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IRS Tax Rulling May Have Just Killed Alt-Coin Mining

Presenting the IRS a Real Use-Case Scenario to Teach Them About the Possible Unintended Consequence the Alt-Coin Mining Taxes

I just finished my taxes.

I  feel like I was just punished for being on the cutting edge of computer and monetary science. That will teach me – why would I want to be part of an innovative technology in the USA?

 How dare I?

Before I relate my experience and interpretations, know up front, I’m not a tax expert. I’m only indicating how I interpreted the rulings. Your professional tax person might advise differently so don’t use this story as any kind of tax advice.

I doubt any IRS researcher actually took time to sit down with an actual alt-coin miner to study the effects of how their ruling  that, in effect, double or triple taxes alt-coin mining.  I suspect they never sat down with somebody in the trenches and asked some very simple “What if” questions.  The unexpected consequences of making broad decisions  over complex systems might kill the innovation from ever developing.  I would be interested to see proof of any actual real-life use-case study that was used by the IRS to predict the results their ruling. I’ve taken it upon myself to take create one case study by examining one day of the life and times of a digital currency miner (me). Hopefully this will enlighten somebody to actually understand how the ruling could affect us. Perhaps it will become obvious that nasty and probably unexpected consequences might follow these actions.

They declared that alt-coin miners must pay income tax, and well as capital gains tax as soon as they’ve swapped them for another digital currency such as bitcoin.  I believe they treated alt-coins as if you could also sell them directly for fiat which is incorrect almost all of the time. In addition- when those bitcoins you’ve traded them for then are sold for dollars, or used to purchase something – you’ve just been triple taxed it before it has become useful for anything in the real world.

First  tax=  income at coin creation.

Second tax = Capital gains tax when selling the coin for a dollar-exchangeable coin. Higher short-term capital asset tax.

Third tax =  Capital gains tax again when selling your converted bitcoin it to fiat, or simply buying something. Heaven forbid if you buy something with it before it exists for one year as you will get taxed at an even higher rate. Again.

The way I see it, there might be two directions this ruling may lead:

  1. IRS efforts appear to be trying to kill digital mining in the USA through regulation.

    • The rules of tracking, accounting, and reporting are so complicated that the effort required to even begin to keep up will cause such a loss that there will be no will to go on. Any invention, research – experimentation or good that would have come out of amazing potential of digital currencies – will have to come from other countries. Technology follows the path of least resistance. If you put up dams, the flow of technology will find somewhere else to flow and thrive.

 

  1. IRS efforts may create a new army of tax dodgers and rogues that go deeper underground  to continue with the efforts of science and innovation outside of the prying eyes of the government. Thanks to our government in the US, we can now get a taste of what it feels like to live in communist countries.

    • We can thank the efforts of the governments around the world to regulate Napster out of existence, then just about any other centralized company that tried to allow for file-sharing. Because of this, we now have bittorrent, port hopping decentralized DNS and TOR.  Our nature as humans is to follow the path of least resistance. Consider any ruling that you have: if it is seen as unreasonable or a blockage for technology, it will simply be bypassed and made irrelevant.   The law of unintended consequences could develop around the revolutionary technology in ways you can’t possibly imagine.  Did the record industry or the movie industry predict bittorrent would be developed when they simply tried to stop file sharing?

Let me shine a light into the world of a “stay-at-home” digital currency miner so the IRS might actually have an example of a case-study.

I heard about digital currencies last spring and thought that was a cool idea and I ought to look into it.  I’ve been a computer junkie for 20 years and figured it would be something I could master. After spending a week trying to mine bitcoin with my computer CPU last spring, it became obvious that bitcoin was already too hard to mine without purposely built ASICs computer chips that were just then coming to market.  Chasing a tiny bit of profit would have to come through “Scrypt Mining” beginning with litecoin. I know how to build computers and can install software so I figured I would experiment and dabble.

My research into digital currency mining stretched from a few days to weeks and eventually  months.  I read, tweaked, fiddled, readjusted, stayed awake all night, tweaked again, rebooted, bought new hardware, rebuilt, tested, rebuilt and rebooted…a lot.  Running video cards at the peak performance is like rocking back in a rocking chair and getting all the way back to the point you almost tip backwards…and then hold it there. It seems only a slight gust of wind would be enough to push the system over the edge and crash. You are literally pushing the boundaries of your hardware way past the point the manufacturer intended. Needless to say, I don’t expect the hardware to live long enough to make it past the  warranty period.  I calculated that if I added my time together doing all of this research, trial and error and various mining activities I’ve spent close to working a full time job for four months just through experimenting on it.  I was often still going past 2 am before I could drag myself to bed.

