How to treat Bitcoin mining income for tax purposes?

[niko]

Mining income is clearly different from trading income/losses (capital gains and capital losses). Any thoughts as to reporting your mining income? I'd say mining is most similar to a lottery, and in Canada lottery winnings are not taxable - but then again, Bitcoin mining is surely not recognized and regulated as a lottery by the government.

[mckoss]

If you were to run mining as a business, you almost certainly would not have much in profits to report.

You should be able to deduct the cost of electricity, and depreciation of your hardware against your income.  I think most will find they are paying as much in electricity costs, as the value of the Bitcoin that they are receiving.

If you hold on to your Bitcoin, you should be able to claim all future gains in their value as a (hopefully, long-term) capital gain - which is taxed in the US at a much lower rate (15% max) than ordinary income (35% max).

[Stephen Gornick]

 - http://en.bitcoin.it/wiki/Tax_compliance

[Epoch]

Mining income is clearly different from trading income/losses (capital gains and capital losses). Any thoughts as to reporting your mining income? I'd say mining is most similar to a lottery, and in Canada lottery winnings are not taxable - but then again, Bitcoin mining is surely not recognized and regulated as a lottery by the government.

Mining income is most certainly not treated as lottery winnings. Stephen Gornick's link (https://en.bitcoin.it/wiki/Tax_compliance) is a good starting resource, though not exhaustive.

Bitcoin mining would fall under the same category as producing goods. Say you have a loom which makes sweaters. You sell those sweaters on eBay and get money. That money is considered income and is taxable in Canada. The bitcoin version: you have a PC which generates bitcoins. You sell those bitcoins on an exchange and get money. That money is considered income and is taxable in Canada.

There is a caveat: if your mining operation is small enough, it can be considered a 'hobby' and Revenue Canada will generally not worry about it. In this case, you will not be able to deduct operating expenses. If your operation is large enough (hard to say exactly what that point is ... perhaps a few thousand $ annually) it will be considered a 'business' (whether you have registered it as such or not) and all income must be reported and will be taxed. The one benefit of this is that you can deduct operating expenses (electricity and equipment depreciation being the main ones).

How does Revenue Canada know that you are selling bitcoins on an Exchange for cash? Well, under current regulatory rules the exchanges themselves (MtGox in Japan, or CaVirtex in Canada) are not treated as banks so they don't have to report anything. But eventually you need to deposit your bitcoin cash into your own bank. Your bank will eventually report it to Revenue Canada; it will have a record of all deposits that have been made during the year into your account (including deposits from your regular wages, and deposits from any bitcoin exchange). Revenue Canada compares the bank's report to the income you reported on your Income Tax form; if there is a significant discrepancy your return can be selected for a tax audit. That situation is best avoided.

The grey area is how to treat stored bitcoins. Say you mined 100 bitcoins worth $4, hung onto them for a year, and then sold for $5. A case could be made for one of 2 scenarios:

1] report value of bitcoins as they are created as taxable income. Then, when selling, report the difference between their value at time of creation and their value at time of selling as a taxable capital gain; or
2] report the value of bitcoins only at the time they are sold as taxable income.

In case [1], if you sold them for $3 (a loss) instead of $5, you could report it as a capital loss.

[paraipan]

@Epoch nice tax guide man, i just realized that we pay too many of them.
We live in the internet forest now so they can come and collect whenever they want

[niko]

Thanks for taking time to clarify things, Epoch. It will be interesting to see how taxation (and in effect recognition) of Bitcoin will play out in 2012 in different countries.

[Epoch]

Not a problem. I'm no lawyer, but this is my understanding. I'm just a small-time miner.

[lonelyminer (Peter Šurda)]

The tax wiki page says

it is possible that the taxing authority will treat the receipt of a Bitcoin through a mining pool, or from an individual mining operation, as a taxable event.

I would not be so sure about it.

Based on published articles and papers, for tax purposes, Bitcoin seems to be a commodity rather than security or currency. This seems to be the case both in the US (one article and one research paper) and EU (an article by a German lawyer). While this classification might change in the future, for the time being, it looks like it's a commodity.

