Market Segment Specialization Program (MSSP)
Placer Mining Industry
Table of Contents
Chapter 2 - Mining Income
Gold refiners are generally the primary market for miners. Raw gold is usually delivered to the refiner where it is purchased from the miner, processed, and refined. At the point of sale, funds received are considered income to the miner. Examination of a refiner's cost-of-goods sold is a source of information to identify the refiner's suppliers.
IRC section 6045 establishes information reporting requirements for brokers to file information returns showing the gross proceeds from sales of property. This information is reported on Form 1099-B. IRC section 6045 establishes information reporting requirements for brokers relating to gross proceeds including the reporting on sales of property that can be delivered to satisfy a contract approved for trading by the Commodity Futures Trading Commission (CFTC). This applies to both Gold Coins and Bulk Bullion. CFTC contracts for gold coins call for a minimum delivery of 25 coins in the form of South African Krugerrands, Canadian Maple Leafs, Mexican one-ounce coins, or any other type of gold coin.
Rev. Proc. 92-103, 1992-2 C.B. 583, has effectively limited the IRS's ability to verify income to a miner by examining the refiner's records. This Revenue Procedure has retroactively raised the limits required to have a reporting document issued to the limits set by the Commodities Futures Trading Commission rules and regulations concerning futures contracts. Due to this increase, a individual selling bulk gold to a refiner will generally not meet the limit requirements and thus a Form 1099 would not be issued to reflect the income received. Due to this revision of the reporting requirements, the refiners will be required to issue fewer Forms 1099 unless the weight or number requirements are met.
There are two types of contracts for bulk gold as outlined by the Chicago Board of Trade (CBOT): Kilo Gold and 100 Ounce Gold. CBOT Rules and Regulations section A1536.01 covering Kilo Gold contracts states the contract grade for delivery on futures contracts made under the Regulations
CBOT Rules and Regulations section B1536.01 covering 100 Ounce Gold contracts states that each futures contract made under the regulations-
The Chicago Board of Trade rules and regulations are based on the rules and regulations of the Commodities Futures Trading Commission.
When examining individual returns without the aid of refiner-obtained information, an indirect method will likely be used to determine income or if it is properly reported. Initially, a bank deposit analysis should be conducted with examination of any large or unusual items. If the taxpayer is a wage earner and has other sources of regular income, look for deposits which are out of the norm. The cleanup of the placer usually takes place at the end of the mining season, generally fall or early winter, and particular attention should be given to this time period for an indication of mining activity.
It is not uncommon for miners to deal strictly in cash. If there are indications that the taxpayer is hoarding gold and selling it only as needed, it becomes difficult to determine income through the analysis of bank records. If this appears to be the case, the Cash-T or Net Worth indirect methods should be pursued. The excess of income over expenses or assets over resources should be thoroughly examined. If expenditures prove to be in excess of the taxpayer's resources, the income issue should be raised. CTR's should always be checked as it is not uncommon for the miner to deal in cash as much as possible. Determine if any bartering activity or the trading of services are present in the operation.
Another area indicating unreported income is the acquisition of depreciable assets. If there are purchases of equipment or other items pertaining to the activity, determine and verify what resources were used to obtain the asset. Third-party contacts with the sellers may be necessary to determine the amount paid and when assets were acquired. If it is determined that the individual purchased the asset with a loan, verify the lender, what relationship they had with the purchaser, and what type of collateral was used to obtain financing. If gold was used as collateral, verify the value placed upon it by the bank or other lender. If the gold is used as collateral for a loan, it becomes income to the taxpayer and should be reported. A summons of bank records may be required to obtain this information.
Income information may be obtained in examination of the Affidavits of Annual Labor. The affidavit will list the names and addresses of those individuals who performed labor on the claim. It is often the case that an owner will pay for labor in gold. Verification of the amount of payment for labor performed may also indicate income to the miner.
Discuss the issue of cash hoards with the taxpayer at the initial interview. This information can be useful if an income question arises later in the examination. Question the taxpayer about any accumulations of gold or other precious metals. If the taxpayer is in the production stage, with income but no cost-of-goods sold, the issue of inventory should be raised. Determine how much gold was on hand at the beginning of the year, how much was produced and sold, and the amount left at the end of the year.
