Source: TaxDAO

2024 is a year for Bitcoin to step onto the central stage of the global financial arena, and it is also a carnival year for meme coins. Relevant data shows that about 75% of meme coins were born this year, and as of early December, meme coin trading has increased by over 950%, with a total market capitalization exceeding $140 billion. The popularity of meme coins has not only brought a new wave of excitement to the crypto market but has also attracted an increasing number of ordinary investors into the crypto asset space.

The meme coin craze inevitably reminds one of the ICO boom around 2017. In 2017, with the emergence of the ERC-20 standard, the cost of issuing tokens was greatly reduced, leading to a plethora of hundredfold and thousandfold projects, with billions of dollars flooding into the ICO frenzy; this year, a batch of launch platforms represented by Pump.fun has made token issuance simpler and fairer, sparking a meme coin storm that continues to this day. Although there are many technical and logical differences between ICOs and the issuance of meme coins, the tax compliance risks faced by investors and projects may be similar. In the last ICO boom, many investors and projects faced tax troubles related to ICOs. Now, as the meme coin craze continues, tax compliance issues will once again become a core concern for crypto asset investors and meme coin issuers. In this issue, FinTax will revisit the Oyster case and the Bitqyck case, using these two tax evasion cases related to ICOs as examples to provide crypto investors with cold reflections on tax compliance amid the meme coin frenzy.

1. Two Typical ICO Tax Evasion Cases

1.1 Oyster Case: Unreported Token Sale Income, Founder Sentenced to Four Years in Prison

The Oyster Protocol platform was initiated by Bruno Block (real name Amir Bruno Elmaani) in September 2017, aiming to provide decentralized data storage services. In October 2017, Oyster Protocol began its ICO, issuing a token named Pearl (PRL). Oyster Protocol claimed that the issuance of PRL was to create a win-win ecosystem where both websites and users could benefit from data storage, and to realize value exchange and incentive mechanisms through PRL. At the same time, founder Bruno Block publicly promised that after the ICO, the supply of PRL would not increase, and the smart contract for creating PRL would be "locked."

Through the ICO, Oyster Protocol initially raised about $3 million, and with this funding, it launched its mainnet and officially started data storage services, turning Oyster Protocol from an idea into a usable product. However, the good times did not last long. In October 2018, founder Bruno Block exploited a vulnerability in the smart contract to privately mint a large amount of new PRL and sold it on the market, causing the price of PRL to plummet, while Bruno Block personally gained huge profits.

The sharp decline in PRL's price attracted the attention of regulatory authorities. The U.S. Securities and Exchange Commission (SEC), the Internal Revenue Service (IRS), the Federal Bureau of Investigation (FBI), and other relevant departments launched investigations, ultimately leading the SEC to file a civil lawsuit against him for defrauding investors, while the prosecution filed a criminal lawsuit against Bruno Block for tax evasion. Regarding tax issues, prosecutors argued that Bruno Block not only undermined investor trust but also violated the obligation to pay taxes on millions of dollars in cryptocurrency profits. Bruno Block submitted only one tax return during the period from 2017 to 2018, claiming he earned about $15,000 from his "patent design" business in 2017, and did not submit a tax return in 2018, nor did he report any income to the IRS, despite spending at least $12 million on properties, yachts, and more.

Ultimately, Oyster founder Bruno Block confessed to his tax evasion in court and signed a plea agreement in April 2023, being sentenced to four years in prison and ordered to pay approximately $5.5 million to the tax authorities to cover tax losses.

1.2 Bitqyck Case: Unreported ICO Transfer Income, Two Founders Sentenced to a Combined Eight Years

Bitqyck is a cryptocurrency company founded by Bruce Bise and Samuel Mendez. The company first launched the Bitqy coin, claiming to provide an alternative path to wealth for "those who missed Bitcoin," and conducted an ICO in 2016. At the same time, Bitqyck promised investors that each Bitqy coin would come with 1/10 of a share of Bitqyck common stock. However, in reality, the company shares were always held by founders Bise and Mendez, and the company never distributed the promised shares or corresponding profits to investors. Soon after, Bitqyck launched a new cryptocurrency, BitqyM, claiming that purchasing this coin would allow investors to join the "Bitcoin mining business" by paying to power Bitqyck's Bitcoin mining facilities in Washington State, but such mining facilities did not exist. Through false promises, Bise and Mendez raised $24 million from over 13,000 investors through Bitqyck, using most of the funds for personal expenses.

In response, the SEC filed a civil lawsuit against Bitqyck for defrauding investors. In August 2019, Bitqyck admitted to the facts and reached a civil settlement, with Bitqyck and the two founders collectively paying approximately $10.11 million in civil penalties to the SEC. Meanwhile, the prosecution continued to press tax evasion charges against Bitqyck: from 2016 to 2018, Bise and Mendez earned at least $9.16 million through the issuance of Bitqy and BitqyM but underreported their income to the IRS, resulting in over $1.6 million in tax losses; in 2018, Bitqyck earned at least $3.5 million from investors but did not submit any tax returns.

