How do crypto enthusiasts earn revenue? Is it just from trading cryptocurrencies? Not quite. Besides trading, crypto enthusiasts earn income and capital gains by staking and mining cryptocurrencies, building a passive source of revenue over time – and taxes need to be paid.
Though a profitable venue, you can no longer hide it from the IRS and have to file income tax returns. So what are the tax implications of mining and staking cryptocurrency in 2023?
What does Staking and Mining Cryptocurrency Involve, and What are Their Tax Implications?
Crypto mining is similar in context to regular mining. The only difference is that crypto mining promotes the generation of cryptocurrencies, including Bitcoin, Litecoin, Dogecoin, Ethereum, and more. In comparison, regular mining involves extracting valuable items from the Earth’s core.
On the other hand, crypto staking does away with the Proof of Work (PoW) consensus. It’s based on the Proof of Stake (PoS) consensus mechanism wherein transactions are verified by individuals who stake their tokens.
This sounds good in theory, but why do crypto enthusiasts spend their time and energy mining and staking cryptos? What’s in it for them?
Why do crypto enthusiasts participate in crypto mining and staking?
Mining allows the verification and securitization of new transactions on a blockchain network. However, it can’t be achieved without miners since they offer the necessary processing power to support the development and maintenance of the blockchain network.
But mining is no easy task. It’s time-consuming and requires sophisticated and expensive hardware to solve complex mathematical problems.
So why do individuals participate in it?
They participate in mining because the rewards outweigh the challenges since:
- the first miner to solve the cryptographic problem receives new tokens, and
- gets to add the new authenticated block of transactions to the blockchain network.
Similarly, staking offers the same rewards as crypto mining but differs in the aspect that no one has to solve complex mathematical problems to earn rewards. Since it uses less processing power, it reduces energy consumption, increases process efficiency, and helps lower fees.
Crypto staking is usually carried out by crypto investors who want their holdings to work for them. It’s also a great way of supporting and securing their favored blockchain projects, making the project immune to malicious attacks while allowing it to process huge volumes of transactions.
Though considered superior to mining, it’s not without its challenges. Anyone can indeed begin staking, yet to protect your investment, you must possess the following:
- expert technical knowledge,
- a minimum number of tokens to stake, and
- dedicated hardware that can confirm transactions 24*7 without any glitches.
Additionally, staking has a mandatory lock-in period (differs from project to project), during which you can’t use or trade your staked tokens to take advantage of price fluctuations.
Now that you’re familiar with mining and staking top cryptocurrencies, let’s take a look at their tax implications and filing requirements.
Tax implications associated with crypto staking and mining
The revenue in the cryptocurrency segment is expected to reach US $64.87 billion by 2027, showcasing a CAGR of 14.40% between 2023 to 2027. This data highlights how lucrative the crypto space will be in the coming years, translating to higher tax revenue.
Even though the crypto tax implications vary globally, you must pay either income or capital gains tax on the rewards earned from mining and staking activities.
That said, paying income tax on the passive income generated from crypto makes sense. But how would you qualify to pay capital gains tax on your rewards? Since the IRS treats cryptocurrencies as property for income tax purposes, you must follow the capital gains and losses rule to file taxes.
But which activities are taxable, and are there any exemptions? Let’s find out.
Crypto employee grants
The crypto world is evolving, and the employment landscape is shrinking.
With developments in Web 3.0 and remote work policies, companies—especially those contributing to Web3—are looking for ways to compensate their employees using cryptos, stablecoins, and tokens.
This is no experiment where employers test their employees’ attitude to the company’s exemplary benefits. For such companies, it’s a way of showing their appreciation and ensuring that their employees get their fair share of the assets they’re contributing to their growth.
Full-time employees and contractual contributors also prefer it. However, it’s not easy for employers to pay their employees in crypto or related assets.
Tax implications employers must consider when paying their employees in crypto
The lack of clear guidelines regarding crypto compensation and varied tax laws make crypto grants for full- and part-time employees challenging. Moreover, companies must be aware of the following to legally and compliantly offer their employees crypto grants:
- Minimum fiat currency requirement that they must meet.
- KYC (know your customer), AML (anti-money laundering), and other related regulations, such as bank secrecy, to follow the associated rules and regulations.
- The manner cryptos are treated—commodities, stocks, or property—in their employee’s country of residence.
- Required licenses to pay their employees in crypto.
That’s not all. Crypto tax calculation and payment is another headache employers and employees must contend with. But it’s not all doom and gloom. Some solutions support crypto grants for employees, allowing you to manage token vesting for your global workforce.
These platforms make payroll integration, compliance with local crypto rules, tax calculation, and detailed documentation reporting a breeze. Moreover, if you get stuck anywhere, such solutions offer 24*7 support options so you’ve all the information and help you need when you need it.
But crypto grants don’t just affect employers. They affect their employees too.
Tax implications employees must consider when receiving crypto grants
After receiving crypto grants, employees need to determine which category their grants fall into to calculate their taxable income. Generally, there are three key categories, including:
- Income tax: employees may have to pay income tax if they receive their salary in crypto, based on their jurisdiction. The taxable amount is determined, given the fair market value at the time of receipt.
- Capital gains tax: Employees must pay capital gains tax if they convert the received cryptocurrencies into fiat currency. They can calculate it by deducting the fair value at the time of receipt from the value at the time of conversion. The treatment is similar if they use their grants to purchase goods and services.
- Fringe benefits tax: non-cash crypto benefits might also be taxable.
Crypto mining as a hobby
If you mine the different types of cryptocurrencies as a hobby, you’ll have to report your gains as ‘Other Income’ on Form 1040. Your levied tax percentage will be dependent on your taxable income amount.
Remember that no exemptions are available to individuals mining crypto as a hobby.
Crypto mining as a business
If you’re mining crypto as a business, you must declare your income on Schedule C (Form 1040). A crypto mining business is entitled to certain exemptions if adequate documentation is maintained, such as:
- Electricity: power used for mining crypto can be treated as a business expense. If you’re using another property or your home for mining, you must keep track of the electricity used solely.
- Equipment: generally, you’d be able to deduct the cost of your mining equipment in the year of its purchase under Section 179. If your purchase value exceeds $2.7 million, you can deduct the cost yearly through the asset’s depreciation.
- Rent: if you’re renting office space to mine crypto, the expense is treated as a business expense and is deductible. However, if you use your home as your headquarters, you can claim a home office deduction based on the space you use for your operations.
- Losses: if you incur losses on mining crypto, you can use this amount to offset other income.
- Repairs: repairing costs incurred on any mining asset is deductible.
Taxation rules for crypto staking
Staking rewards are taxed the same as crypto mining gains, meaning that it’s subject to income tax upon reception and capital gains tax upon expenditure. But if you move your crypto to a third-party staking solution, staking pool, or wallet, it’s usually not taxed.
However, if you receive crypto due to transferring your crypto, you’ll have to pay tax on that.
Subsequently, staking directly or through a third party has varied tax consequences. For instance, if you stake directly, your resultant staking rewards would be completely tax-free. On the other hand, if you use a third party to participate in staking activities, you’ll have to report the resultant rewards as ‘Other Income’ and pay income tax.
File your tax returns for income generated through mining and staking
Since the IRS can easily monitor your crypto activities, file your tax returns on time. Otherwise, you’ll have to pay penalties and interest if you don’t pay the penalty on time.
Moreover, your tax amount will depend on your income for a fiscal year and whether you owned the crypto for short—under one year—or long-term—over a year. Typically, short-term capital gains are taxed more than long-term gains.