Initial Coin Offerings (ICOs) don’t seem to stop, with new projects popping up on an almost daily basis. Some people got rich in an ICO, some were left without any returns whatsoever.
We are not going to discuss the legitimacy of any particular project today; rather, we’ll take a look at how taxes affect token issuers and their buyers.
Bear in mind that regulations change and that at the time you’re reading this, some things could be different. Also, we are looking at the situation in the United States, and thing could look differently in other countries.
Regulatory bodies to know
As far as issuers are concerned, there are a few regulatory bodies that could be involved:
- The Securities and Exchange Commission (SEC) will be concerned if a token acts like an equity/security,
- The Commodity Futures Trading Commission will be responsible if a token is/should be treated as a commodity, and
- The Treasury Department’s Financial Crimes Enforcement Network (FinCEN) will want to get involved for issuers acting as money services businesses.
On the other hand, we have the Internal Revenue Service (IRS), which has yet to release any guidance concerning the tax treatment of token issuances. Therefore, people are left to apply existing tax rules by relying on precedents and rules that provide imperfect analogies to token issuances.
Different token types
We have previously compared security and utility tokens, but the situation can get even more complicated. A token could provide investors with various rights, based on which token issuers and buyers will get a different tax treatment.
Tokens as equity
Tokens characterized for tax purposes as equity of a corporation generally do not result in current tax to issuers. Also, if structured properly, they allow investors to defer tax on any appreciated cryptocurrency used to acquire the tokens until they use or dispose of the tokens. However, if the equity interest is in a partnership, the rules can get very complicated, and the taxable income of the partnership will flow through to the investors, so they may have ongoing tax liability.
Tokens as debt
Tokens characterized as debt, which are those that include a definite obligation to repay the investor with interest, generally do not give rise to current tax to either the issuer or investor. However, they can result in deemed interest payments over the life of the “loan.” Also, they can result in tax to the issuer if the loan is ever forgiven.
Tokens for prepaid good/services (utility tokens)
Utility tokens enable users (token holders) to acquire goods or services provided on the platform and, could be characterized as a prepayment for such goods or services. If the issuer meets certain requirements, including not recognizing the income for financial accounting purposes, it may defer recognition of the income from prepaid goods or services until the following tax year.
Tokens as property
Tokens characterized as property generally result in current tax to the issuer equal to the amount of the proceeds received less any basis in the tokens.
A special category that involves issuers offering their tokens free of charge through an “airdrop.” When this happens, the value of tokens received in an airdrop is likely taxable income to the recipient, but they could give rise to a deduction to the issuer if they are considered payments for marketing activities. (related: Cryptocurrency Airdrops: A Few Things You Must Know)
SAFT and SAFE-T
Token issuers often pre-sell some tokens through a Simple Agreement for Future Tokens (SAFT) or Simple Agreement for Future Equity or Tokens (SAFE-T).
Under the former, investors typically pay a fixed amount for the right to receive a determinable amount of tokens upon the occurrence of a token sale to the public. These sort of agreements generally provide that the intended tax treatment of the SAFT is as a forward contract. If this treatment is respected, then taxation of the purchase amount should be deferred until delivery of the tokens to the SAFT holder.
However, if IRS doesn’t think of a SAFT as a forward contract but as a debt instrument, it can tax the proceeds upon receipt.
On the other hand, a SAFE-T — based on a Simple Agreement for Future Equity (SAFE) — is intended to be treated as equity. Its tax treatment of a SAFE-T is uncertain, as it contains elements of both a SAFT and a SAFE.
While we wait for the IRS to release its official guidance, it is important to educate yourself/ourselves. We suggest everyone to pay his/her dues and are also hoping that someone from the IRS deciding on this matter will have an ear for new technologies and propose something, say, liberal; something that won’t stifle innovation.
In the meantime, we must add that nothing written here shouldn’t be taken as an accounting advice. We can’t be held responsible if you missed to pay your taxes. 😉