From what I recall from the classes about accounting / taxation I took long time ago is that what you produce (commodities) is not taxed if you don't sell it. Let's say a company manufactures and sells widgets. In a tax period, it produces 1000 widgets and sells 10. It's not taxed based on the market price or cost of the 1000 widgets, rather on the difference between revenue and expenditures. Most likely, in this scenario, it would make a loss, so there should not be any income tax. If the market price or production cost of widgets changes, while this might affect your expenditures (for example, the law might say that you're supposed to value your reserves at actual cost, current cost or market price), this affects your expenditures side, but has no effect on your revenue.

So, I think that you should only pay income tax on the Bitcoins you mine if you either sell them or trade them for something else. If you just hoard them, there should be no income tax implication. It might become different if the legal classification changes and Bitcoins are treated as a security or currency (or an entirely new category). The first one, security, seems unlikely, since the miner is under no obligation to the bearer. The other options might happen though, there are precedents, for example gold is sometimes treated different than other commodities from legal point of view.

[Epoch]

The tax wiki page says

it is possible that the taxing authority will treat the receipt of a Bitcoin through a mining pool, or from an individual mining operation, as a taxable event.

I would not be so sure about it.

Based on published articles and papers, for tax purposes, Bitcoin seems to be a commodity rather than security or currency. This seems to be the case both in the US (one article and one research paper) and EU (an article by a German lawyer). While this classification might change in the future, for the time being, it looks like it's a commodity.

...

So, I think that you should only pay income tax on the Bitcoins you mine if you either sell them or trade them for something else. If you just hoard them, there should be no income tax implication. It might become different if the legal classification changes and Bitcoins are treated as a security or currency (or an entirely new category). The first one, security, seems unlikely, since the miner is under no obligation to the bearer. The other options might happen though, there are precedents, for example gold is sometimes treated different than other commodities from legal point of view.

Agreed. Treating bitcoins as a commodity ('sweaters' in my example) is the correct approach in the US and European Union; there has already been precedents set  in those regions. It is not yet clear in Canada (which is where I assume the OP is located), and I am not aware of any published classification in other regions yet.

But until there is some legal classification set in Canada (I fully expect them to follow the US), I would treat bitcoins as commodities as well. That is, you pay income tax on your bitcoins at the point of sale, not at point of mining. In this case you can report an operating loss (if your income from selling bitcoins is less than your operating expenses), but you cannot claim a capital loss on the bitcoins if they lose value between the time they are mined and the time they are sold.

[mcdett]

Treating bitcoins as a commodity ('sweaters' in my example) is the correct approach in the US and European Union;

I agree completely.  We need more attention given to promoting btc as a commodity to be traded rather then currency.  btc to me are the same as old baseball cards that I buy/trade for usd.

When you start using the term currency you start falling into deep dirty areas of federal government regulation and compliance.  Places that should be avoided for now.

[twobitcoins]

There is still a question of whether bitcoins obtained via mining are created by the miner, and thus similar to manufactured goods, or are received as payment for performing a service, and thus similar to barter income.

The portion of mined coins coming from transaction fees in particular seems like payment for a service, but even the new 50 BTC may be seen as a payment.  A miner can't simply do a million times as many hashes and create 50 million bitcoins.  Miners only get what the other network participants are willing to grant.  In the US, payment for a service would be taxable regardless of whether the payment is in gold, Beanie Babies, or bitcoins.

[Epoch]

There is still a question of whether bitcoins obtained via mining are created by the miner, and thus similar to manufactured goods, or are received as payment for performing a service, and thus similar to barter income.

The portion of mined coins coming from transaction fees in particular seems like payment for a service, but even the new 50 BTC may be seen as a payment.  A miner can't simply do a million times as many hashes and create 50 million bitcoins.  Miners only get what the other network participants are willing to grant.  In the US, payment for a service would be taxable regardless of whether the payment is in gold, Beanie Babies, or bitcoins.

Taxation laws in Canada (relevant for OP) make no distinction between income obtained by providing a service or by providing goods. But even in jurisdictions where there is a distinction, it is irrelevant to bitcoin.

