Behind Meme Coin’s Dream of Getting Rich: A Deadly Tax Trap in the $140 Billion Market

Source: TaxDAO

2024 is the year when Bitcoin will move to the center of the world’s financial stage, and it will also be a carnival year for meme coins. Relevant data shows that about 75% of meme coins were born this year. As of early December this year, meme coin transactions increased by more than 950%, and the total market value exceeded US$140 billion. The popularity of meme coins not only brings a new round of enthusiasm to the crypto market, but also attracts more and more ordinary investors to the crypto asset field.

The meme coin craze is reminiscent of the ICO craze around 2017. In 2017, with the emergence of the ERC-20 standard, the cost of issuing tokens was greatly reduced. Hundred-fold and thousand-fold projects emerged in an endless stream. Billions of dollars poured into the ICO craze; and this year, represented by Pump.fun A number of launch platforms have made it easier and fairer to issue tokens, creating a meme currency storm in the circle that continues to this day. Although there are many differences in technology and logic between ICO and meme currency issuance, the tax compliance risks faced by investors and project parties may be similar. In the last round of ICO boom, many investors and projects faced ICO-related tax troubles. Now, as the craze for meme coins continues, tax compliance issues will once 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, taking these two ICO-related tax evasion cases as examples to provide crypto investors with some cold thoughts on tax compliance amid the meme currency craze.

1. Two typical ICO tax evasion cases

1.1 Oyster case: Income from coin sales was not declared, and the founder

was sentenced to four years in prison

The Oyster Protocol platform was launched in September 2017 by Bruno Block (real name Amir Bruno Elmaani) to provide decentralized data storage services. In October 2017, Oyster Protocol started an ICO, and the issued token was called Pearl (PRL). Oyster Protocol claims that the purpose of issuing PRL is to create a win-win ecosystem, allowing both websites and users to benefit from data storage, and to realize value exchange and incentive mechanisms through PRL. At the same time, founder Bruno Block also publicly promised that after the ICO, the supply of PRL will not increase and the smart contract that creates PRL will be "locked".

Through ICO, Oyster Protocol raised approximately US$3 million in the initial stage, and used this capital to launch the mainnet and officially launch data storage services, turning Oyster Protocol from an idea into a usable product. But the good times did not last long. In October 2018, founder Bruno Block took advantage of a loophole in the smart contract to privately mint a large amount of new PRL and sell it on the market, causing the price of PRL to plummet. However, Bruno Block personally gained huge profits.

The plummeting price of PRL attracted the attention of regulatory authorities. The U.S. Securities and Exchange Commission (SEC), the U.S. Internal Revenue Service (IRS), the Federal Bureau of Investigation (FBI) and other relevant departments launched investigations. Ultimately, the SEC investigated it for defrauding investors. A civil lawsuit was filed against Bruno Block, and the prosecutor's office filed a criminal lawsuit against Bruno Block regarding tax evasion. On the tax issue, prosecutors believe that Bruno Block not only damaged the trust of investors, but also violated his obligation to pay taxes on millions of dollars in cryptocurrency profits. Between 2017 and 2018, Bruno Block filed only one tax return in 2017, saying he only earned about $15,000 in income from his "patented design" business, and no tax return in 2018, either. He did not report any income to the IRS, but spent at least $12 million on properties, yachts, etc.

In the end, Oyster founder Bruno Block confessed to his tax evasion in court, signed a plea agreement in April 2023, and was sentenced to four years in prison for tax evasion and paid approximately $5.5 million in compensation to the tax department to cover tax losses. .

1.2 Bitqyck case: ICO transfer income was not paid, the two promoters

served a total of eight years in prison

Bitqyck is a cryptocurrency company founded by Bruce Bise and Samuel Mendez. The company first launched 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 comes with 1/10 of a share of Bitqyck common stock. But in fact, the company's shares have always been held by founders Bise and Mendez, and the company has never distributed promised shares and corresponding profits to investors. Soon, Bitqyck launched a new cryptocurrency BitqyM coin, saying that purchasing the coin allows investors to join the "Bitcoin mining business" by paying to power the Bitqyck Bitcoin mining facility in Washington State, but in fact such mining The facilities don't exist. Through false promises, Bise and Mendez raised $24 million from more than 13,000 investors through the company Bitqyck and used the majority of the funds for their personal expenses.

In response, the SEC filed a civil lawsuit against Bitqyck for defrauding investors. In August 2019, Bitqyck admitted the facts and reached a civil settlement. Bitqyck and its two founders jointly paid a civil penalty of approximately US$10.11 million to the SEC. The prosecutors continued to file tax evasion charges against Bitqyck: from 2016 to 2018, Bise and Mendez earned at least US$9.16 million by issuing Bitqy and Bitqy but underreported relevant income to the IRS, resulting in a total loss of more than US$1.6 million. tax losses; in 2018, Bitqyck earned at least $3.5 million from investors without filing any tax returns.

In the end, regarding tax issues, Bise and Mendez pleaded guilty in September and October 2021 respectively. They were each sentenced to 50 months in prison for tax evasion (a total of about eight years for the two), and each bore joint liability of US$1.6 million. .

2. Detailed 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 income. In ICO, an emerging form of financing, some issuers obtain huge amounts of income by defrauding investors or other improper means, but underreport the income or fail to file tax returns, which in turn triggers tax compliance issues.

