A Closer Look At Block Rewards

Bitcoin block rewards accrue to miners and consist of two components: a block subsidy and transaction fees. Each of these has different definitions and frameworks as referenced in the tax law.

Taxing Transaction Fees

Transaction fees are the simpler of the two components. These fees accrue to miners and are sent from bitcoin users within each transaction. Miners aggregate all the fees across all transactions in the block and earn those fees once their block wins the mining tournament and joins the blockchain. Today, these fees count as income to the miner and are taxed as such.

This makes some sense because the miner is performing a service, namely, gathering the transactions together and appending them onto the chain. When the miner receives those transaction fees, the cost basis is the current market price of bitcoin, i.e. the BTC/USD exchange rate at the moment. When the miner sells that bitcoin that he earned through transaction fees, it will calculate the gain on that cost basis.

In this sense, the miner acts as any other recipient of a bitcoin transaction, and therefore, his tax treatment should match that of general bitcoin transactions. So, we need no separate analysis for the taxation of transaction fees; just copy and paste from our taxation of transactions. If we adopt my own preferred solution of a very high de minimis exception for bitcoin transactions, so too should that apply to the miner for his bitcoin earned through transaction fees. Thus, the taxation of bitcoin transaction fees is simply a special case of a broader policy on bitcoin transactions, and needs no special treatment of its own.

Taxing The Block Subsidy

The block subsidy, however, is another matter. The block subsidy is the only route through which new bitcoin emerges. Since 2014, this block subsidy has been taxed as income. This may have occurred as an unintended consequence of the semantics of proof of work, which makes it sound as though the miners should, therefore, earn income for their work. But there’s a key difference.

Unlike individual or corporate income, which emerges from employment or the sale of goods and services, there is no third party involved in the miner’s work: no employer, no customer, no investor. And so taxing the subsidy as income makes little sense.

The right analogy here is to gold. A gold miner who discovers a new nugget of gold is not taxed on the value of that gold as income. Rather, he pays tax only on sale. To see this in detail, you can inspect the financial statements of public gold miners. For example, on page 165 of the 2022 10k of Newmont, you can see traditional inventory costing and methodology. i.e., they are capitalizing both direct and indirect costs into inventory and work-in-process, not recognizing revenue at the time precious metals are extracted. And so, the precedent for gold mining is clear. So too should bitcoin miners face no income tax on the receipt of the block subsidy, but rather only on sale

The Internal Revenue Service Misfire

New technologies traditionally benefit from a lack of regulation, and bitcoin is no exception. The early years of bitcoin have allowed it to fly under the radar as the government gropes for right regulatory framework.

The taxation of block rewards is one example where the IRS policy overshot, and is excessively onerous. Most legal and accounting professionals who know how bitcoin works acknowledge that the block subsidy should be taxed as property, not as income. Making this actual policy will require participation from bitcoin miners.

To date, the mining industry supports the position that new bitcoin is property, not income. But, they have not yet mobilized on this. After the next halving, I expect this to be a bigger issue since the smaller subsidy will put more economic pressure on the miners, and expose the excessive taxation currently in place.

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