Source: TaxDAO
2024 is the year when Bitcoin takes center stage in the global financial arena, and also the year of the meme coin frenzy. Relevant data shows that about 75% of meme coins were born this year, and as of early December this year, the trading volume of meme coins has increased by more than 950%, with a total market value exceeding $140 billion. The popularity of meme coins has not only brought a new round of heat to the crypto market, but also attracted more and more ordinary investors to the crypto asset field.
The meme coin craze inevitably reminds people of the ICO craze around 2017. In 2017, with the emergence of the ERC-20 standard, the cost of issuing tokens was greatly reduced, and projects with hundredfold or thousandfold returns emerged one after another, with tens of billions of dollars pouring into the ICO craze; this year, a batch of issuance platforms represented by Pump.fun have made token issuance simpler and fairer, sparking a meme coin storm that continues to this day. Although ICOs and the issuance of meme coins differ in terms of technology and logic, the tax compliance risks faced by investors and project parties may be similar. In the previous ICO craze, there was no shortage of investors and project parties facing tax troubles related to ICOs. Now, with the continued meme coin craze, tax compliance issues will again become a core issue that crypto asset investors and meme coin issuers need to pay attention to. In this issue, FinTax will review the Oyster case and the Bitqyck case, and use these two tax evasion cases related to ICOs as examples to provide crypto investors with some cold thoughts on tax compliance in the meme coin craze.
1. Two Typical ICO Tax Evasion Cases
1.1 Oyster Case: Unreported Coin Sale Revenue, Founder Sentenced to Four Years in Prison
The Oyster Protocol platform was launched 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 called Pearl (PRL). Oyster Protocol claimed that the issuance of PRL was to create a win-win ecosystem where websites and users could both benefit from data storage, and to realize value exchange and incentive mechanisms through PRL. At the same time, the founder Bruno Block also 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 raised about $3 million in the initial stage, and with this funding, it realized the launch of the mainnet and officially started the data storage service, turning Oyster Protocol from an idea into a usable product. But the good times did not last long. In October 2018, the founder Bruno Block used a loophole in the smart contract to privately mint a large amount of new PRL and sell them on the market, causing the PRL price to plummet, but Bruno Block personally gained huge profits from this.
The plunge in the PRL price caught the attention of the regulators, and the SEC, IRS, FBI and other relevant departments launched an investigation. Eventually, the SEC filed a civil lawsuit against him for defrauding investors, and the prosecution brought criminal charges against Bruno Block for tax evasion. On the tax issue, the prosecutor believed that Bruno Block not only damaged the trust of investors, but also violated the obligation to pay taxes on hundreds of millions of dollars in crypto currency profits. During the period from 2017 to 2018, Bruno Block only filed a tax return in 2017, claiming he only earned about $15,000 from "patent design" business, and in 2018 he did not file any tax return or report any income to the IRS, but spent at least $12 million to purchase real estate, yachts and other assets.
Ultimately, Oyster founder Bruno Block admitted the facts of his tax evasion in court, signed a plea agreement in April 2023, and was sentenced to four years in prison and ordered to pay the tax authorities about $5.5 million in restitution to make up for the tax loss.
1.2 Bitqyck Case: ICO Proceeds Not Reported, Two Founders Sentenced to a Total of Eight Years
Bitqyck is a crypto currency company founded by Bruce Bise and Samuel Mendez. The company first launched the Bitqy coin, claiming to provide an alternative way to get rich for those who missed out on Bitcoin, and conducted an ICO in 2016. At the same time, Bitqyck promised investors that each Bitqy coin would come with 1/10 share of Bitqyck common stock. But in fact, the company shares were always held by the founders Bise and Mendez, and the company never distributed the promised shares and corresponding profits to investors. Soon, Bitqyck also launched a new crypto currency called BitqyM, claiming that by purchasing this coin, investors could join the "Bitcoin mining business" by paying to power Bitqyck's Bitcoin mining facilities in Washington state, but in fact such mining facilities did not exist. Through false promises, Bise and Mendez raised $24 million from more than 13,000 investors through the Bitqyck company, and used most of the funds for their personal expenses.
In response, the SEC filed a civil lawsuit against Bitqyck for defrauding investors. In August 2019, Bitqyck and the two founders admitted the facts and reached a civil settlement, with Bitqyck and the two founders jointly paying the SEC a civil penalty of about $10.11 million. The prosecution then continued to bring tax evasion charges against Bitqyck: from 2016 to 2018, Bise and Mendez earned at least $9.16 million through the issuance of Bitqy and Bitqy, but underreported the relevant income, causing a tax loss of more than $1.6 million; in 2018, Bitqyck company earned at least $3.5 million from investors, but did not file any tax returns.
Ultimately, on the tax issue, Bise and Mendez pleaded guilty separately in September and October 2021, and were sentenced to 50 months in prison each (a total of about eight years) on charges of tax evasion, and each took on $1.6 million in joint and several liability.
2. Explanation 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 proceeds. In this new form of fundraising, some issuers have obtained huge revenues through fraud or other improper means, but have underreported their earnings or failed to file tax returns, leading to tax compliance issues.
2.1 How Does U.S. Law Judge Tax Evasion?
In the U.S., tax evasion is a felony, referring to the intentional use of illegal means to reduce the tax payable, usually manifested as concealing income, falsely reporting expenses, failing to file tax returns or pay taxes on time. According to Section 7201 (26 U.S.C. §7201) of the U.S. Internal Revenue Code, tax evasion is a federal crime, and once judged as a tax evader, an individual may face up to 5 years in prison and a fine of up to $250,000, while an entity may face a fine of up to $500,000, with the specific punishment depending on the amount and nature of the tax evasion.
