Crypto Mining and Retirement Accounts | Freeman Law


Crypto mining has been extremely profitable in recent years, with Bitcoin miners earning an estimated $15 billion in revenue and several mining companies going public in 2021. Miners are instrumental in preventing the double spending problem on decentralized Cryptocurrency networks like Bitcoin. Validate and add blocks of transactions to the block chain ledger competing with other miners to solve complex math problems and receive crypto tokens as a reward for their mining activities.

Unsurprisingly, crypto mining profits have drawn the attention of the IRS, which has taken an increasingly aggressive approach in recent years to auditing and taxing mining activities. Given this increased enforcement of the law, both tax professionals and their clients have explored ways to minimize mining profits by conducting mining activities through tax-advantaged vehicles such as IRAs and 401(k) accounts.

Building on existing law, this publication examines the potential tax implications and planning opportunities to carry out mining activities through retirement accounts with tax advantages.

Current Law on Retirement Accounts

Making investments through retirement accounts has become an increasingly popular and controversial practice because investment income is generally allowed to grow tax-deferred. For these purposes, investment income includes real estate rentals, interest, dividends, royalties, and capital gains income related to the purchase or sale of a capital asset. Because the IRS has generally characterized cryptocurrencies as a low capital asset Notice 2014-21any gains from the sale of crypto assets are generally tax-deferred.

However, the specific tax implications may differ based on the type of retirement vehicle used. For workplace 401(k) plans, the member generally makes pre-tax contributions to the account and any investment income is taxed when withdrawn. If any portion of the funds is withdrawn after age 59½, any investment income attributable to the withdrawals (as the case may be). If withdrawals are made before age 59½, any gains attributable to the withdrawn funds are subject to a 10% penalty in addition to capital gains taxes.

Similarly, pre-tax funds are contributed to traditional IRAs, and earnings attributable to withdrawals made after age 59½ are taxed at the applicable earnings rate (again, a $10 penalty is imposed). % on the earnings of said withdrawals made before this age). By contrast, after-tax contributions are made to Roth IRAs, and earnings on withdrawals are not taxed, as long as the withdrawals are made after age 59½. A 10% penalty applies to earnings attributable to withdrawals made before age 59½.

Taxpayers, however, can currently be taxed on any retirement account earnings attributable to “Unrelated Business Taxable Income” (“UBTI”) at a maximum individual rate of 37% (the “UBIT”). In this case, UBTI broadly includes any gross income derived by any organization from an unrelated trade or business. In general, income flowing into or derived from an active business retirement account will be treated as UBTI. As described below, earnings derived from cryptocurrencies mining flowing into a retirement account (eg, IRA, 401(k)) will likely be characterized as UBTI.

Crypto mining like UBTI

The IRS has not specifically commented on whether crypto mining earnings would be considered UBTI. That said, the IRS indicated in Notice 2014-21 that reward tokens received from mining Business or trade activities are included in gross income and are subject to self-employment tax.

Given the Service’s position in Notice 2014-21, earnings flowing into or earned by a retirement account from an active crypto mining the business/activity may be treated as unrelated to the account’s tax-exempt purpose of providing retirement savings for the account owner. In this sense, the tax treatment of cryptocurrencies mining Income as UBTI is similar to income generated by investing an account in a PTP or MLP, a common situation where accounts can inadvertently generate UBTI.

If the crypto mining earnings are treated as UBTI, income will not be tax deferred, but will currently be taxed at variable rates, with a maximum rate of 37%. One way retirement account holders can potentially reduce their UBIT is to contribute retirement funds to a newly created “blocker” C corporation, which would then invest the same funds in the crypto. mining business (either as an investor or as an active participant in the business). In this way, the retirement account would hold 100% of the corporation and the blocker would be the direct investor/winner of the crypto. mining operations.

Under this scenario, the income generated by cryptocurrencies mining activities would be taxed in the blocker at the lower corporate rate of 21% (instead of the higher individual rate of 37%). Once encumbered, the crypto could be distributed by the blocker mining earnings to sole shareholder of IRA or 401(k). A distribution of crypto profits to the account would be treated as a dividend which, as mentioned above, is a permissible form of investment income that will not be subject to current taxes.

Food to go

In light of crypto mining boom, crypto miners and investors in crypto trades have looked for ways to shield their profits from federal taxes. However, using retirement accounts to accomplish this purpose comes with difficulties, as the IRS will likely deal with cryptocurrencies. mining as UBTI subject to current taxation.

PS Insights on cryptocurrency legal issues

Most jurisdictions and authorities have yet to enact laws governing cryptocurrencies, which means that, for most countries, the legality of cryptocurrencies mining is not yet clear.

Under the Financial Crimes Enforcement Network (FinCEN), crypto miners are considered money transmitters, so they may be subject to laws governing that activity. In Israel, for example, cryptocurrencies mining it is treated as a business and is subject to corporate income tax. In India and elsewhere, regulatory uncertainty remains, although Canada and the United States are relatively crypto-friendly. mining.

However, aside from jurisdictions that have specifically prohibited cryptocurrency-related activities, very few countries ban cryptocurrencies. mining.

Our Free Man Law Cryptocurrency Law Resource The page provides a summary of the legal status of cryptocurrency for each country in the world with legal or regulatory provisions governing cryptocurrency.

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