Cryptocurrency miners have two separate tax exposures. The first is the tax at the fair market value of the virtual currency on the day that it is mined into gross income. Generally, the net earnings from this activity will be exposed to self-employment tax.
The second is the capital gains which are due on the sale of bitcoins viewed as a capital asset. The basis price for the coins will be the fair market value on the date of acquisition. Capital gains will be due on the difference between that basis price and the eventual sale price.
When a miner sells their cryptocurrencies that they have mined, they will have to pay capital gains tax on any profit that they have made while owning them. The exception here is if bitcoins aren’t viewed as capital assets, but are instead viewed as inventory. This would be the case if a miner’s core business is selling cryptocurrencies. In that case, any gains on the bitcoins would be taxed as an ordinary gain or loss.
IRS Notice 2014-21 clarifies the treatment for bitcoin miners. Specifically, miners must recognize income for each bitcoin mined during the taxable year. The amount of income is equal to the market price of bitcoin on the day it is awarded on the blockchain. This also becomes the miner’s basis in the bitcoin going forward and will be used to calculate gain/loss in the future when the bitcoin is sold.
Mining expenses, such as electricity, would not be included into basis. Instead, they would be deductible in the taxable year as an expense. Miners will need to determine if their mining activity rises to the level of a trade or business, which is a highly factual determination. Maintaining proper documentation is essential.
Your choice of entity and tax treatment for your business is one of the first decisions that you will make regarding your company, and it should be with care. Like any business decision, the key to making the right choice is having the right information.
The first major step in choosing your tax treatment is selecting a business entity for your operations. You have four main choices:
• Sole proprietorship
• C corporation
• S corporation
To determine whether the S corporation is the right entity structure for your business, you have to know how it compares to your other options. The two main benefits of operating your business as an S-Corporation is relief from double taxation, and savings on employment taxes. If you are simply looking for liability protection, then single member LLC can be a less costly and complicated alternative.
If you own a C corporation, the government taxes both you and your corporation. First, the corporation pays income tax at corporate rates. Second, you as a shareholder pay tax on the dividend you receive from the corporation. S corporations pay taxes only once. An S corporation is a pass-through entity, which means that the S corporation does not pay taxes. Instead, the income, deductions, and tax credit items skip the layer of corporate tax and flow through to taxpayers via a K-1, onto their individual tax returns.
The main reason businesses or individuals choose an S-corporation tax structure is to realize tax savings on employment taxes. This is particularly valuable for miners. When you operate your business as an S corporation, you are both a corporate employee and a shareholder. As an employee, you receive a wage or salary to compensate you for the work you perform. As a shareholder, you receive distributions for your ownership stake in your S corporation. The salary paid to you as an employee is subject to employment tax. Your shareholder distributions are not. Since you set your own salary as the owner of the S-Corporation, you determine how much of the income generated by your business is subject to employment tax.
Tax planning and industry financial expertise is critical in this area. Setting your salary too low exposes you to risk of IRS examination which can result in payment of unpaid employment taxes and hefty penalties and interest. Setting your salary too high leads overpaying taxes. Over the course of your business’ life, the over-payments of tax and lost investment opportunities can cost you hundreds of thousands of dollars.
S corporations offer significant tax benefits to business owners and investors, but impose extra costs onto owners which must be considered when assessing the S-Corporation tax structure for your business. To obtain the tax benefits of an S-corporation structure, you will have to work closely with a CPA during the year on tax planning to ensure you are taking the correct measures to minimize your taxes. As previously mentioned, an annual in-depth analysis of reasonable compensation is required to substantiate your wage levels in the corporation. Additionally, S corporation tax returns are more time intensive and complex than a personal tax return and S corporations create extra tax-related paperwork each time you take money out of the corporation, so this is an additional administrative cost to consider.
All too often, we acquire clients at Camuso CPA who were oversold on the tax benefits of an S corporation, unaware of the additional associated costs, and are rushed into a costly entity structure. Be sure that your CPA or advisor can specially explain the costs and benefits to you before electing S corporation status for your business.
Camuso CPA PLLC’s focus and specialization delivers a unique perspective on best industry practices to provide the most value to clients. Contact our cryptocurrency CPA firm today for financial and tax planning and get your finances in order: https://www.camusocpa.com/contact/#/