We all know that death and taxes are inevitable, but have you forgotten to apply this pearl of wisdom to the tokens you own and issue?
Cryptocurrencies have become a significant revenue-generation tool for businesses across the U.S. in a wide range of industries, and their revenue implications are important not to overlook. Building out your blockchain and token economy runs along the same lines as many other forms of investment and revenue generation, though your valuation is sometimes dependent on the market.
Here are a few of the top considerations you need to understand for your business and the upcoming tax season — remember, this will impact your quarterly returns as well as the annual review, so make sure you update everything relative to the value you’ve created.
ICO Funds Are Largely Considered Income
As it currently stands, the IRS doesn’t look at ICO or other token generation event (TGE) funds as traditional capital. Instead, it sees proceeds from the sales of tokens more in the light of traditional income.
What this means for you is that ICO revenue doesn’t get the tax-free status under the IRS’ Internal Revenue Code.
The best way to protect your business and ensure you set aside the proper amount for taxes is to record the fair market value of your token during the ICO. If this changes or scales during the process, record the volume of tokens sold at each valuation. Track sales throughout the entire ICO, including any pre-ICO sales, as well as the amount of the currency you set aside from the ICO for your business.
The value of this currency is what’s important. You’ll be taxed on the value of what you sell as well as what you create and hold, even if you keep it in your current token and don’t convert it to ETH or fiat.
The IRS looks at this as a receipt of value, which is taxable income.
Brush up on Notice 2014-21
The taxation of tokens and cryptos is being managed by the IRS Notice 2014-21 (PDF link). Beyond the prior section where we discussed it being treated as income, there are a couple of important concerns.
First is that the IRS will look at the tokens you hold as property, so related taxes and costs of property transactions will be applied to exchanges. When you’re doing this, always record the loss or the gain that occurs when you’re trading in tokens for others to buy goods and services.
Have you accountant or partner stay on top of it and keep them in the loop. It can be difficult to go back through the values after considerable time passes. So, if you’re waiting until the end of the year to calculate these gains and losses, it’s possible but will take longer than if you recorded it as you go — and typically, that means paying your tax and governance professionals more.
Put a plan in place to monitor activities and require your staff to record gains and losses for every transaction.
Company and Corporate Structure Matter Pre- and Post-ICO
It is extremely important to pay attention to the structure of your company and the funds you use to secure any tokens — whether they are yours or if you’re buying tokens as part of an investment to give your company a nest egg.
The construction, use, and other circumstances can cause the IRS to view the same tokens as either business, investment, or personal property.
This means you could potentially be personally liable for token-use gains and losses if you’re not structured safely.
Form a corporation and have all your paperwork in place before you start your ICO. It’s also a best practice to have this in place before you start marketing or publish any public-facing information related to your ICO.
It is not enough, in the eyes of the IRS, to have a partnership (formal or informal) to protect you from being personally liable. Partnerships in a variety of forms still require each partner or founder to pay for their share of the business taxes if the business itself does not pay them.
Some individuals may experience gains and losses related to cryptocurrencies as a form of phantom income that significantly raises their taxes without giving them any gains or funds they could use to pay those taxes. Some pass-through business changes could mean this is a likely occurrence when business owners and partners pay taxes on their 2018 gains.
You Need an ICO-Focused Team
The more you dig into the state of ICO-related taxes, the more confusing it’s going to become if your primary work is not as an accountant or tax lawyer. That’s largely because the space is shifting and even the IRS is still working things out, with changes possible during the year.
Securing a team or partner company that knows the ICO space is valuable because it can give you suggestions to minimize exposure and costs. For example, TGEs are like any big source of income: if you have your event at the beginning of the year, you have more time to spend gains on operating expenses (and other tax-deductible expenses) to reduce your final IRS payments.
We can also ensure that you’re setting aside the right amount of state and local taxes.
The global nature of ICOs also has pushed many companies to consider offshore entities for management of tokens and funds. These come with a variety of costs and benefits, and some activities may ultimately remove the benefits you expect when you create that entity. Depending on how much of your company control you sell through the TGE, you might also experience a change in your corporation status.
Plan Ahead: This Won’t Be Routine
Taxes are complicated, and the IRS is currently working through a host of changes and new rules, many of which are outside of the crypto space. As the agency struggles to provide citizens with guidance on how much they should safely withhold in monthly paychecks, we can expect some of the more complex issues of crypto-related taxation to be delayed.
Don’t let it wait. Look ahead and take steps now to prepare yourself. When planning your TGE, consider the fair value relative to what will help you raise funds and what you can afford when the taxes come due.
The cost of doing business in the ICO world is increasing, with taxation and new compliance rules leading the way. As this revenue tool continues to gain in popularity and prominence, we expect to see businesses and investors face more significant challenges with their finances and taxes.
As we all know, when more people are wade into a new area, the potential for mistakes and outright fraud increase. This will likely lead to an increase in audits for the cryptocurrency space.