The IRS probably doesn’t understand that the difficulty just keeps rising as you go so you have to keep buying better hardware just to stay in place in receiving coins. Once you’ve purchased the hardware – you are committed. You can’t expect any kind of return on your investment if it just sits there doing nothing. A crashed system doesn’t pay for itself. Up-time is everything. You have just a fairly short window of opportunity to make the money back before the hardware is obsolete in the digital arms race. Even then we are speculating the price will continue to rise. If not, we’ve just got really expensive toasters.

Then there are all kinds of unexpected challenges for which you must contend. It is not profitable to mine by yourself as the odds of you solving the puzzles to be awarded the new currency are extremely low. We join mining pools. The problem with the early mining pools  are that they are largly run by armature geeks with no proven reliability. Pools would go down often, sometimes for days, or weeks. They were always being hacked, and on many occasions, my lite-coins were stolen before I could withdraw them.

Too many times to count, the pool just went dark. No explanation, just… gone. And my coins with it. That, I suppose, is the price you pay for being on the bleeding edge. It cost me electricity, time, and hardware only to see coins vanish. The media covers the bitcoin exchanges going out, but I haven’t read anything about mining pools doing the same thing. But with the new IRS ruling, technically – as soon as those coins were mined into existence, that was supposedly income for me to report. Unfortunately, there is no record of those coins because those pools took any record of the activity down with them. Hopefully this doesn’t make me an outlaw on somebody’s ‘list’. Those were expensive lessons. Not only did I lose out on the coin, but the electrical costs made my electricity bill double, and I also had the ‘opportunity loss’ where I might have been mining coins at a reliable pool. Losing them hurts triple when you count  the two that were stolen, the electricity it took to create them that might have made you whole,  and the two that you could have earned had you been on a more trustworthy pool to begin with.

But even when it is running perfectly, based on the market – many days were at a loss to even recover the price of electricity. But some of us do it for the pioneering effort to perhaps change the world. It isn’t all just about money. This is a new science and could go in endless directions. Mining is absolutely necessary for the effort to sprout and the destinies someday reached.  To place burdens such as the enormous amount of tracking and paperwork added to the complexity and time involved in just performing this service will kill it, at least in the USA.

To explain this, I will use my mining efforts from yesterday to illustrate.

Bitcoins are too difficult to mine from home on “regular” PC hardware, so unless one is a dedicated business with a lot of money and space to dedicate to this function, regular people are priced out. We’ve had to set our sights on more attainable goals and coins using the “Scrypt” function is about all we have left for the digital currency scraps.

Because of the enormous amount of alt-coins available to mine and new versions seemingly pop up daily, many now use one of the various “multi-coin” pools. The logic running these pools programmatically check the real time value of the various coins will switch all process power to that coin on an hourly basis. This now creates a problem. We must declare income as soon as a coin is mined into existence for each coin not knowing which coin we will be mining from one hour to the next.

For example, dogecoin’s  value is currently so low it takes roughly 100 of them to equal the price a nickel. We are now supposed to recognize that and pay income tax on each one. Using yesterday for an example, the pool automatically switched between feathercoin where I made a total of 41 cents to dogecoin, as the profitability peak changed throughout the day. I made a gross income of $4.33.

But according the calculations on Coinwarz.com – I used $5.28 in electricity for the three machines to pull in the “mother-load”. So my net income for yesterday was negative 94 cents.   I only know this price because that’s what the pool indicated when they were sent the proceeds to my account.  According the the IRS ruling, I have to track that amount each day and report it. Also, I have to keep track of every one of the 10,000 or so dogecoins I helped “birth” yesterday. If I trade in 500 dogecoins someday so I can have a “whole” quarter, I’m supposed to know which daily batch of 10,000 they might have come from, so I can figure the capital gains tax on the 25 cent piece. This only happened once they meet the minimum threshold that the pool considers it worthwhile to even send them as some coins are worth seven numbers right of the decimal point. That means it might take a million to make a dime. Technically, I’m supposed to report a millionth of a dollar? How much paperwork and calculations go into figuring that and reporting it?  Can we agree this is unreasonable? Didn’t somebody at the IRS talk to an actual alt-coin miner to see the burden and understand this will kill any innovation?  As I hope to show –  many will find this is beyond ridiculous.

