Tax Concerns Amid the Meme Coin Craze: Compliance Risks from ICO Cases

In 2024, Bitcoin is stepping onto the central stage of the global financial arena, and meme coins are also celebrating. Data shows that about 75% of meme coins were created this year, and by early December, meme coin trading had increased by over 950%, with a total market capitalization exceeding $140 billion. This wave of enthusiasm has not only brought a new round of excitement to the crypto market but has also attracted more ordinary investors into the realm of crypto assets.

The meme coin craze reminds people of the ICO boom around 2017. At that time, the emergence of the ERC-20 standard significantly reduced the cost of issuing tokens, leading to countless projects with hundredfold and thousandfold returns, and billions of dollars flowing into the ICO market. This year, some launch platforms have made it easier and fairer to issue tokens, triggering a meme coin storm that continues to this day. Although ICOs and meme coins differ in technology and logic, the tax compliance risks faced by investors and projects may be similar.

During the last round of the ICO boom, many investors and project parties encountered tax issues. Now, with the continued popularity of meme coins, tax compliance has once again become a core issue that crypto asset investors and meme coin issuers need to pay attention to. The following will review the Oyster case and the Bitqyck case, two tax evasion cases related to ICOs, to provide crypto investors with thoughts on tax compliance during the meme coin boom.

1. Two Typical ICO Tax Evasion Cases

1.1 Oyster case: Coin sales income not declared, founder sentenced to four years in prison

The Oyster Protocol platform was initiated by Bruno Block in September 2017, aiming to provide decentralized data storage services. In October 2017, Oyster Protocol conducted an ICO and issued a token named Pearl(PRL). The platform claims that PRL aims to create a win-win ecosystem that allows websites and users to benefit from data storage. The founder also publicly promised that the supply of PRL would not increase after the ICO.

The ICO raised about 3 million USD, and the Oyster Protocol achieved its mainnet launch. However, in October 2018, the founder exploited a smart contract vulnerability to privately mint a large amount of PRL and sell it on the market, resulting in a dramatic drop in the price of PRL, while the individual reaped substantial profits.

This matter has triggered an investigation by regulatory authorities. Regarding tax issues, prosecutors believe that Bruno Block not only undermined investor trust but also violated the tax obligations on millions of dollars in cryptocurrency profits. Between 2017 and 2018, he submitted only one tax return in 2017, claiming to have earned approximately $15,000 from "patent design" business, while in 2018 he did not submit a tax return or report any income, yet spent at least $12 million on properties, yachts, and so on.

Ultimately, Bruno Block confessed to the facts of tax evasion and signed a plea agreement in April 2023, being sentenced to four years in prison and compensating the tax authorities approximately 5.5 million dollars.

1.2 Bitqyck case: ICO transfer income not taxed, two founders sentenced to a total of eight years in prison.

Bitqyck was founded by Bruce Bise and Samuel Mendez, who first launched the Bitqy coin, claiming to provide an alternative means of wealth for "those who missed Bitcoin," and conducted an ICO in 2016. The company promised that each Bitqy coin would come with 1/10 of a common stock share, but in reality, the shares were always held by the founders and were never distributed to investors.

Subsequently, the company launched BitqyM coin, claiming that purchases would allow participation in "Bitcoin mining services," but the so-called mining facilities do not exist. Through false promises, Bise and Mendez raised 24 million dollars from over 13,000 investors, most of which was used for personal expenses.

Regarding fraudulent activities, Bitqyck reached a civil settlement with the SEC, with the company and its two founders collectively paying a fine of approximately $10.11 million. The prosecution has also filed tax evasion charges: from 2016 to 2018, Bise and Mendez earned at least $9.16 million by issuing Bitqy and BitqyM but underreported their related income, resulting in over $1.6 million in tax losses; in 2018, the company earned at least $3.5 million from investors but did not submit any tax returns.

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

2. Analysis of Tax Issues Involved in the Two Cases

One of the core issues in the Oyster and Bitqyck cases is the tax compliance of ICO revenue. Some issuers have obtained huge revenues through fraudulent means or improper practices, yet underreport their earnings or fail to file tax returns, leading to tax compliance issues.

How does the United States determine tax evasion?

In the United States, tax evasion is a felony, referring to the intentional use of illegal means to reduce tax liabilities, commonly manifested as concealing income, falsely reporting expenses, failing to file, or failing to pay taxes on time. According to Section 7201 of the United States Code, tax evasion is a federal crime, and individuals may face up to 5 years of imprisonment and a fine of $250,000, while entities may face a fine of up to $500,000.

