July 23, 2018
Tax Considerations for Successful ICOs
Posted by Business Outsourcing Services Team
As cryptocurrency companies plan to raise capital through initial coin offerings (ICOs), it’s vital for them to evaluate the tax implications. This preparation will help ensure that common misconceptions about ICO taxation don’t result in unexpected costs that hamper the company’s ability to survive and grow.
The most important tax consideration to understand is that, unlike a securities offering, the proceeds from an ICO (a crowdfunding method in which a company sells pre-issue tokens to fund cryptocurrency development) are considered taxable income under Internal Revenue Service regulations.
According to the IRS, virtual currency is treated as property for taxation purposes (a position clarified by the agency under guidance issued in 2014). This means the proceeds from an ICO are taxable at the value established at the time of the offering, with the tax obligation assessed at the applicable rates.
The resulting tax bill can have a significant impact on the entity conducting an ICO. For instance, owing a percentage of the capital raised in the offering to federal, state or local tax authorities reduces the amount of money available to the company for coin, network or technology development.
If an entity conducting an ICO is not incorporated, the tax liability will be assumed by the person or people who organize the offering. This personal obligation can be significant, so it’s important to consider incorporation and to talk to a tax professional about the potential tax benefits of different corporate structures before pursuing an ICO.
After the offering, payments made to attorneys, accountants and other vendors can also create taxable events that can increase the complexity of the company’s accounting. While a company can deduct a payment made via token to an outside vendor, it must also record any gains on the value of those tokens that occurred between the date of the offering and when the payment was made.
Similarly, the use of tokens to pay employees or contractors triggers withholding or record-keeping requirements as if the employees or contractors were paid in cash. This, in turn, will result in liabilities for Social Security and unemployment taxes (in the case of employees) or a need to issue 1099 forms to contractors.
If a crypto company receives tokens as part of its business arrangements with another company, those will be considered taxable income, as well.
It’s also important to plan for potential state and local tax obligations. Many of these will dovetail with IRS regulations regarding the treatment of coins and tokens as property, as well as the associated tax liabilities and possible deductions.
ICO Taxation Misconceptions
Because ICOs are a new form of capital raising, evolving regulations have resulted in crypto companies making some regulatory assumptions. A number of these either haven’t proven true, or were corrected as regulations and legislation evolved.
For example, the federal 2017 tax reform legislation specified that the exchange of tokens for a different form of cryptocurrency would not qualify as a tax-deferred like-kind exchange of similar property. This provision is common in the real estate, art and airline industries, and some cryptocurrency advocates were using it to defer tax obligations when swapping tokens for an established coin, or for exchanging one form of coin for another. Under the new tax laws, however, each transaction in which tokens are exchanged for coins is a taxable event.
The tax reform legislation also eliminated loss carrybacks, the ability of a company to offset ICO proceeds with losses in two subsequent years. So companies can’t use operating losses in 2019 or 2020 to offset income from an ICO in 2018, for example.
International ICO taxation is another important consideration for companies considering conducting an offering through an entity located outside the United States. A number of companies have issued ICOs in non-U.S. jurisdictions, primarily to avoid potential registration requirements under U.S. securities law.
The new tax law, however, has clarified that the proceeds from a coin offering conducted by an entity outside the United States are subject to U.S. taxation when those proceeds enter the United States. While there may be securities-law-related reasons for conducting an ICO in an overseas jurisdiction, careful consideration of U.S. tax consequences should be an important part of any international ICO strategy.
Careful Planning Is Required
Like other forms of fundraising, an ICO is a significant financial event, as well as an important milestone in a company’s development. Companies considering an ICO need to go beyond the technological and marketplace factors and consider the tax-related implications of their proposed offering.
Failing to plan for the taxation of ICO proceeds can reduce the amount of capital available. It can also raise thorny compliance issues that can―at a minimum―distract management from focusing on their core technology and building a successful business.
Armanino’s Business Outsourcing Services team brings 30+ years of specialized experience to the financial, accounting and HR function in private businesses and nonprofit organizations.
With a strong mix of expertise across all HR & financial functions―management, human resources, recruiting, restructuring, reporting, accounting and tax―as well as technology expertise, we can hit the ground running to meet your specific needs.