The reason is that BTC itself is treated as a commodity (US and EU have set precedent), not as currency or other financial vehicle. Commodities are not considered as income, and thus not taxable, regardless of how they have been obtained. What is taxable is when BTC is actually exchanged for fiat currency (USD or CDN, for example). The USD/CDN then represents taxable income (obtained by exchanging your BTC commodity for cash).

Thus if you want to argue that your miners are providing a service (and are rewarded with BTC for that service), or are actually producing a good (BTC), it doesn't matter. Being a commodity, BTC itself is not directly taxable.

The question of transaction fees is academically interesting, but at this point mostly irrelevant. Currently, transaction fees represent only a tiny fraction (typically less than 0.1%) of the 50BTC reward. When bitcoin was originally designed Satoshi envisioned that, as the block reward is reduced towards 0 in the years/decades to come, transaction fees would represent a greater and greater proportion of the 'reward'. Right now, and in the foreseeable future (at least 5 years, after which the block reward drops to 12.5BTC/block), the contribution of transaction fees can be safely ignored. Unless you are solo mining, you never see any transaction fees anyway (the pool operators keep them. I'm not aware of one that doesn't).

[twobitcoins]

Commodities are not considered as income, and thus not taxable, regardless of how they have been obtained.

Interesting.  So you are saying that in Canada if a store sells someone a T-shirt and accepts payment in the form a gold coins (or a barrel of oil or whatever), no income tax would be due?  And similarly if a plumber repairs someone's leaky sink and accepts gold coins, no income tax would be due?  I'm not aware of anything that would cause such treatment in the US, hence the questions about whether the bitcoins are created vs. received as payment.  It may not matter in Canada.

Unless you are solo mining, you never see any transaction fees anyway (the pool operators keep them. I'm not aware of one that doesn't).

In a mining pool, you are not necessarily receiving (a portion of) the 50 BTC reward either.  In a PPS pool for example, you are receiving a fixed payment for submitting a fixed number of shares, regardless of how many blocks the pool finds, so it's more like you are being paid in bitcoins for hashing work.  Even if the pool operator is seen as "manufacturing" new coins that are not taxed at the time of manufacture, it's not clear that such treatment would extend to workers in the pool.  (Again, this is based on my understanding that bitcoin income is taxable in the US.  Maybe it is off topic for this thread.)

[paraipan]

Commodities are not considered as income, and thus not taxable, regardless of how they have been obtained.

Interesting.  So you are saying that in Canada if a store sells someone a T-shirt and accepts payment in the form a gold coins (or a barrel of oil or whatever), no income tax would be due?  And similarly if a plumber repairs someone's leaky sink and accepts gold coins, no income tax would be due?  I'm not aware of anything that would cause such treatment in the US, hence the questions about whether the bitcoins are created vs. received as payment.  It may not matter in Canada.

.....

interesting indeed, so it means that if you and i engage in a barter transaction, without even touching fiat, we are exempt from paying income taxes. I could exchange with you a mobile phone for 100 magic cards then without taxes. Cool

[Epoch]

Commodities are not considered as income, and thus not taxable, regardless of how they have been obtained.

Interesting.  So you are saying that in Canada if a store sells someone a T-shirt and accepts payment in the form a gold coins (or a barrel of oil or whatever), no income tax would be due?  And similarly if a plumber repairs someone's leaky sink and accepts gold coins, no income tax would be due?  I'm not aware of anything that would cause such treatment in the US, hence the questions about whether the bitcoins are created vs. received as payment.  It may not matter in Canada.

.....

interesting indeed, so it means that if you and i engage in a barter transaction, without even touching fiat, we are exempt from paying income taxes. I could exchange with you a mobile phone for 100 magic cards then without taxes. Cool

Yes, that is my understanding. Pure commodities are not 'income' from Revenue Canada's point of view and receipt of any commodity does not need to be reported for income tax purposes. But if you decide to sell them at some point, the cash you get does. Bitcoins are, at least in the US and EU, considered as a pure commodity. Canada hasn't said anything one way or another so, until they do, it is not unreasonable to go along with the US and EU classification.

