Article reprinted from: TaxDAO
Source: TaxDAO
The year 2024 marks Bitcoin's entry onto the world financial stage, as well as a carnival year for meme coins. Relevant data shows that approximately 75% of meme coins were born this year, and by early December, meme coin trading volume had increased by over 950%, with a total market capitalization exceeding $140 billion. The popularity of meme coins has not only brought a new wave of heat to the crypto market but has also attracted more and more ordinary investors into the crypto asset field.
The meme coin craze inevitably brings to mind the ICO boom around 2017. In 2017, with the emergence of the ERC-20 standard, the cost of issuing tokens dramatically decreased, leading to numerous projects with hundredfold or thousandfold returns, and billions of dollars flooded into the ICO craze; this year, a group of launch platforms represented by Pump.fun has made token issuance simpler and fairer, sparking an ongoing meme coin storm. Although ICOs and the issuance of meme coins have significant technical and logical differences, the tax compliance risks faced by investors and projects may be similar. During the last ICO boom, many investors and projects faced tax troubles related to ICOs. Now, as the meme coin craze continues, tax compliance issues will once again become a core concern for both crypto asset investors and meme coin issuers. In this issue, FinTax will revisit the Oyster case and the Bitqyck case, using these two tax evasion cases related to ICOs as examples to provide crypto investors with cold reflections on tax compliance amid the meme coin frenzy.
1. Two Typical ICO Tax Evasion Cases
1.1 Oyster Case: Unreported Sale Income, Founder Sentenced to Four Years in Prison
The Oyster Protocol platform was initiated by Bruno Block (real name Amir Bruno Elmaani) in September 2017, aiming to provide decentralized data storage services. In October 2017, Oyster Protocol started its ICO, issuing a token named Pearl (PRL). Oyster Protocol claims that the issuance of PRL is intended to create a win-win ecosystem, allowing both websites and users to benefit from data storage, and to achieve value exchange and incentive mechanisms through PRL. At the same time, founder Bruno Block publicly promised that after the ICO, the supply of PRL would not increase, and the smart contract that created PRL would be 'locked'.
Through the ICO, Oyster Protocol initially raised about $3 million, using these funds to achieve the mainnet launch and formally start data storage services, turning Oyster Protocol from an idea into a usable product. However, the good times were short-lived. In October 2018, founder Bruno Block exploited a vulnerability in the smart contract to privately mint a large number of new PRL and sold them on the market, causing PRL prices to plummet, while Bruno Block personally reaped huge profits.
The sharp drop in PRL prices attracted the attention of regulatory authorities, and the SEC, IRS, FBI, and other relevant departments conducted investigations into this matter. Ultimately, the SEC filed a civil lawsuit against them for defrauding investors, while prosecutors initiated a criminal lawsuit against Bruno Block regarding tax evasion issues. On tax matters, prosecutors argued that Bruno Block not only damaged investors' trust but also violated the obligation to pay taxes on millions of dollars in cryptocurrency profits. From 2017 to 2018, Bruno Block submitted only one tax return in 2017, claiming to have earned about $15,000 from 'patented design' business, and did not submit a tax return in 2018 nor report any income to the IRS, yet he spent at least $12 million on properties and yachts.
Ultimately, Oyster founder Bruno Block admitted to his tax evasion in court and signed a plea agreement in April 2023, being sentenced to four years in prison and ordered to pay approximately $5.5 million to the tax authorities to compensate for tax losses.
