code and cryptocurrency. You could spend hours trying to figure out what you owe or you could leave the work to our crypto tax pros.
Do you need help reducing your crypto mining taxes?