Regarding @twobitcoins' examples, gold and other precious metals are a special case in that they are legally categorized as both a commodity and a currency, so receiving payment in those forms would be considered income. I'm not sure about crude oil ... ... but I've never been offered payment in the form of a barrel of oil so I won't worry about it too much.

Consider this: if a plumber fixes your sink and charges $100, he must report it as income. Similarly if he accepted payment in gold he would be required to report it (gold is treated as currency). But if he accepts payment in the form of 100kg of salt, he would not have to report it. Similary, if he charged 20BTC for his work, he would not have to report it. What he would have to report is the $ he gets when he eventually sells the salt or sells the BTC for $.

One more thing (perhaps this is going into too much detail): for business purposes the plumber has the option of reporting the current value of the salt/BTC when he receives it; the benefit being that he can take business deductions off of that income and, if he sells it in the future at a loss, it is considered as a capital loss which could be used to reduce his future tax. Conversely if he sells it at a profit, that profit (not the full value, just the profit) would be considered as a capital gain and would be taxable.

@Paraipan, yes, we could trade a phone for 100 magic cards without tax (technically, there could be PST/GST/HST involved, depending on whether or not it is considered a business transaction, but I'm not going to go there). 100 magic cards won't help me with my mortgage payments or grocery shopping, so eventually I'd have to convert them into cash. And that's where the tax man steps in.

[niko]

...
Consider this: if a plumber fixes your sink and charges $100, he must report it as income. Similarly if he accepted payment in gold he would be required to report it (gold is treated as currency). But if he accepts payment in the form of 100kg of salt, he would not have to report it. Similary, if he charged 20BTC for his work, he would not have to report it. What he would have to report is the $ he gets when he eventually sells the salt or sells the BTC for $.
...

I thought so, until I saw some UK regulations where, if I understood correctly, this would be considered a barter, and subject to  tax. Can't remember how exactly this tax was categorized (sales? VAT?).

Either way, currently my understanding is that "creation" (mining) of bitcoins as a commodity is not subject to tax per se.

[Epoch]

...
Consider this: if a plumber fixes your sink and charges $100, he must report it as income. Similarly if he accepted payment in gold he would be required to report it (gold is treated as currency). But if he accepts payment in the form of 100kg of salt, he would not have to report it. Similary, if he charged 20BTC for his work, he would not have to report it. What he would have to report is the $ he gets when he eventually sells the salt or sells the BTC for $.
...

I thought so, until I saw some UK regulations where, if I understood correctly, this would be considered a barter, and subject to  tax. Can't remember how exactly this tax was categorized (sales? VAT?).

Either way, currently my understanding is that "creation" (mining) of bitcoins as a commodity is not subject to tax per se.

Correct; the creation of bitcoins as a commodity is not subject to tax; only when you sell them for cash. It would not be considered bartering.

FYI: On the topic of 'barter', I've researched this with the Canada Revenue Agency; my initial explanation of 'bartering commodities' is wrong. According to CRA's Interpretation Bulletin IT-490, there is going to be a tax implication when you barter. According to the CRA, a barter transaction should be treated as though you have received a payment for whatever good/service you have traded. The value of this payment is the fair market value of the good/service you have provided to the other party.

One caveat is that barter transactions are only taxable when the goods or services you're giving up are of the kind generally provided by you in the course of earning income from a business or a profession carried on by you. As a 'hobbyist', as long as you barter only occasionally, you won't face tax.

Again, bartering does not apply to bitcoin miners exchanging bitcoin for $. It does, however, apply to our ficticious plumber providing a service in exchange for a bag of salt (he is exchanging his plumbing services for a good), or @paraipan providing 100 magic coins for a phone (if this was only occassional, and @paraipan is not in the business of selling phones, this transaction would not be taxed).

[lonelyminer (Peter Šurda)]

I thought so, until I saw some UK regulations where, if I understood correctly, this would be considered a barter, and subject to  tax. Can't remember how exactly this tax was categorized (sales? VAT?).

It's VAT, from what I remember. That of course only affects parties that are registered for VAT purposes: if you're a private person paying for, say, services of a plumber, you do not need to charge him VAT. The plumber, however, does have to if he would have to charge in pounds as well.

