Bitcoin is a decentralized virtual currency that has become increasingly popular. As the utilization and popularity of this virtual currency continue to expand, the likelihood for government enforcement actions will continue to increase. In fact, in 2016, the IRS issued a round of John Doe summons to the largest Bitcoin exchanges in operation. The IRS and Department of Justice can use John Doe summons to unmask the identity of previously anonymous account-holders. Once the accountholder’s identity is revealed, the IRS and Department of Justice can theoretically pursue tax penalties and other tax enforcement options against the individual or business.
In an incredibly simplified sense, Bitcoin and many other virtual currencies work by following a distributed model where interested third parties devote computing resources to validate Bitcoin transactions and maintain the public Bitcoin transaction ledger. Third parties are incentivized to provide CPU and GPU cycles used to maintain the virtual currency’s network, through the concept of “mining.” That is, in exchange for providing computing power, they can be awarded a certain amount of Bitcoin, Dogecoin, Quark, or other relevant virtual currency.
In short, yes, bitcoin miners are required to pay tax on virtual currency received. Every individual who mines bitcoins and receives something of value for the use of their computing resources is required to pay tax even if the amount earned does not trigger a reporting statement. As set forth more fully in IRS Publication 525, income can come in many forms. Bitcoin and similar virtual currencies are simply one additional type of income that is taxed as property.
While companies can incur business tax obligations for mined bitcoins, the more common scenario involves a miner who is working independently toward a shared mining pool. When a taxpayer engages in “mining” activity as a trade or a business as a “non-employee”, the net income gained through these activities constitutes self-employment income and is subject to the self-employment tax. Chapter 10 of IRS Publication 334, Tax Guide for Small Business, sets forth additional information on the self-employment tax. When the self-employment tax applies, the fair market value of virtual currency received for services performed is subject to tax. If the IRS does decide to treat your Bitcoin mining operations as a business, you may qualify for tax deductions or credits that will offset the tax obligation.