 

Because it’s unlikely that many alt-coins will ever be worth much in my opinion, it’s safer to convert them into bitcoin or some other digital currency as soon as they’ve been awarded to you. Bitcoin has  proven itself to be more trustworthy over the long term for holding some value- comparatively speaking. But as soon as you convert the tiny bits of any coin, that becomes the basis of a capital gains transaction. And because you held it less than a year, it is taxed at the higher rate. What is the tax on ten thousandth of a dollar? Worse, I have to actually track that? The cost of tracking a single dogecoin is perhaps a thousand times more expensive than the actual transaction itself. Yet, this is how it appears to be written. They treat a $600 bitcoin and a $.0004 coin the same. And by the time I buy a meat thermometer at Overstock.com I’ve paid tax on it three times.

So I’m done. Why go through all of this?  They’ve just killed my interest as it’s too expensive to comply. Somebody outside of the US will have to do it. Any innovation that might have come from this science will have to be done in a friendlier nation. There doesn’t seem to be any talk of “safe harbor” for miners to let the science expand  – before taxing it into oblivion with socialist abandon. Without miners to process these transactions and run the networks, they will fail. It appears that the IRS has just done their best to make sure alt-coins fail. To me, it doesn’t really matter if this was unintentional or not. The end result is the same – I’m done. As far as you know.

The US has stifled innovation.

The other option is for miners to go further underground. But what could be the unintended consequences of that?  Is it possible that once somebody has gone underground and found themselves on the wrong side of the law, that other more serious crimes may follow? Is tax evasion, even on a micro-scale, a gateway that may lead down a darker paths and more mistrust of government?  What are the possible ramifications of that?  Do we want to be that country that compels its own people to fear it? It’s not hard to see where the entire anarchist movement comes from.

Perhaps this may be just as well. It was bad government policy that was at least part responsible to spur the innovation that created the doorway to this entire new realm of digital currencies. Some might argue that getting around the rules without first asking for permission is what this community does best. The harder government becomes to work with, the more innovative the solutions to just go around them and completely change the paradigm that gave them the power they now have.  By issuing these tax rulings without understanding the ramifications – who can guess what might result from the unintended consequences? Perhaps this ruling will spur even more innovations that make the IRS themselves increasingly irrelevant.  The block-chain already allows for such transparency and with programmable money, perhaps taxes  collection will be programmed in as well.  Perhaps there will no longer be a need for the IRS.

Perhaps these IRS rulings themselves will be the cause their own extinction.

Think of the irony.

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  • Title Correction

    “IRS Tax Rulling May Have Just Killed Alt-Coin Mining”… in the US

  • FreeJack

    The solution is simple…don’t pay the taxes. The IRS is going to be playing the biggest game of whack-a-mole in history, trying to collect on crypto miner taxes.

    If your mining is your primary income, yes…you have to worry about this. But if you’re just someone mining for a little extra spare cash, the IRS is not going to be any more successful taxing you on that income than they are taxing every property sale you make on eBay or Craigslist, or at a garage sale, etc…

    If the IRS ruling doesn’t change, Puerto Rico will fast become the Mecca for crypto mining in the U.S.

    • Mark Rees

      I agree, hence the cover photo of miners in masks. I think the mind-set of most people mining today is more of evasion than just pulling the plug. *ahem*…from what I’ve heard.

  • Ryven Cedrylle

    My money’s that the IRS doesn’t think crypto is ever going to be a real thing and threw down a quick knee-jerk ruling to make it similar to something that looks sort of like crypto does right now – stocks. (Note how the stock market isn’t stopped by arcane tax laws.) Honestly, it might be the best move they could have made. Crypto in 5 years isn’t going to look like crypto now. We don’t know what this movement is going to turn into or where it might go. The gov’t axted lazily and kicked the can down the road, the way they tend to do on policy if things don’t involve invading foreign soil. When it settles down, they can come up with a better idea – or just leave it the heck alone.

    On a tangential note, I call bullcrap on “the US kills innovation.” Why are all the big pharmaceutical companies here? Why is Google here? IBM? ConAgra (whether you like them or not)? Why do we still have the biggest immigration influx in the world by magnitudes? I’m by no means defending the purity of Uncle Sam, mind you. He makes a lot of stupid and corrupt decisions. I still, however, find it ludicrous to look at what actually happens on a daily basis here and call it “stifling.”

