Presenting the IRS a Real Use-Case Scenario to Teach Them About the Possible Unintended Consequence the Alt-Coin Mining Taxes

I just finished my taxes.

I feel like I was just punished for being on the cutting edge of computer and monetary science. That will teach me – why would I want to be part of an innovative technology in the USA?

How dare I?

Before I relate my experience and interpretations, know up front, I’m not a tax expert. I’m only indicating how I interpreted the rulings. Your professional tax person might advise differently so don’t use this story as any kind of tax advice.

I doubt any IRS researcher actually took time to sit down with an actual alt-coin miner to study the effects of how their ruling that, in effect, double or triple taxes alt-coin mining. I suspect they never sat down with somebody in the trenches and asked some very simple “What if” questions. The unexpected consequences of making broad decisions over complex systems might kill the innovation from ever developing. I would be interested to see proof of any actual real-life use-case study that was used by the IRS to predict the results their ruling. I’ve taken it upon myself to take create one case study by examining one day of the life and times of a digital currency miner (me). Hopefully this will enlighten somebody to actually understand how the ruling could affect us. Perhaps it will become obvious that nasty and probably unexpected consequences might follow these actions.

They declared that alt-coin miners must pay income tax, and well as capital gains tax as soon as they’ve swapped them for another digital currency such as bitcoin. I believe they treated alt-coins as if you could also sell them directly for fiat which is incorrect almost all of the time. In addition- when those bitcoins you’ve traded them for then are sold for dollars, or used to purchase something – you’ve just been triple taxed it before it has become useful for anything in the real world.

First tax= income at coin creation.

Second tax = Capital gains tax when selling the coin for a dollar-exchangeable coin. Higher short-term capital asset tax.

Third tax = Capital gains tax again when selling your converted bitcoin it to fiat, or simply buyingsomething. Heaven forbid if you buy something with it before it exists for one year as you will get taxed at an even higher rate. Again.

The way I see it, there might be two directions this ruling may lead:

IRS efforts appear to be trying to kill digital mining in the USA through regulation.

The rules of tracking, accounting, and reporting are so complicated that the effort required to even begin to keep up will cause such a loss that there will be no will to go on. Any invention, research – experimentation or good that would have come out of amazing potential of digital currencies – will have to come from other countries. Technology follows the path of least resistance. If you put up dams, the flow of technology will find somewhere else to flow and thrive.

IRS efforts may create a new army of tax dodgers and rogues that go deeper underground to continue with the efforts of science and innovation outside of the prying eyes of the government. Thanks to our government in the US, we can now get a taste of what it feels like to live in communist countries.

We can thank the efforts of the governments around the world to regulate Napster out of existence, then just about any other centralized company that tried to allow for file-sharing. Because of this, we now have bittorrent, port hopping decentralized DNS and TOR. Our nature as humans is to follow the path of least resistance. Consider any ruling that you have: if it is seen as unreasonable or a blockage for technology, it will simply be bypassed and made irrelevant. The law of unintended consequences could develop around the revolutionary technology in ways you can’t possibly imagine. Did the record industry or the movie industry predict bittorrent would be developed when they simply tried to stop file sharing?

Let me shine a light into the world of a “stay-at-home” digital currency miner so the IRS might actually have an example of a case-study.

I heard about digital currencies last spring and thought that was a cool idea and I ought to look into it. I’ve been a computer junkie for 20 years and figured it would be something I could master. After spending a week trying to mine bitcoin with my computer CPU last spring, it became obvious that bitcoin was already too hard to mine without purposely built ASICs computer chips that were just then coming to market. Chasing a tiny bit of profit would have to come through “Scrypt Mining” beginning with litecoin. I know how to build computers and can install software so I figured I would experiment and dabble.

My research into digital currency mining stretched from a few days to weeks and eventually months. I read, tweaked, fiddled, readjusted, stayed awake all night, tweaked again, rebooted, bought new hardware, rebuilt, tested, rebuilt and rebooted…a lot. Running video cards at the peak performance is like rocking back in a rocking chair and getting all the way back to the point you almost tip backwards…and then hold it there. It seems only a slight gust of wind would be enough to push the system over the edge and crash. You are literally pushing the boundaries of your hardware way past the point the manufacturer intended. Needless to say, I don’t expect the hardware to live long enough to make it past the warranty period. I calculated that if I added my time together doing all of this research, trial and error and various mining activities I’ve spent close to working a full time job for four months just through experimenting on it. I was often still going past 2 am before I could drag myself to bed.

The IRS probably doesn’t understand that the difficulty just keeps rising as you go so you have to keep buying better hardware just to stay in place in receiving coins. Once you’ve purchased the hardware – you are committed. You can’t expect any kind of return on your investment if it just sits there doing nothing. A crashed system doesn’t pay for itself. Up-time is everything. You have just a fairly short window of opportunity to make the money back before the hardware is obsolete in the digital arms race. Even then we are speculating the price will continue to rise. If not, we’ve just got really expensive toasters.

Then there are all kinds of unexpected challenges for which you must contend. It is not profitable to mine by yourself as the odds of you solving the puzzles to be awarded the new currency are extremely low. We join mining pools. The problem with the early mining pools are that they are largly run by armature geeks with no proven reliability. Pools would go down often, sometimes for days, or weeks. They were always being hacked, and on many occasions, my lite-coins were stolen before I could withdraw them.