To constitute tax evasion, the following must be met: (1) a substantial amount of taxes owed; (2) active tax evasion behavior; (3) the presence of subjective intent to evade taxes. Investigations typically involve tracing and analyzing financial transactions, sources of income, and asset flows. In the cryptocurrency domain, due to its anonymity and decentralized characteristics, tax evasion is more likely to occur.

2.2 Tax-related behaviors in the two cases

In the United States, each stage of an ICO may involve tax obligations, with project parties and investors bearing different tax responsibilities at different stages. Project parties must comply with tax compliance requirements when raising funds through an ICO. The funds raised through the ICO can be considered as sales revenue or capital fundraising. If used to pay for company operating expenses, develop new technologies, or expand business, these funds should be regarded as company income and taxed according to the law.

Investors have tax obligations after obtaining tokens through an ICO. When the obtained tokens bring rewards or airdrops, these rewards will be considered capital gains and are subject to capital gains tax. The value of airdropped and rewarded tokens is usually calculated based on market value for tax reporting. Profits made from selling tokens held for a period of time by investors will also be subject to capital gains taxation.

In the cases of Oyster and Bitqyck, the actions of the parties not only infringed on the interests of investors and constituted fraud, but also violated U.S. tax laws to varying degrees.

2.2.1 Tax evasion in the Oyster case

In the Oyster case, founder Bruno Block exploited a smart contract vulnerability to privately mint a large amount of PRL and sell it, reaping huge profits while failing to fulfill tax obligations, thus violating Section 7201 of the Federal Tax Code.

The behavior of Bruno Block in this case is unique because he minted before selling Pearl. It is undoubtedly necessary to pay capital gains tax on the proceeds from the sale of tokens, but there is no conclusion on whether the act of minting tokens should be taxed. Some opinions suggest that minting tokens is similar to mining, as both involve creating new digital assets through computation, and therefore should also be taxable. Whether the income from minting needs to be taxed should depend on the market liquidity of the tokens. When the token market has not yet formed liquidity, the value of minted tokens is difficult to determine, making it impossible to clearly calculate the income; however, if the market has a certain level of liquidity, these tokens possess market value, and the income from minting should be regarded as taxable income.

2.2.2 The tax evasion behavior of the Bitqyck case

The tax evasion behavior in the Bitqyck case involves false promises to investors and the illegal transfer of raised funds. After successfully raising funds through the ICO, founders Bise and Mendez failed to fulfill the promised investment returns and instead used a large portion of the funds for personal expenses. This kind of fund transfer is essentially equivalent to converting investors' funds into personal income, rather than being used for project development or fulfilling investor interests.

According to the U.S. Internal Revenue Code, all income, whether legal or illegal, is considered taxable income. The U.S. Supreme Court confirmed this rule in the case of James v. United States (1961). U.S. citizens must report illegal gains as income when filing their annual tax returns, but these taxpayers typically do not report such income, as it may trigger investigations by relevant authorities into illegal activities. Bise and Mendez did not report the illegal gains transferred from ICO fundraising as income, directly violating tax law regulations, and ultimately faced criminal liability.

3. Tax Compliance Recommendations

With the boom of meme coins, many individuals in the crypto industry have gained substantial returns. However, as evidenced by previous ICO tax evasion cases, in the meme coin market where wealth myths frequently emerge, we not only need to pay attention to technological innovation and market opportunities, but also focus on the important matter of tax Compliance.

First, understand the tax liabilities of issuing meme coins to avoid legal risks. Although issuing meme coins does not directly generate profits like an ICO does, when the tokens of meme coin issuers and early investors appreciate, they should still pay taxes on related capital gains when sold. While anyone can anonymously issue meme coins on-chain, this does not mean that issuers can evade 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 trading process of meme coins and ensure that transaction records are transparent. Due to the high speculation in the meme coin market and the continuous emergence of new projects, investors may trade meme coins very frequently, leading to a multitude of transaction records. Cryptocurrency investors need to maintain detailed transaction records, especially using professional cryptocurrency management and tax reporting software, to ensure that all buys, sales, transfers, and profits are traceable, and that they receive the correct tax treatment during tax reporting, thus avoiding potential tax disputes.

Third, keep up with tax law developments and collaborate with professional tax advisors. The tax law systems regarding crypto assets in various countries are still in their infancy and are subject to frequent adjustments, with key changes potentially directly affecting actual tax burdens. Therefore, both investors and issuers of meme coins should maintain a high level of attention to the tax law dynamics in their respective countries, and seek professional tax advice when necessary to assist in making optimal tax decisions.

In summary, the meme coin market, which has reached 140 billion dollars, has a huge wealth effect, but this wealth is also accompanied by a new round of legal challenges and Compliance risks. Issuers and investors need to fully recognize the relevant tax risks and remain cautious and vigilant in the volatile market to reduce unnecessary risks and losses.