Taxing Crypto and Jurisdiction Shopping

Source: Cointracking

Source: Cointracking

The American 2017 tax-year is over, which means a whole bunch of people are panicking about how they should pay taxes on their cryptocurrency gains without becoming Wesley Snipes. To start off, we highly recommend some professional tax advice, as well as the Forbes and Bad Crypto podcasts on this issue. The short answer is that nothing has really changed since the 2014 IRS memo treating crypto as property, which means anytime you get in and out of a crypto asset, that is a taxable event. But let's broaden the conversation to jurisdiction shopping, which is the practice of companies choosing where to domicile entities (like funds) and do business to optimize their choice of law. Israel just proposed some favorable ICO tax rules, which would allow ICO proceeds to be legitimized. Many of today's crypto companies have an entity in Gibraltar, Singapore, Switzerland or Estonia. Why?

There are several reasons we've heard that cryptopreneurs go jurisdiction shopping: (1) taxable treatment of ICO funds raised, (2) ability to open a bank account despite a decentralized fund-raising, (3) capital gains treatment on crypto currency transactions, and (4) treatment of token distribution to founders and advisors. As tax professionals develop sophistication in the space, these become more and more important. 

ICOs today try to avoid equity tokens so that they do not run into securities law, with its registration rules and requirements. But that implies the ICOs are selling digital goods, subject to Income tax on the profits. To solve this, projects structure a foundation to receive the revenue as a grant. That didn't work so well for Tezos. Second, the bank account issue is why we see so many foundations start in Gibraltar, where AML/KYC standards are more permissive, and thus companies can open bank accounts with proceeds from contributions of thousands of anonymous people online. On capital gains, we will likely see massive confusion come tax season, in whatever jurisdiction. The most conservative reading is that any crypto-to-crypto exchange is a taxable event, and requires the payment of fiat on the capital gain. Similarly, a purchase with Bitcoin of a sandwich will trigger a capital gain (or loss) realization for the price of the sandwich -- so you'd be paying tax there too. Check out Cointracking as a possible solution to at least know what you owe.

The last piece is probably the most invisible to folks who have not started private companies before. These tax issues, especially around illiquid private stock, pop up all the time. Imagine a startup worth $100 million and you join as VP Product, and get 1% of the equity, which is not yet liquid. Well, you also immediately get a $450,000 tax bill, payable that year. So in early stage tech, there are many solutions for these problems -- like options, 83(b) elections for stock that vests, and so on. Crypto has none of this. If a founder wants to file an 83(b) election and pre-pay their taxes on worthless tokens, they can't because the tokens are not equity. Or similarly bad would be having to pay tax on allocated founder tokens valued at a Tezos valuation in cash upon receipt. So the traditional tools do not work, and the potential tax burden to individuals involved in the space is quite severe. That's one way to slow down the pace of innovation.