The default rule in the U.S. is that the receipt of any sort of property, be it cash, real estate, securities, or even drugs, is a taxable event...unless the IRS or the Tax Code says otherwise. This means that as a default you recognize income, whether you are repaid for your efforts and/or investments in the form of cocaine, or you are mining coins. This is good and bad news for mining pools and investors in those pools. While you are subject to U.S. taxation, knowing this ahead of time should allow you to plan and structure mining operations, pools, and investments appropriately. But what does it mean to be subject to taxation in a global economy?
Let’s take, as a case study, a mining pool with operations in the U.S. and with investors both within the U.S. and abroad. For all practical purposes, for the investor this is no different than investing in any other sort of business within the United States. The U.S. operations means the pool is engaged in a U.S. trade or business, which in turn means that the business is subject to U.S. taxes, whether it earns profits in altcoins or U.S. dollars. For U.S. investors, there is no surprise that the mined coins should be included as income. If this business is passing profits through to its investors abroad, then we look to the appropriate tax treaties in effect between the U.S. and the country of residence of each foreign investor, and the various US-sourced income withholding rules. Structuring the relationship as an individual investor simply leasing mining equipment, as opposed to investing in a mining pool, does not change this basic principle, or the end result.
Typically, there are two possible characterizations of the income flowing out to a non-resident alien (NRA) investor: 1. It could be income effectively connected to a U.S. trade or business (ECI), or 2. It could be considered fixed and determinable periodic income (FDAP). FDAP is subject to withholding under IRC §1441(a). As a default, this means the payor (e.g., the mining pool in this instance) is required to withhold 30% of the GROSS payment to the NRA. This 30% rate is reduced in many instances depending on the particular investor’s country of residence and that country’s tax treaty with the United States.
On the other hand, ECI is exempt from this harsh withholding requirement and is instead subject to taxation on a NET basis at normal U.S. income tax rates. Depending on where an investor is located, structuring the mining activities to generate ECI may or may not be preferable to having the profits or payments treated as FDAP. These two classifications can have wildly different results, and the difference in classification can sometimes stem from very simple variations in structuring. This means that a little proactive planning for your mining investment and/or the setup of your mining operation/pool can go a long way towards reducing your tax burden.