Chapter 3 - Prospecting Activities
Of the stages involved in the creation of a profitable mining operation, the prospecting or discovery stage is generally the first activity. A discovery need not be of commercial quantity. However, it should be of a character where an ordinary and prudent person would be justified in further expense with a reasonable expectation of success and profit potential.
Prospecting activities are generally considered a form of exploration so the associated expenses may be allowable under IRC section 617. Normally, state or federal reporting is not completed for general prospecting. The contention that there can be no exploration expenses because there are no documents filed cannot be used as a reason to disallow the expenses. Generally, a taxpayer only needs to show that there is an intent to be in an active trade or business for profit. However, all factors must be considered in determining if a "not for profit" issue (IRC section 183) can be raised. See Chapter 4.
Exploration expenditures as defined by IRC section 617 include amounts paid or incurred for the purpose of ascertaining the existence, location, extent, or quality of a mineral deposit, and paid or incurred prior to the development stage of the mining operation. Prospecting expenditures constitute capital expenditures which increase the basis of the mineral property to the same extent as exploration expenditures. However, Treas. Reg. section 1.617-1(c)(1) grants the taxpayer a right to make an election to currently deduct the expenditures.
By definition, the type of expenditures qualifying as prospecting or exploration expenses are very limited for the placer miner. Expenses should be analyzed to determine if they relate to the types allowable by IRC section 617.
Chapter 4 - Economic Substance, Sham Transactions, and the Hobby Activity
Losses incurred by an individual miner should be reviewed to determine if the activity was engaged in for profit or if it had no economic feasibility for profit. The facts of each case should be considered to determine if the mining activity had economic substance, if it was a sham transaction, or if it involved a hobby activity. An activity "not for profit" is considered a hobby, with expenses limited to the extent of income produced from the activity (except for deductions allowable regardless of whether a "not for profit" issue exists, such as interest and taxes).
IRC section 183(a) provides that if an activity is not engaged in for profit, no deduction attributable to such activity shall be allowed. IRC section 183(c) defines an activity not engaged in for profit as "any activity other than one with respect to which deductions are allowable for the taxable year under IRC section 162 or under paragraph (1) or (2) of IRC section 212".
The following list from Treas. Reg. section 1.183-2(b) sets forth nine non-exclusive objective factors to determine whether an activity is engaged in for profit.
The regulation factors should not merely be counted to determine the number of items "for" and "against" the taxpayer. All the facts and circumstances must be considered and more weight may be given to some of the factors. Not all factors may be applicable in every case and no one factor is considered controlling.
The following is a list of mining cases dealing mainly with gold mining. They provide insight into mining activity and set forth principles used by the courts in determining economic substance and the objective or reasonable prospect of a profit.
Generally, in order for expenses to be allowable, they must be supported by the taxpayer's actual motive to make a profit. If the profit motive is absent, tax deductions relating to the investment are limited under IRC section 183 to the income generated from the activity. Maurice C. Dreicer v. Commissioner, 78 T.C. 642 (1982).
It is important to remember that while a reasonable expectation of profit is not required, the taxpayers's profit motive must be bona fide. Refer to the decisions reached in Henry N. and Marilyn Hulter v. Commissioner, 91 T.C. 371 (1988) and Truett E. Allen and Barbara Allen v. Commissioner, 72 T.C. 28 (1979). Whether a taxpayer has an actual profit motive is a question of fact and is to be resolved from all the relevant facts and circumstances. The burden of proving the motive is on the taxpayer.
The economic substance of the transaction is one of the factors that is relevant in analyzing a taxpayer's profit motive. Transactions entered into solely for the purpose of obtaining a tax benefit and without economic substance will not be allowed. If the taxpayer is using the mining activity to create a loss to offset income or deduct personal expenses under the guise of a mining activity, they should be not be respected for tax purposes. The cases of Frank Lyon Company v. United States, 78-1 U.S.T.C. Para 9370; and James L. Hudson v. Commissioner, 103 T.C. 90 (1994), support this position.