Source: TaxDAO

2024 is the year Bitcoin takes center stage in the world financial arena and is also the carnival year for meme coins. Relevant data shows that about 75% of meme coins were born this year, and as of early December this year, meme coin trading has increased by over 950%, with a total market value exceeding $140 billion. The popularity of meme coins has not only brought a new wave of heat to the cryptocurrency market but also attracted more and more ordinary investors into the cryptocurrency field.

The meme coin craze inevitably reminds one of the ICO boom around 2017. In 2017, with the emergence of the ERC-20 standard, the cost of issuing tokens drastically decreased, and projects with hundredfold or thousandfold returns emerged one after another, pouring billions of dollars into the ICO frenzy; while this year, a group of launch platforms represented by Pump.fun has made issuing tokens simpler and fairer, sparking a meme coin storm that continues to this day. Although there are numerous differences between ICOs and issuing meme coins in terms of technology and logic, the tax compliance risks faced by investors and projects may be similar. In the previous 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 cryptocurrency investors and meme coin issuers. In this issue, FinTax will revisit the Oyster and Bitqyck cases, using these two tax evasion cases related to ICOs as examples to provide cryptocurrency investors with cold reflections on tax compliance amidst the meme coin craze.

1. Two typical ICO tax evasion cases

1.1 Oyster case: Sale income not reported, 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 began its ICO, issuing a token named Pearl (PRL). Oyster Protocol claimed that the issuance of PRL was to create a win-win ecosystem, allowing both websites and users to benefit from data storage and realize 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 for creating PRL would be 'locked'.

Through the ICO, Oyster Protocol initially raised about $3 million, using these funds to launch the mainnet and officially start data storage services, turning Oyster Protocol from an idea into a usable product. However, not long after, in October 2018, founder Bruno Block exploited a vulnerability in the smart contract to privately mint a large amount of new PRL and sold it on the market, causing the price of PRL to plummet, while Bruno Block personally gained enormous profits.

The sharp drop in the price of PRL attracted the attention of regulators. The SEC, IRS, FBI, and other relevant departments launched investigations, ultimately leading the SEC to file a civil lawsuit against it for fraud against investors, and the prosecutors filed a criminal lawsuit against Bruno Block for tax evasion. On tax matters, prosecutors believed that Bruno Block not only undermined investor trust but also violated the obligation to pay taxes on millions of dollars of cryptocurrency profits. From 2017 to 2018, Bruno Block submitted only one tax return in 2017, stating he earned about $15,000 from his 'patent design' business, and did not submit a tax return in 2018 or report any income to the IRS, despite spending at least $12 million on properties, yachts, and more.

Ultimately, Oyster founder Bruno Block confessed to his tax evasion facts 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 cover the tax loss.

1.2 Bitqyck case: ICO transfer income not taxed, two founders sentenced to a total of eight years in prison

Bitqyck is a cryptocurrency company founded by Bruce Bise and Samuel Mendez. The company first launched the Bitqy coin, claiming to provide an alternative way to wealth for 'those who missed Bitcoin,' and conducted an ICO in 2016. At the same time, Bitqyck promised investors that each Bitqy coin was accompanied by 1/10 share of Bitqyck common stock. However, in reality, the company shares were always held by founders Bise and Mendez, and the company never distributed the promised shares and corresponding profits to investors. Shortly after, Bitqyck launched a new cryptocurrency, 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 a mining facility did not exist. Through false promises, Bise and Mendez raised $24 million from over 13,000 investors through Bitqyck and used most of the funds for personal expenses.

In this regard, the SEC filed a civil lawsuit against Bitqyck for fraudulent behavior towards investors. In August 2019, Bitqyck acknowledged the facts and reached a civil settlement, with Bitqyck and the two founders collectively paying around $10.11 million in civil penalties to the SEC. Meanwhile, prosecutors continued to press tax evasion charges against Bitqyck: from 2016 to 2018, Bise and Mendez earned at least $9.16 million by issuing Bitqy and Bitqy, but reported low income to the IRS, resulting in a collective tax loss of over $1.6 million; in 2018, Bitqyck earned at least $3.5 million from investors but failed to submit any tax returns.

Ultimately, regarding the tax issues, Bise and Mendez pleaded guilty in September and October 2021, respectively, and were each sentenced to 50 months in prison (a total of about eight years for the two) and jointly held liable for $1.6 million.

2. Detailed analysis of the tax issues involved in the two cases

In the Oyster and Bitqyck cases, one of the core issues is the tax compliance of ICO income. In this emerging fundraising form, some issuers fraudulently obtain large amounts of income from investors or engage in other improper means, reporting less income or failing to file tax returns, which leads to tax compliance issues.

2.1 How does U.S. law determine tax evasion?

In the U.S., tax evasion is a felony, defined as deliberately taking illegal measures to reduce tax liabilities, usually manifested as concealing income, falsely reporting expenses, failing to report or timely pay taxes, etc. According to Section 7201 of the U.S. Federal Tax Code (26 U.S.C. §7201), tax evasion is a federal crime, and once determined as a tax evader, an individual may face up to five years in prison and a maximum fine of $250,000, while entities may face a maximum fine of $500,000, depending on the amount and nature of the tax evasion.

