Bitcoin Taxpayers

The Miner Ms. Alicia Underhill started a Bitcoin mining business in January 2018. She invested in 50 AntMiner S9i Bitcoin mining machines at a cost of $668/machine, for a total investment of $33,400. The AntMiner S9i is currently the most powerful miner available on the market. Each machine is currently capable of mining 0.3603 Bitcoins per month at the current level of computational difficulty, which means that her 50 machines can create approximately 18 Bitcoins a month. The day the Bitcoins are mined is considered the day of receipt. Over the past year, the price of a Bitcoin in U.S. dollars (USD) has swung wildly, trading between $3,226 and $19,350, with a range between $6,000 and $10,000 for most of the past 6 months. In addition to the cost of the Bitcoin mining machines, Ms. Underhill has to rent space for her machines in a data center; this rent expense is $400 per month. The data center houses and cools the mining machines and provides electrical and networking services, which cost an additional $720 for each AntMiner S9i. Once Ms. Underhills mining operations produce Bitcoins, she sells them to her business associate, Mr. Thomas Green. Ms. Underhill estimates that after accounting for all of her costs, she can generate $330 of gross profit a month from each AntMiner S9i. However, this is a soft number. Her revenue depends on the price of Bitcoins when she sells them to Mr. Green, and the amount of Bitcoins she is able to generate each month. The rate of Bitcoin generation depends on the amount of overall computational power on the network that is dedicated to Bitcoin mining; as more miners compete for Bitcoins, the rate of production declines. Her cost structure also varies based on the monthly data center costs (which vary with the price of electricity).

Assignment

1. Use your knowledge of the tax law to identify the tax issues faced by Amanda Underhill related to her Bitcoin activities.

2. Prepare a technical research memo that summarizes your findings. The memo should include an analysis and conclusion about the proper tax treatment of each of the identified issues. Include primary authorities to support the suggested conclusion as well as any authorities that are contrary to this position. Note that Bitcoin is a new technological development that does not have specific primary authority. You will need to relate existing primary authority to a new setting. Include any tax-planning strategies that the taxpayer should be aware of in the future. You will need to use a tax research database to facilitate your research in addition to Notice 2014-21 from the Internal Revenue Service (2014).