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

In the United States, tax evasion is a felony, which refers to the intentional use of illegal means to reduce the tax payable, which usually manifests itself in concealing income, falsely reporting expenditures, failing to declare or pay taxes on time, etc. According to Section 7201 of the U.S. Federal Tax Code (26 USC §7201), tax evasion is a federal crime. Once convicted as a tax evader, an individual may face up to 5 years in prison and a fine of up to $250,000. You may face fines of up to $500,000, depending on the amount and nature of the tax evaded.

Under the provisions of Article 7201, to constitute the crime of tax evasion, the following conditions must be met: (1) a large amount of tax is owed; (2) an active act of tax evasion is carried out; (3) there is a subjective intention to evade tax. Investigations into tax evasion usually involve the tracing and analysis of financial transactions, sources of income, asset flows, etc. Especially in the cryptocurrency space, tax evasion is more likely to occur due to its anonymity and decentralized characteristics.

2.2 Tax-related behaviors in the two cases

In the United States, all aspects of ICO may involve tax obligations, and project parties and investors bear 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 by an ICO can be considered sales proceeds or capital raising. For example, if the funds raised by an ICO are used to pay for the company's operating expenses, develop new technologies, or expand the business, then these funds should be regarded as company income and subject to tax according to law. On the other hand, investors also have tax obligations after obtaining tokens through ICO. Especially when investors obtain tokens through ICOs that bring rewards or airdrops, these rewards will be considered capital gains and subject to capital gains tax. In the United States, the value of airdrop and reward tokens is typically calculated and reported for tax purposes based on their market value. When investors hold the tokens for a period of time, profits gained from selling these tokens will also be taxed as capital gains.

Objectively speaking, whether it is the Oyster case or the Bitqyck case, the actions of the parties not only violated the interests of investors and constituted fraud, but also violated the provisions of U.S. tax laws to varying degrees. Of course, the tax evasion behaviors in the two cases were not the same. The article will analyze it in detail.

2.2.1 Tax evasion in the Oyster case

Specific to the Oyster case, after PRL conducted an ICO, Bruno Block, the founder of the Oyster Protocol platform, took advantage of a smart contract vulnerability to privately mint a large amount of PRL and sell it off, earning huge profits from it. Bruno quickly accumulated wealth by selling PRL, but failed to fulfill relevant tax obligations. This behavior violates Section 7201 of the Federal Tax Code.

However, Bruno Block’s behavior in this case is special because he also minted Pearl before selling it. It goes without saying that capital gains tax should be paid on the income from the sale of tokens, but the IRS has not yet reached a conclusion on whether the act of minting tokens should be taxed. In this regard, some people believe that minting tokens and mining both create new digital assets through calculation, so the income from minting tokens should also be taxed. Some believe that minting tokens is similar to the mining process, creating new digital assets through calculation, and therefore should also be taxed. FinTax believes that whether minting income is taxable should depend on the market liquidity of the token. 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 involved false promises to investors and the illegal transfer of raised funds. After successfully raising funds through ICO, Bitqyck's founders Bise and Mendez failed to fulfill their investment returns as promised and instead used most of the funds for personal expenses. This kind of fund transfer behavior is essentially equivalent to converting investors' funds into personal income, but is not used for project development or the realization of investors' interests. Different from the direct sale of tokens during the ICO process, the key tax issue in the Bitqyck case lies in the illegal transfer and unreported income of the funds raised by the ICO.

According to the relevant provisions of the U.S. Internal Revenue Code (Internal Revenue Code), both legal income and illegal income are included in taxable income. The U.S. Supreme Court also confirmed this rule in James v. United States (1961). U.S. citizens are required to report illegal gains as income when filing their annual tax returns, but such taxpayers often do not report such income because reporting illegal income could trigger an investigation into their illegal actions. Bise and Mendez failed to report illegal gains transferred from ICO funds as income as required, directly violating the relevant provisions of the tax law, and ultimately bore criminal liability for this.

3. FinTax Tips and Suggestions

With the popularity of meme coins, many people in the crypto industry have received huge returns from them. However, as previous ICO tax evasion cases have shown, in the meme currency market where wealth myths exist every day, we not only need to pay attention to technological innovation and market opportunities, but also the important matter of tax compliance.

First, understand the tax responsibilities of issuing meme coins and avoid legal risks . Although the issuance of meme coins does not directly generate income from raising funds like an ICO, when the tokens purchased early by meme coin issuers and investors appreciate in value, they should still pay taxes on the relevant capital gains when they sell them. At the same time, although everyone can issue meme coins anonymously on the chain, this still does not mean that issuers can avoid tax audits. The best way to avoid tax risks is to comply with tax laws rather than seeking more effective means of on-chain anonymity.

Second, pay attention to the meme currency transaction process and ensure that transaction records are transparent . Since the meme currency market is more speculative and various new projects are constantly emerging, investors may trade meme coins very frequently, followed by numerous 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 sales, purchases, transfers and profits are traceable and are correctly reported during tax reporting. tax laws to avoid potential tax disputes.

Third, follow up on tax law developments and cooperate with tax professionals . The tax law systems for crypto-assets in various countries are still in their infancy, and there will be frequent adjustments, and key changes may directly affect the actual tax burden. Therefore, investors and issuers of meme coins should pay close attention to the tax laws of the country where they are located, and when necessary, seek the advice of professional tax professionals to help them make optimal tax decisions.

In short, the meme currency market, which has reached US$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 relevant tax risks, remain cautious and sensitive in the volatile market, and reduce unnecessary risks and losses.