Index - https://steemit.com/tax/@alhofmeister/tax-blog-index
Introduction
To finalize my most recent series of case studies on the tax implications that the choice of entity has on a cryptocurrency mining operation, I've decided to put together a summary which highlights the pros and cons of each type of entity.
Case Study Problem
Taxpayer A decides to mine Bitcoin in January. To accomplish this task, Taxpayer A acquires mining hardware for $500, purchases software for $50 and joins a mining pool that distributes earnings net of a 5% surcharge. Each month, the mining operation increases the electricity bill by $100. In addition, Taxpayer A manages the website the mining pool uses to advertise and is paid $50 a month. Taxpayer A uses a personal computer that is also used for personal reasons (40% personal/60% business). The personal computer was acquired in a prior year and converted to it's current use. The computer cost $600 when it was originally purchased but it's current fair market value is $300. Over the course of the year, Taxpayer A receives the following payouts from the mining operation:
- In February, Taxpayer A is awarded 0.05 Bitcoins when it is valued at $13,000.
- In April, Taxpayer A is awarded 0.08 Bitcoins when it is valued at $14,000.
- In May, Taxpayer A is awarded 0.04 Bitcoins when it is valued at $10,000.
- In August, Taxpayer A is awarded 0.02 Bitcoins when it is valued at $16,000.
- In November, Taxpayer A is awarded 0.10 Bitcoins when it is valued at $12,000.
Additionally, Taxpayer A engages in the following transactions throughout the year:
- In September, Taxpayer A sells 0.07 Bitcoins when it is valued at $16,000. Transaction fees totaled $50.
- In December, Taxpayer A sells 0.04 Bitcoins when it is valued at $13,000. Transaction fees total $50.
Results
Before launching into a detailed analysis, I must temper the conclusions with the following considerations:
The case studies were prepared under the assumption that reasonable compensation for conducting a cryptocurrency mining operation would be less than the taxable income resultant from the business. Note that this has a huge impact on the calculation and could drastically change the answer presented below;
The tax calculated below assumes that the coins mined by the taxpayer would be considered capital gain property based on their selling patterns. This treatment might be disallowed by the IRS (but has not currently been ruled on). The case studies analyzed below are the non-inventory examples;
The appearance that the C corp business entity results in reduced taxation at higher levels assumes that the operations stated in the example represent the entities total activities. The favorable tax calculated below is a result of the corporate tax rate (15%) being so much lower than the individual tax rate (33%+); and
Payroll (self employment) taxes are calculated based on the assumption that the taxpayer does not make more than $127,200 in active income for the year.
The 20% pass through entity deduction applies to cryptocurrency mining operations. Note that this represents a major assumption of the case studies. Based on wording in the new tax law combined with the SEC's recent position on cryptocurrency (and the potential use of that position by the IRS), cryptocurrency mining operations might not be able to claim the deduction
I believe that the most clear conclusion that can be drawn from the studies is that the best entity choice is largely dependent upon the facts and circumstances surrounding the taxpayer. 9 out of 10 times, however, the S corp is going to be the best entity assuming that the restrictions regarding ownership and operation do not preclude the taxpayer from selecting that entity type. Notice, however, that as the taxpayer's marginal income tax rate increases, the benefit of the 20% deduction begins to outweigh the benefit of avoiding self employment taxes. This leads to the conclusion that a disregarded entity might be the most tax effective entity at higher levels.
References
S Corp Example - https://steemit.com/tax/@alhofmeister/case-study-9-1-taxation-of-cryptocurrency-mining-s-corp-tax-liability
C Corp Example - https://steemit.com/tax/@alhofmeister/case-study-6-1-taxation-of-cryptocurrency-mining-c-corp-tax-liability
Disregarded Entity Example - https://steemit.com/tax/@alhofmeister/case-study-6-1-taxation-of-cryptocurrency-mining-disregarded-entity-tax-liability
S Corp vs. LLC Explained - https://steemit.com/tax/@alhofmeister/the-difference-in-taxation-between-a-s-corp-and-an-llc
20% Deduction Explained - https://steemit.com/tax/@alhofmeister/calculation-of-the-20-deduction-for-2018-pass-through-entities
Disclaimer
Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.