Too many times to count, the pool just went dark. No explanation, just… gone. And my coins with it. That, I suppose, is the price you pay for being on the bleeding edge. It cost me electricity, time, and hardware only to see coins vanish. The media covers the bitcoin exchanges going out, but I haven’t read anything about mining pools doing the same thing. But with the new IRS ruling, technically – as soon as those coins were mined into existence, that was supposedly income for me to report. Unfortunately, there is no record of those coins because those pools took any record of the activity down with them. Hopefully this doesn’t make me an outlaw on somebody’s ‘list’. Those were expensive lessons. Not only did I lose out on the coin, but the electrical costs made my electricity bill double, and I also had the ‘opportunity loss’ where I might have been mining coins at a reliable pool. Losing them hurts triple when you count the two that were stolen, the electricity it took to create them that might have made you whole, and the two that you could have earned had you been on a more trustworthy pool to begin with.

But even when it is running perfectly, based on the market – many days were at a loss to even recover the price of electricity. But some of us do it for the pioneering effort to perhaps change the world. It isn’t all just about money. This is a new science and could go in endless directions. Mining is absolutely necessary for the effort to sprout and the destinies someday reached. To place burdens such as the enormous amount of tracking and paperwork added to the complexity and time involved in just performing this service will kill it, at least in the USA.

To explain this, I will use my mining efforts from yesterday to illustrate.

Bitcoins are too difficult to mine from home on “regular” PC hardware, so unless one is a dedicated business with a lot of money and space to dedicate to this function, regular people are priced out. We’ve had to set our sights on more attainable goals and coins using the “Scrypt” function is about all we have left for the digital currency scraps.

Because of the enormous amount of alt-coins available to mine and new versions seemingly pop up daily, many now use one of the various “multi-coin” pools. The logic running these pools programmatically check the real time value of the various coins will switch all process power to that coin on an hourly basis. This now creates a problem. We must declare income as soon as a coin is mined into existence for each coin not knowing which coin we will be mining from one hour to the next.

For example, dogecoin’s value is currently so low it takes roughly 100 of them to equal the price a nickel. We are now supposed to recognize that and pay income tax on each one. Using yesterday for an example, the pool automatically switched between feathercoin where I made a total of 41 cents to dogecoin, as the profitability peak changed throughout the day. I made a gross income of $4.33.

But according the calculations on Coinwarz.com – I used $5.28 in electricity for the three machines to pull in the “mother-load”. So my net income for yesterday was negative 94 cents. I only know this price because that’s what the pool indicated when they were sent the proceeds to my account. According the the IRS ruling, I have to track that amount each day and report it. Also, I have to keep track of every one of the 10,000 or so dogecoins I helped “birth” yesterday. If I trade in 500 dogecoins someday so I can have a “whole” quarter, I’m supposed to know which daily batch of 10,000 they might have come from, so I can figure the capital gains tax on the 25 cent piece. This only happened once they meet the minimum threshold that the pool considers it worthwhile to even send them as some coins are worth seven numbers right of the decimal point. That means it might take a million to make a dime. Technically, I’m supposed to report a millionth of a dollar? How much paperwork and calculations go into figuring that and reporting it? Can we agree this is unreasonable? Didn’t somebody at the IRS talk to an actual alt-coin miner to see the burden and understand this will kill any innovation? As I hope to show – many will find this is beyond ridiculous.

Because it’s unlikely that many alt-coins will ever be worth much in my opinion, it’s safer to convert them into bitcoin or some other digital currency as soon as they’ve been awarded to you. Bitcoin has proven itself to be more trustworthy over the long term for holding some value- comparatively speaking. But as soon as you convert the tiny bits of any coin, that becomes the basis of a capital gains transaction. And because you held it less than a year, it is taxed at the higher rate. What is the tax on ten thousandth of a dollar? Worse, I have to actually track that? The cost of tracking a single dogecoin is perhaps a thousand times more expensive than the actual transaction itself. Yet, this is how it appears to be written. They treat a $600 bitcoin and a $.0004 coin the same. And by the time I buy a meat thermometer at Overstock.comI’ve paid tax on it three times.

So I’m done. Why go through all of this? They’ve just killed my interest as it’s too expensive to comply. Somebody outside of the US will have to do it. Any innovation that might have come from this science will have to be done in a friendlier nation. There doesn’t seem to be any talk of “safe harbor” for miners to let the science expand – before taxing it into oblivion with socialist abandon. Without miners to process these transactions and run the networks, they will fail. It appears that the IRS has just done their best to make sure alt-coins fail. To me, it doesn’t really matter if this was unintentional or not. The end result is the same – I’m done. As far as you know.

The US has stifled innovation.

The other option is for miners to go further underground. But what could be the unintended consequences of that? Is it possible that once somebody has gone underground and found themselves on the wrong side of the law, that other more serious crimes may follow? Is tax evasion, even on a micro-scale, a gateway that may lead down a darker paths and more mistrust of government? What are the possible ramifications of that? Do we want to be that country that compels its own people to fear it? It’s not hard to see where the entire anarchist movement comes from.

Perhaps this may be just as well. It was bad government policy that was at least part responsible to spur the innovation that created the doorway to this entire new realm of digital currencies. Some might argue that getting around the rules without first asking for permission is what this community does best. The harder government becomes to work with, the more innovative the solutions to just go around them and completely change the paradigm that gave them the power they now have. By issuing these tax rulings without understanding the ramifications – who can guess what might result from the unintended consequences? Perhaps this ruling will spur even more innovations that make the IRS themselves increasingly irrelevant. The block-chain already allows for such transparency and with programmable money, perhaps taxes collection will be programmed in as well. Perhaps there will no longer be a need for the IRS.

Perhaps these IRS rulings themselves will be the cause their own extinction.

Think of the irony.