    • Mark Rees

      All good points, but I would wager that a lot of the greatest inventions were made by people who BROKE the rules. It’s the American way. – It’s in our DNA – our country was founded by rebels. Even Steve Jobs got his start hacking into the phone system to make free phone calls. I think they’ll eventually come around on this one too, but somebody needs to have a reality check with them.

  • DavosBTC

    You’re overpaying your taxes then.

    * Proceeds from mining, less amortized equipment cost + operating costs (electricity, pool fees, etc) = income (denominated in USD)

    * Convert DOGE to BTC – Is USD value higher now? If yes, pay capital gains tax on the profit of this trade. If equal, no tax. If less, record it as a capital loss (offsets your other gains)

    * Convert BTC to USD – Is your USD value higher than when you converted to BTC? If yes, pay capital gains tax on the profit of this trade; if equal, no tax; if less, record as a capital loss (offsets your other gains).

    If you’ve got less total money at the end of this whole process than you did before you’re either mining unprofitably or overpaying your taxes.

    • Mark Rees

      That’s a whole lot of record keeping for coins that are measured in hundredths of thousandths of a penny. Yes, I’m sure there are programs out there to calculate that somewhat – but just take amortization – how long do you think the equipment will last? One year? It might be better to just expense it. It will be obsolete in a year even if it’s still running.

      The point was that the IRS made some rush to judgement without understanding what they were doing. That they made this all retro-active is proof of that. I know people that work for the IRS…they are just now getting around to having any kind of internal talk about how to acknowledge it. So it will likely be subjective and applied unevenly. The was reactive announcements that just “tried to do something” when they read about bitcoin millionaires. Perhaps it would have been wiser to seek comments and input before putting everybody in the same ‘bitcoin millionaire’ box.

      I believe there’s no harm in letting an industry grow a bit before you douse it with taxes.

  • Edward

    Hi Mark how funny that you wrote this article, because your solution is maybe here:
    http://bitcoinmagazine.com/12570/crossing-borders-bitcoin/

    • Mark Rees

      I think a lot of people will move to where it will be more profitable. This is all speculative. Bitcoin mining was unprofitable for much of 2009 and 2010 if they were trying to cash in right then. Good thing for those that held on. Maybe true of some of today’s alts. The running electricity bill is the investment.

  • Jason M. Tyra, CPA

    Any tax practitioner will tell you that the IRS guidance is consistent with treatment for capital assets as a class and does not discriminate against bitcoin specifically. How the IRS can proceed with something new like bitcoin is determined by the letter and intent of the Internal Revenue Code, which is promulgated based on statutes written and enacted by the Congress. The IRS doesn’t really get to create a new category on its own authority, but must act within the existing framework.

    Personally, I think that everything about bitcoin says currency, but I was in the minority in that respect prior to the point at which the IRS definitively ruled it out. I’ve written about this subject extensively for Bitcoin Magazine. It’s worth noting here that most other countries that have addressed this issue have also decided that bitcoin is a capital asset. Tax codes aren’t all that dissimilar from country to country, so we should expect this kind of problem in other places, too.

    The best way forward will probably be to lobby aggressively for creation of a new class of asset with favorable treatment (Bitcoin Foundation to lead?) to be incorporated into one or more of the tax reform proposals currently floating around Washington.

    • Mark Rees

      Hi Jason, I read those articles- and grit my teeth as I did knowing that this was likely coming. This is likely the first time a property, or commodity was also used as currency in living memory. I like the approach Brazil took. It is taxed “either or”. You can use it as a currency for a ceiling amount. After that point you must treat it as property. That approach would tax it in the way it was intended to be used. I believe the UK also reversed course and also allowed currency recognition.

      The value of bitcoin the capital asset only exists because it has value when used like a currency. Arguably, the only intrinsic value bitcoin has is its use in novel ways when it’s used as a currency. It can do things no other currencies can do, But if you’ve taxed it four times (the three mentioned in the article + Sales tax) – you’ve bled all the value out of it.

      Hopefully articles like this will spur the talk to get the right people involved. Hopefully, you’ll be one of our most valued voices!

  • binaryphile

    Double taxation is being taxed on the same income or gains. You’re calling it double on separate income and gains.

