DAO Taxation: Everything Crypto Investors Need to Know
Published November 24, 2022.
Decentralized autonomous organization (DAO) taxation is a rather unique subject to tackle. While the IRS requires taxes on cryptocurrency to be filed and paid, there are no clear rules yet concerning DAOs.
Many cryptocurrency projects have adopted the DAO framework in recent years, causing quite a few investors to fumble around with their taxes. How exactly should one report taxes on their DAO tokens, anyway?
In this guide, we'll go into a thorough but easy-to-understand discussion of how DAOs are taxed and what investors should look out for in terms of taxable events.
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Criteria for Taxation of DAO Payments
Even though a DAO doesn't have a physical presence, it can be seen as an entity for tax purposes. In the United States, for instance, tax regulations stipulate that contractual arrangements engaged in trade, business, venture, or financial operation that affords them profits, may create a separate entity.
Since a DAO is created by investors who vote on investment proposals, contribute funds for investment, and share the profits, it may be considered a separate tax entity. However, DAOs not created for profit, such as one formed to raise funds to buy a copy of the U.S. Constitution, are not considered taxable entities.
Now, if a DAO has been established as its own tax entity, the next question is: What category does this DAO fall into for taxation purposes? Let’s take a look:
Corporations vs. Partnerships
The primary types of business classifications are corporations and partnerships. If a business entity has two or more members who share unlimited liability, the default classification is a partnership. In contrast, a corporation is a separate legal entity with shareholders not personally liable for their business' debts or obligations.
Domestic vs. Foreign
Another criterion to consider is if the DAO is domestic or foreign. The term "domestic" means created or established in the U.S. or under U.S. law, while "foreign" refers to any partnership or corporation outside the U.S.
Note that these classifications are just potential factors that may affect how DAOs are taxed in the future. Currently, only the overarching tax rules on cryptocurrency are strictly implemented by the IRS. These include taxable gains and losses that may come from:
- Selling a crypto asset for fiat money
- Exchanging cryptocurrency for goods, services, or property
- Trading one crypto asset for another type of crypto asset
- Receiving cryptocurrency as payment for goods or services
- Obtaining a new crypto asset resulting from a hard fork
- Acquiring a new crypto asset from mining or staking
- Receiving cryptocurrency from an airdrop
» Learn all about the advantages and disadvantages of DAOs
How DAO Payments Are Taxed
The IRS has yet to release clear guidance on how DAOs will be taxed. However, they will likely be taxed much like traditional corporations moving forward — with a few adjustments.
The United States already has a legal precedent for this. In 2017, during a discussion of the DAOs governance tokens by the SEC, it was ruled that these types of tokens were offered by a "virtual organization" and were, therefore, subject to securities law.
Currently, however, there is no straightforward way to report cryptocurrency taxes on the profits that DAOs make from fees, investment strategies, or other sources. That said, if a DAO's blockchain sends you crypto in exchange for goods or services, those assets may be taxed as income in accordance with IRS rules. For example, if a DAO paid an artist in crypto, they would need to file taxes for that income in the state and/or country where they performed the work.
Short & Long-Term Capital Gains Tax
When you sell a long-term crypto asset for more money than what you originally paid, the surplus is called a capital gain. How much tax you'll pay on your capital gain depends on the duration of your ownership of the asset before you sell it. Capital gains are classified as either long-term or short-term and taxed differently.
Profits you make off of selling an asset are taxable, especially if you day trade online. Short-term gains taxes are equal to income taxes and are paid if the crypto assets were owned for 365 days or less.
If you sell an asset you've held for longer than a year, any profit is considered a long-term capital gain. The tax rate on these gains is 0%, 15%, or 20%, depending on your total income.
Tax Treatment of Governance Tokens & NFTs
If you receive governance tokens or non-fungible tokens (NFTs) from a DAO launch (or as an incentive/reward), you'll need to file them under your crypto taxes as regular income. In addition, if you sell your governance tokens or NFTs in the future, any profit you make will be subject to crypto capital gains tax.
Royalties or commissions from NFT resales are also considered income – but there are no clear guidelines on taxing this at the moment. Technically, reselling an NFT would be a taxable sale of property, much like other cryptocurrencies considered by the tax code as property.
Will DAOs Be Taxed in the Future?
The jury is still out on how DAOs will be taxed in the future, particularly when it comes to identifying who will be responsible for the entity’s taxes and where those taxes are to be paid.
In the U.S., pass-through entity tax has been suggested as a possible model for taxing DAOs in the future. Pass-through entities are business organizations in which the owners and/or members file the 1040s and pay individual income taxes on their share of any profits. This includes partnerships (including some limited liability companies ) and S-corporations.
Although DAOs are not primarily for profit, should they be taxed as pass-through entities, members are liable to report the DAO's earnings from investments, fees, etc., while filing their personal income tax returns even if the said income hadn't been distributed yet.
» Discover how to find new DAO projects
Despite the lack of clear tax guidelines for DAOs, you must file your cryptocurrency taxes accurately. Whether you are a member of a DAO or simply invested in one, it's crucial to know how digital currencies are taxed and what reporting requirements apply.
Careful planning and record-keeping can help you stay on top of your crypto taxes and minimize your tax burden.
» Ready to get started with DAOs? Check out the best crypto DAO Projects to invest in