Under the provisions of Section 7201, to constitute tax evasion, the following must be met: (1) a large amount of tax is owed; (2) active tax evasion measures have been taken; (3) there is a subjective intent to evade taxes. Tax evasion investigations usually involve tracing and analyzing financial transactions, sources of income, and asset flows. Especially in the crypto currency field, due to its anonymity and decentralized nature, tax evasion is more likely to occur.
2.2 Taxable Behaviors in the Two Cases
In the U.S., various stages 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 requirements when raising funds through an ICO. The funds raised through an ICO can be treated as sales revenue or capital raising. For example, if the funds raised through an ICO are used to pay for the company's operating expenses, develop new technologies, or expand the business, these funds should be treated as company income and taxed accordingly. On the other hand, investors who obtain tokens through an ICO also have tax obligations. Especially when the tokens obtained through an ICO bring rewards or airdrops, these rewards will be treated as capital gains and subject to capital gains tax. In the U.S., the value of airdrops and reward tokens is usually calculated based on their market value and reported for tax purposes. When investors hold these tokens for a period of time and then sell them for a profit, the profits will also be treated as capital gains and taxed accordingly.
Objectively speaking, whether it is the Oyster case or the Bitqyck case, the actions of the parties involved not only infringed on the interests of investors and constituted fraud, but also to varying degrees violated the tax laws of the United States, although the tax evasion behaviors in the two cases are not exactly the same, which will be analyzed in detail later.
2.2.1 Tax Evasion in the Oyster Case
Specifically in the Oyster case, after the PRL ICO, the founder of the Oyster Protocol platform, Bruno Block, used a smart contract vulnerability to mint a large amount of PRL and sell it, gaining huge profits. Through the sale of PRL, Bruno quickly accumulated wealth, but failed to fulfill the relevant tax obligations. This behavior violated the relevant provisions of Section 7201 of the Federal Tax Code.
However, Bruno Block's behavior in this case has a special aspect, because he existed the minting of Pearl before the sale. The sale of tokens should be subject to capital gains tax, but the IRS has not yet reached a conclusion on whether the minting of tokens should be taxed. Some believe that minting tokens, like mining, is the creation of new digital assets through calculation, and therefore the income from minting should also be taxed. FinTax believes that whether the income from minting needs to be taxed depends on the market liquidity of the tokens. When the token market has not yet formed liquidity, the value of the minted tokens is difficult to determine, and the income cannot be clearly calculated; but if the market already has a certain degree of liquidity, these tokens have market value, and the income from minting should be regarded as taxable income.
2.2.2 Tax Evasion in the Bitqyck Case
Unlike the Oyster case, the tax evasion in the Bitqyck case involves false promises to investors and the illegal transfer of funds raised. After successfully raising funds through the ICO, the founders of Bitqyck, Bise and Mendez, did not fulfill the promised investment returns as planned, but instead used most of the funds for personal expenses. This fund transfer behavior is essentially equivalent to converting the investors' funds into personal income, without being used for project development or the realization of investors' interests. Unlike the direct sale of tokens in the ICO process, the key tax issue in the Bitqyck case is the illegal transfer of ICO-raised funds and the unreported income.
According to the relevant provisions of the U.S. Internal Revenue Code, both legal income and illegal income are included in taxable income. The U.S. Supreme Court has also confirmed this rule in the case of James v. United States (1961). U.S. citizens must report illegal income as income when submitting their annual tax returns, but such taxpayers usually do not report this type of income, as reporting illegal income may lead to investigations by the relevant authorities into their illegal activities. Bise and Mendez failed to report the illegal income from the transfer of ICO-raised funds as required, directly violating the relevant tax law provisions, and ultimately bore criminal responsibility for this.
3. FinTax's Tips and Suggestions
With the popularity of meme coins, many crypto industry practitioners have gained huge returns from them. However, as the previous ICO tax evasion cases have shown, in the meme coin market where wealth myths emerge every day, we not only need to focus on technological innovation and market opportunities, but also on 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 through fundraising like ICOs, when the tokens purchased by meme coin issuers and investors at an early stage appreciate, they should still pay capital gains tax when selling them. At the same time, although anyone can anonymously issue meme coins on the chain, this does not mean that the issuer can avoid tax audits. The best way to avoid tax law risks is to comply with tax laws, rather than seeking more effective on-chain anonymity measures.
Second, pay attention to the meme coin trading process and ensure transaction records are transparent. Due to the stronger speculative nature of the meme coin market and the constant emergence of new projects, investors' meme coin transactions may be very frequent, accompanied by a large number of transaction records. Crypto asset investors need to keep detailed records of a series of transactions, especially using professional crypto asset management and tax reporting software, to ensure that all buying, selling, transfers and gains have a clear trail, and are correctly characterized for tax purposes, thereby avoiding potential tax disputes.
Third, keep up with tax law dynamics and cooperate with professional tax experts. The tax systems for crypto assets in various countries are still in the initial stage, and there may be frequent adjustments, and key changes may directly affect the actual tax burden. Therefore, meme coin investors and issuers should pay close attention to the tax law dynamics in their jurisdictions, and seek the opinions of professional tax experts when necessary, to assist in making the most optimal tax decisions.
In summary, the meme coin market, which has reached a staggering $140 billion, has a huge 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, maintain caution and vigilance in the volatile market, and reduce unnecessary risks and losses.