Under Section 7201, to constitute tax evasion, the following must be satisfied: (1) a large amount of tax is owed; (2) active tax evasion behavior has been implemented; (3) there is subjective intent to evade taxes. Investigations into tax evasion usually involve tracing and analyzing financial transactions, sources of income, asset flows, etc. 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 the two cases

In the U.S., every aspect of an ICO may involve tax obligations, with project parties and investors bearing different tax responsibilities at different stages. On the one hand, project parties must comply with tax compliance requirements when raising funds through ICOs. The funds raised through ICOs can be viewed as sales revenue or capital fundraising. For example, if the funds raised through an ICO are used to pay for company operating expenses, develop new technologies, or expand the business, these funds should be regarded as company income and taxed accordingly. On the other hand, investors also have tax obligations after obtaining tokens through ICOs. Especially when the tokens obtained by investors through ICOs provide rewards or airdrops, these rewards will be regarded as capital gains, subject to capital gains tax. In the U.S., the value of airdropped and rewarded tokens is usually calculated based on their market value for tax reporting. When investors hold tokens for a period and then sell them, the profits obtained will also be regarded as capital gains for taxation.

Objectively speaking, both the Oyster and Bitqyck cases involve behaviors that not only infringe upon investor interests and constitute fraud but also indeed violate U.S. tax law to varying degrees. Of course, the tax evasion behaviors in the two cases are not identical, and further analysis will be provided.

2.2.1 Tax evasion behavior in the Oyster case

Specifically concerning the Oyster case, after the PRL ICO, founder Bruno Block exploited a vulnerability in the smart contract to privately mint a large amount of PRL and sold it, gaining enormous profits. Bruno quickly amassed wealth through the sale of PRL, but failed to fulfill his tax obligations. This behavior violated the relevant provisions of Section 7201 of the Federal Tax Code.

However, there are special circumstances regarding Bruno Block's behavior in this case, as he also engaged in minting Pearl before selling it. It goes without saying that capital gains tax should be paid on the income from the sale of tokens, while it remains undecided whether the act of minting tokens should be taxed by the IRS. Some opinions suggest that minting tokens and mining both create new digital assets through computation, thus the income from minting tokens should also be taxable. FinTax believes that whether the income from minting should be taxed should depend on the market liquidity of the tokens. When the token market has not yet formed liquidity, the value of minted tokens is difficult to determine, making it impossible to clearly calculate the income; however, if the market possesses a certain level of liquidity, these tokens have market value, and the income from minting should be considered 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 failed to fulfill their promised returns to investors and instead used most of the funds for personal expenses. This behavior of transferring funds is essentially equivalent to converting investor funds into personal income, rather than using them for project development or fulfilling investor interests. Unlike the direct sale of tokens during the ICO process, the key tax issue in the Bitqyck case lies in the illegal transfer of funds raised through the ICO 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 submitting their annual tax returns, but taxpayers usually do not report such income because reporting illegal income may trigger investigations into their illegal activities. Bise and Mendez failed to report the illegal income transferred from ICO-raised funds as required, directly violating relevant tax laws, and ultimately bore criminal responsibility.

3. FinTax's tips and recommendations

With the popularity of meme coins, many people in the cryptocurrency industry have gained huge returns. However, as indicated by previous ICO tax evasion cases, in the meme coin market where wealth myths emerge daily, we need to pay attention not only 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 revenue like ICOs, when the tokens purchased early by meme coin issuers and investors appreciate, they still need to pay taxes on related capital gains upon sale. At the same time, although anyone can anonymously issue meme coins on the blockchain, this does not mean that issuers can evade tax audits. The best way to avoid tax law risks is to comply with tax laws rather than seeking more effective anonymous measures on the blockchain.

Second, pay attention to the trading process of meme coins to ensure the transparency of transaction records. Due to the highly speculative nature of the meme coin market and the continuous emergence of various new projects, investors may engage in meme coin trading very frequently, leading to numerous transaction records. Cryptocurrency investors need to keep detailed records of a series of transactions, especially by using professional cryptocurrency management and tax reporting software, to ensure that all buys, transfers, and profits are traceable, and to receive accurate tax characterizations during tax reporting to avoid potential tax disputes.

Third, keep up with tax law dynamics and collaborate with professional tax professionals. The tax law systems for cryptocurrencies in various countries are still in their infancy and will undergo frequent adjustments, with significant changes potentially directly affecting actual tax burdens. Therefore, investors and issuers of meme coins should closely monitor the tax law dynamics of their respective countries and, if necessary, seek the advice of professional tax professionals to assist in making optimal tax decisions.

In summary, the meme coin market, which has reached $140 billion, has a huge wealth effect, but this wealth is also accompanied by a new round of legal challenges and compliance risks. Both issuers and investors need to fully understand the related tax risks, maintaining caution and sensitivity in a capricious market, to reduce unnecessary risks and losses.