1.2 Bitqyck Case: ICO Transfer Income Not Taxed, Two Founders Sentenced to a Combined Eight Years
Bitqyck is a cryptocurrency company founded by Bruce Bise and Samuel Mendez. The company first launched the Bitqy coin, claiming to offer an alternative way to wealth for 'those who missed Bitcoin,' and conducted an ICO in 2016. Additionally, Bitqyck promised investors that each Bitqy coin came with 1/10 of a share of Bitqyck common stock. However, in reality, the company's shares were always held by founders Bise and Mendez, and the company never distributed the promised shares and corresponding profits to investors. Shortly thereafter, Bitqyck launched a new cryptocurrency called BitqyM, claiming that purchasing this coin would allow investors to join the 'Bitcoin mining business' by paying for the electricity of Bitqyck's Bitcoin mining facility in Washington State, but in fact, such mining facilities did not exist. Through false promises, Bise and Mendez raised $24 million from over 13,000 investors through Bitqyck, using most of the funds for personal expenses.
In response, the SEC filed a civil lawsuit against Bitqyck for defrauding investors. In August 2019, Bitqyck admitted to the facts and reached a civil settlement, with Bitqyck and its two founders jointly paying approximately $10.11 million in civil fines to the SEC. Meanwhile, prosecutors continued to bring tax evasion charges against Bitqyck: from 2016 to 2018, Bise and Mendez raised at least $9.16 million through the issuance of Bitqy and Bitqy, but underreported relevant income to the IRS, causing over $1.6 million in tax losses; in 2018, Bitqyck earned at least $3.5 million from investors but failed to file any tax returns.
Ultimately, regarding tax issues, Bise and Mendez pleaded guilty in September and October 2021, respectively, and were each sentenced to 50 months in prison (a combined total of about eight years), and they each assumed joint liability of $1.6 million.
2. Detailed Explanation of Tax Issues Involved in Both Cases
In both the Oyster and Bitqyck cases, one of the core issues is the tax compliance of ICO income. In this emerging fundraising form of ICOs, some issuers have obtained huge income through defrauding investors or other improper means, but reported less income or failed to file tax returns, leading to tax compliance problems.
2.1 How Does U.S. Law Determine Tax Evasion?
In the United States, tax evasion is a felony, referring to the deliberate use of illegal means to reduce tax liabilities, usually manifested as hiding income, inflating expenses, failing to report or pay taxes on time, and other behaviors. According to Section 7201 of the U.S. Federal Tax Code (26 U.S.C. §7201), tax evasion is a federal crime; once determined to be a tax evader, individuals may face up to five years in prison and a fine of up to $250,000, while entities may face fines of up to $500,000, with specific penalties depending on the amount and nature of the tax evasion.
Under Section 7201, to constitute tax evasion, the following needs to be met: (1) a large amount of taxes owed; (2) active tax evasion behavior; and (3) subjective intent to evade taxes. Investigations into tax evasion usually involve tracing and analyzing financial transactions, income sources, and asset flows. Especially in the cryptocurrency field, due to its anonymity and decentralized characteristics, tax evasion is more likely to occur.
2.2 Tax-related Behaviors in Both Cases
In the United States, various aspects of ICOs may involve tax obligations, with project parties and investors bearing different tax responsibilities at different stages. On one hand, project parties must comply with tax requirements when raising funds through ICOs. Funds raised through ICOs can be considered as sales revenue or capital fundraising. For example, if the funds raised from an ICO are used to pay for company operating expenses, develop new technologies, or expand the business, then these funds should be regarded as company income, and taxes must be paid accordingly. On the other hand, investors also have tax obligations when obtaining tokens through ICOs. Especially when tokens obtained through ICOs come with rewards or airdrops, these rewards are considered capital gains and are subject to capital gains tax. In the U.S., the value of airdropped and rewarded tokens is typically calculated according to their market value for tax reporting. When investors hold tokens for a period and then sell them for profit, those profits are also considered capital gains for taxation.
Objectively speaking, both the Oyster and Bitqyck cases demonstrate that the actions of the parties not only infringe upon the interests of investors and constitute fraud but also indeed violate U.S. tax laws to varying degrees. Of course, the tax evasion behaviors in the two cases are not identical, and further analysis will be provided later.
