Marla R. Chambers, CPA, CFP®
Senior Financial Planner
Recently cryptocurrency (especially Bitcoin) has made headlines due to the increases in value that were observed during 2017. Many individuals equate trading in cryptocurrency with anonymity and criminal activities. In fact, the federal department that oversees virtual currencies is the Financial Crimes Enforcement Network (FinCEN). However, most of the individuals who have embraced cryptocurrency are law abiding citizens who need assistance with complying with tax and accounting requirements.
This article will focus on reporting requirements for individuals who are in the business of mining for cryptocurrencies. Virtual currency mining is the process where virtual coins are added to the public ledger (the block chain), and new virtual coins are released. As with any new technological advancement, the IRS and other regulatory agencies take time to understand the issues and to develop guidance related to the innovation. As regulations change and guidance is issued, compliance requirements are adjusted. At this time, the IRS has issued Notice 2014-21 that describes the application of general tax principles to transactions using virtual currency.
ACCOUNTING FOR VIRTUAL CURRENCY MINING BUSINESSES
When virtual currencies are mined, they are considered inventory to the mining business. The value of the inventory created is recognized as income (at the current fair market value of the cryptocurrency) when received (or mined). Then when the virtual currency is sold (or traded for other virtual currencies), the business recognizes the gain or loss on the “sale” of the “inventory” (the previously mined virtual currency).
When you use virtual currency that was mined and part of your inventory to purchase goods or services, the transaction needs to be reported as income (and offset by the cost of the “inventory”). The cost of the goods or services, if considered expenses of the company, would offset the income recognized.
Direct expenses that are associated with the virtual currency mining businesses include:
- • Hardware/Software
- • Electricity
- • Internet Costs
- • Cost of the “inventory” (previously reported as income when the currency was originally mined)
- • Other Direct Expenses
Other costs (include, but are not limited to):
- • Building costs such as:
- o Rent
- o Mortgage Interest
- o Real Estate Taxes
- o Insurance
- • Business Insurance
- • Accounting & Legal Costs
- • Wages
Bank account reconciliations are the backbone for accounting for typical businesses. It makes it much easier to account for income and expenses when you can use the bank account transactions to verify that all income and expenses are recognized. Whereas, since the virtual currency mining is all done without the use of a bank account, you will need to print the virtual wallet transaction history. Then, the transactions will need to be converted to US Dollars based on the fair market value of the coin at the time of the transaction.
If you pay wages or outside services in virtual currencies, you will need to comply with reporting requirements as if they were paid in cash. This includes issuing W-2s, 1099s and submitting payroll taxes to the appropriate agencies.
TAXATION FOR VIRTUAL CURRENCY MINING BUSINESSES
The taxable income and loss of the virtual currency mining business is ordinary income/loss. Therefore, the net profit of the business (taxed as a sole proprietor or partnership) is subject to self-employment tax in addition to federal, state and local income taxes.
If your virtual currency is held in a foreign exchange (such as Binance), and the value of your account was greater than $10,000 at any time during the year, you may be required to report the account on a Foreign Bank Account Report (a FinCEN 114). If the balance exceeded $50,000 ($100,000 for MFJ) on the last day of the year or $75,000 ($150,000 for MFJ) at any time during the year, you may be required to file a Form 8938 (Statement of Specified Foreign Financial Assets) with your income tax return. This is one of the areas that is unclear, since the IRS has declared that virtual currencies are classified as “property.” It would be safer to report the foreign holdings (if applicable) than to potentially face a penalty up to 50% of the balance in the account and potential criminal penalties.
You will also need to keep in mind potential state compliance issues such as:
• Use tax filing requirement for sales tax payable on machines purchased without paying sales tax
• Gross revenue tax assessments such as Ohio’s Commercial Activity Tax which is due on businesses with gross revenues more than $150,000 annually
Tax and Accounting for Cryptocurrency Mining can be extremely complicated. If you are trying to prepare your income tax return and don’t know where to start, give us a call at Buckingham Financial Group and Weston & Co, CPAs. We can provide consulting, set up your accounting system, and/or assist you with your tax compliance issues.