However, when you receive Bitcoins as an employee, from their employer, other rules may apply and it still might be taxable as personal income, just like, say, fringe benefits.

[twobitcoins]

Correct; the creation of bitcoins as a commodity is not subject to tax; only when you sell them for cash. It would not be considered bartering.

Again, bartering does not apply to bitcoin miners exchanging bitcoin for $. It does, however, apply to our ficticious plumber providing a service in exchange for a bag of salt (he is exchanging his plumbing services for a good), or @paraipan providing 100 magic coins for a phone (if this was only occassional, and @paraipan is not in the business of selling phones, this transaction would not be taxed).

Suppose I offer the service of password cracking using a cluster of GPUs in exchange for bitcoins (and I am in the business of doing so).  Would you now consider that to be a taxable barter transaction?

If so, how is it different if I offer the service of block generation and transaction processing in exchange for bitcoins?  Does it not come down to the question of whether I am creating the mined bitcoins or receiving them in exchange for a service?

I still think there is a significant chance that mining bitcoins amounts to barter -- certainly in the case of solo mined transaction fees, likely in the case of payments received from pool operators, and quite possibly even in the case of solo mined 50 BTC block rewards granted by the other network participants in exchange for helping to secure the network.

[Epoch]

Correct; the creation of bitcoins as a commodity is not subject to tax; only when you sell them for cash. It would not be considered bartering.

Again, bartering does not apply to bitcoin miners exchanging bitcoin for $. It does, however, apply to our ficticious plumber providing a service in exchange for a bag of salt (he is exchanging his plumbing services for a good), or @paraipan providing 100 magic coins for a phone (if this was only occassional, and @paraipan is not in the business of selling phones, this transaction would not be taxed).

Suppose I offer the service of password cracking using a cluster of GPUs in exchange for bitcoins (and I am in the business of doing so).  Would you now consider that to be a taxable barter transaction?

If so, how is it different if I offer the service of block generation and transaction processing in exchange for bitcoins?  Does it not come down to the question of whether I am creating the mined bitcoins or receiving them in exchange for a service?

I still think there is a significant chance that mining bitcoins amounts to barter -- certainly in the case of solo mined transaction fees, likely in the case of payments received from pool operators, and quite possibly even in the case of solo mined 50 BTC block rewards granted by the other network participants in exchange for helping to secure the network.

I think these are some of the questions to which we all would like definitive answers to. Unfortunately, at least for now, there is no clear (or any) legal/official answer yet. None that I am currently aware of, at least. The whole ecosystem surrounding bitcoin is very much still a grey area. Bitcoin is a virtual construct; it is created out of 'thin air'. It has no intrinsic value other than that which people decide to give it.

The only concrete guidance is that a 'bitcoin' has been classified as a commodity by US and EU regulatory bodies. Other countries/regions have not published anything yet. So, at least in the US and EU, obtaining bitcoin by way of trade constitutes barter. Whether that is taxable depends on the situation (i.e. business/regular transaction, or occasional transaction).

How bitcoin mining itself is classified is still nebulous, because there are several different aspects of it. But I think we're splitting hairs here. In solo mining, your own miner actually generates the 50BTC block itself; it is not 'granted' by the network participants. I would not consider this as a barter situation; you are clearly generating the BTC commodity yourself.

In pooled mining you occasionally [a] generate 50BTC yourself and 'gift' it to the pool (this could be argued as being a barter); and more often you are rewarded by the pool with BTC in exchange for submitting shares (again, possibly argued as being a barter). But taking a macroscopic view of the situation, one can argue that their miner is generating (i.e. helping to create) xyz amount of BTC per day. It is not a barter; it is the creation of a commodity.

Until a jurisdiction rules definitively on the subject of bitcoin mining, it is reasonable to use whatever definition works best for your personal situation. Clearly there are logical arguments to be made for more than one point of view. The taxation departments of Canada, or the US, or the UK, should be happy that you are at least not trying to hide income. Whether you want to report your mined BTC earning at time of mining, or at the time of selling, is up to you.

I think most people would opt for 'report at time of selling', if for no other reason than it being simpler to deal with. Non-casual miners may want to report it at time of mining so that they can claim deductions.