2.2.1 Tax Evasion Behavior in the Oyster Case
Specifically regarding the Oyster case, after the PRL ICO, Oyster Protocol platform founder Bruno Block exploited a vulnerability in the smart contract to privately mint a large amount of PRL and sold it, gaining huge profits. Bruno rapidly accumulated wealth through the sale of PRL but failed to fulfill related tax obligations. This behavior violated Section 7201 of the Federal Tax Code.
However, there are special circumstances regarding Bruno Block's behavior in this case because he had minted Pearl before selling it. It goes without saying that capital gains tax is payable on the profits from token sales, but whether the IRS should impose taxes on the act of minting tokens is still inconclusive. Some opinions suggest that minting tokens and mining both create new digital assets through computation, thus the income from minting tokens should also be taxed. FinTax believes that whether the income from minting needs to be taxed should depend on the market liquidity of the tokens. When the market has not formed liquidity, the value of minted tokens is difficult to determine, making it impossible to clearly calculate income; however, if the market has certain liquidity, these tokens have market value, and the income from minting should be treated as taxable income.
2.2.2 Tax Evasion Behavior in the Bitqyck Case
Unlike the Oyster case, the tax evasion behavior in the Bitqyck case involves false promises to investors and the illegal transfer of raised funds. After successfully raising funds through the ICO, Bitqyck's founders Bise and Mendez did not fulfill the promised returns to investors and instead used most of the funds for personal expenses. This fund transfer behavior essentially equates to converting investors' funds into personal income, and did not serve the development of the project or realization of investor benefits. Unlike the direct sale of tokens during the ICO process, the key tax issues in the Bitqyck case revolve around the illegal transfer of ICO-raised funds and unreported income.
According to relevant provisions of the U.S. Internal Revenue Code, both legal and illegal income are included in taxable income. The U.S. Supreme Court also confirmed this rule in the case of James v. United States (1961). U.S. citizens must report illegal gains as income when filing their annual tax returns, but such taxpayers generally do not report this income, as reporting illegal income may trigger investigations into their illegal activities. Bise and Mendez failed to report illegal gains transferred from ICO-raised funds as income, directly violating relevant tax laws and ultimately bearing criminal responsibility for it.
3. FinTax's Tips and Recommendations
With the popularity of meme coins, many people in the crypto industry have gained substantial returns. However, as previous ICO tax evasion cases have shown, in the meme coin market where wealth myths emerge daily, we must not only pay attention to technological innovation and market opportunities but also to the important issue of tax compliance.
First, understand the tax responsibilities of issuing meme coins to avoid legal risks. Although issuing meme coins does not directly generate income like ICOs through fundraising, when the tokens purchased by meme coin issuers and early investors appreciate, they should still pay taxes on related capital gains upon sale. Also, although anyone can anonymously issue meme coins on-chain, this does not mean issuers can evade tax audits. The best way to avoid tax law risks is to comply with tax laws rather than seek more effective anonymous methods on-chain.
Second, focus on the meme coin trading process and ensure transparent transaction records. Due to the speculative nature of the meme coin market and the constant emergence of new projects, investors may engage in frequent meme coin trading, leading to numerous transaction records. Crypto asset investors need to maintain detailed records of a series of transactions, especially by using specialized crypto asset management and tax reporting software to ensure all buys, sales, transfers, and profits can be traced, and receive correct legal classification during tax reporting, thus avoiding potential tax disputes.
Third, keep up with tax law dynamics and collaborate with professional tax personnel. Tax laws regarding crypto assets in various countries are still in their infancy and will undergo frequent adjustments, and key changes may directly affect actual tax burdens. Therefore, both meme coin investors and issuers should remain highly attentive to the dynamics of tax laws in their respective countries and, when necessary, seek the advice of professional tax personnel to help make optimal tax decisions.
In summary, the meme coin market, which has reached $140 billion, has a tremendous wealth effect, but this wealth also comes with a new round of legal challenges and compliance risks. Issuers and investors need to fully recognize the relevant tax risks, remain cautious and alert in a volatile market, and minimize unnecessary risks and losses.