    • Mark Rees

      I didn’t say double taxation, just that the same coin can be identified from the time it is created so you can see each time it is subject to taxation. I didn’t even mention the SALES tax. That would make the same coin taxed – four times – before it changes ownership.

      • binaryphile

        I’m referring to the part where you say “you’ve just been triple taxed”.

        • Mark Rees

          Ok, to track one dogecoin.
          1. I mine it as part of 1000 coins. Deposits from mining pool to my exchange wallet account.
          2. My exchange has automatic conversion that I use to sell it for bitcoin immediately. If that happens right away no problem. For other coins, there’s no market depth and the coin might sit with my offer to sale but no takers for days or weeks. That one can be recognized as a capital event when somebody finally buys it.
          3. No I have my bitcoin, but I paid income tax on it, and capital gains tax during the doge to bitcoin property sale. – Now I want to spend it at overstock.com. This is a week later and bitcoin prices has gone up from the time I converted it from dogecoin. I have to find the market price for bitcoin that day and when I make my purchase, I record the amount of the purchase and deduct that amount proportionally to an entire coin, and subtract that from my basis price.The difference is my 2nd capital gains tax.
          4. Because Overstock.com does business in my state, I have to pay sales tax.
          These all could have been losses as well, or a mix and match- it’s the PAPERWORK involved that kills you.

          • binaryphile

            Are you saying this under the guidance of a tax attorney, or are you just giving your interpretation of the IRS guidance?

          • Mark Rees

            No attorney. But educated guesses. I’ve done my own taxes for 30 years. I’ve had many tax related university level courses and worked as an accountant for a time so I’m no dummy either. I spent about 30 hours going over the various schedules, forms, guidance, and left myself a long trail of breadcrumbs to retrace my steps if needed.

            Needless to say, many four letter words escaped my unhappy mouth during this experience.

  • Christian

    The fact remains nobody knows what an alt-coin is worth until its sold.

    • Mark Rees

      They expect you to know what the going rate is for the date you first mine it. As ridiculous as that seems. So that’s the basis for your income tax, and the basis beginning point of the capital gains tax. So I used the coinmarketcap.com daily averages in history and tried to match up best I could. I spent three days going over all the regs and schedules, and online publications, and my records – and I lost count how many times I flipped off my monitor while nobody was watching. It was…therapeutic.

      • Christian

        I read another thread on this as well. Every example of tax the IRS used was in dollars. I doubt anyone has voted the IRS the power to tax Crypto. The banks of the world can’t use it. Why would the IRS magically have power over it? Did they simply write something in a computer. Can do anything? You are aware they are not a government agency. They are a private corporation.

        • jow

          What are you rambling on about. The IRS is all out an arm of the United States Government. It enforces the tax code as passed into law by the US congress.

          • Scott Phoenix

            Jow – it’s a private corporation…just like the federal reserve. The tax code was established by a bunch of leftist retards from England in 1913 – the same year the fed was created.

  • Tony Rose

    Keep in mind that the ruling is the IRS position and it does not mean they are right. A farmer does not pay tax when he harvests his crops nor does a bicycle maker pay tax when he creates a bike. This ruling, with regard to miners, is clearly wrong. Is Bitcoin a capital asset, it might be. From a tax theory standpoint, it should be no more taxable than when an author or music writer creates a work of art for sale.

    Having said that, you are absolutely right. The safe course for anyone in the US dealing in ALT currencies is to treat it the way you have. It will take large pockets to fight the IRS on this or to influence legislation to get the IRS to behave themselves.

    • Mark Rees

      I hope this is a wake-up call and sort of a “call to arms” for people to take a stand and help the IRS “see the light”. Perhaps they will eventually get it right, but I don’t want to get stuck in a mountain of paperwork until then.

      We need altcoin miners to SPEAK UP, if we are going to get this fixed.

  • Supreme1906

    As a proud and loyal American, I have no problem paying taxes. However, we have no obligation as Citizens to pay more taxes than we have to; and when companies like General Electric, Verizon and Boeing pay NO federal taxes, then I have no problem using every LEGAL(ish) loophole I can find to pay as little as possible…

  • APV

    Or just move your cash to a crypto coin like DOGE that trades in China.. EU and Russia convert your DOGE coins in silver and gold in Geopay.me and say Yo quiero taco bell to the yankees!