Ultimately, regarding tax issues, Bise and Mendez pleaded guilty in September and October 2021, respectively, each being sentenced to 50 months in prison for tax evasion (a combined total of about eight years) and jointly liable for $1.6 million.

2. Detailed Analysis of the Tax Issues Involved in Both Cases

In the Oyster and Bitqyck cases, one of the core issues is the tax compliance of ICO income. In this emerging fundraising form, some issuers obtain huge revenues through defrauding investors or other improper means, but underreport their earnings or fail to file tax returns, leading to tax compliance issues.

2.1 How Does U.S. Law Determine Tax Evasion?

In the United States, tax evasion is a felony, defined as the intentional use of illegal means to reduce tax liabilities, typically manifested as concealing income, inflating expenses, failing to report or pay taxes on time, etc. According to Section 7201 of the U.S. Federal Tax Code (26 U.S.C. §7201), tax evasion is a federal crime, and once determined to be a tax evader, an individual may face up to 5 years in prison and a fine of up to $250,000, while entities may face fines of up to $500,000, with specific penalties depending on the amount and nature of the evasion.

Under the provisions of Section 7201, to constitute tax evasion, the following must be met: (1) a substantial amount of tax is owed; (2) active tax evasion behavior has been implemented; (3) there is subjective intent to evade taxes. Investigations into tax evasion typically involve tracing and analyzing financial transactions, sources of income, and asset flows. Particularly in the cryptocurrency space, due to its anonymity and decentralized characteristics, tax evasion is more likely to occur.

2.2 Tax-Related Behaviors in Both Cases

In the U.S., various stages of an ICO may involve tax obligations, with project parties and investors bearing different tax responsibilities at different stages. On one hand, project parties must comply with tax requirements when raising funds through an ICO. The funds raised in an ICO can be viewed as sales revenue or capital fundraising. For example, if the funds raised in an ICO are used to pay for company operating expenses, develop new technologies, or expand business, then these funds should be considered company income and taxed accordingly. On the other hand, investors also have tax obligations when obtaining tokens through an ICO. Especially when the tokens obtained through an ICO bring rewards or airdrops, these rewards will be considered capital gains and subject to capital gains tax. In the U.S., the value of airdropped and rewarded tokens is typically calculated based on their market value for tax reporting. When investors hold tokens for a period and then sell them for profit, those profits will also be taxed as capital gains.

Objectively speaking, both the Oyster and Bitqyck cases involved behaviors that not only infringed on investor interests and constituted fraud but also indeed violated U.S. tax laws to varying degrees. Of course, the tax evasion behaviors in the two cases are not identical, and further analysis will follow.

2.2.1 Tax Evasion Behavior in the Oyster Case

Specifically in the Oyster case, after the ICO of PRL, Oyster Protocol founder Bruno Block exploited a vulnerability in the smart contract to privately mint a large amount of PRL and sold it, gaining huge profits. Bruno quickly accumulated wealth through the sale of PRL but failed to fulfill related tax obligations. This behavior violated the relevant provisions of Section 7201 of the Federal Tax Code.

However, there is a special aspect to Bruno Block's behavior in this case, as he engaged in minting Pearl before selling it. It goes without saying that capital gains tax should be paid on the income from the sale of tokens, but whether the IRS should tax the act of minting tokens remains undecided. Some viewpoints argue that minting tokens and mining are both processes of creating new digital assets through computation, thus the income from minting tokens should also be taxed. FinTax believes that whether the income from minting should be taxed depends on the market liquidity of the tokens. When there is no market liquidity for the tokens, the value of the 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 considered taxable income.

2.2.2 Tax Evasion Behavior in the Bitqyck Case

Unlike the Oyster 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, Bitqyck founders Bise and Mendez failed to fulfill their promised returns to investors and instead used most of the funds for personal expenses. This transfer of funds essentially equates to converting investors' funds into personal income, rather than using them for project development or fulfilling investor interests. Unlike the direct sale of tokens during the ICO process, the key tax issue in the Bitqyck case lies in the illegal transfer of funds raised through the ICO and the failure to report income.

According to the relevant provisions of the U.S. Internal Revenue Code, both legal and illegal income are included in taxable income. The U.S. Supreme Court also confirmed this rule in the case of James v. United States (1961). U.S. citizens must report illegal gains as income when submitting their annual tax returns, but such taxpayers often do not report this income because reporting illegal income may trigger investigations by relevant authorities into their illegal activities. Bise and Mendez's failure to report the illegal income transferred from the funds raised through the ICO as required directly violated tax law provisions, ultimately leading to their criminal liability.

3. FinTax's Tips and Recommendations

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

First, understand the tax responsibilities of issuing meme coins to avoid legal risks. Although issuing meme coins does not directly generate income like an ICO through fundraising, when the tokens purchased early by meme coin issuers and investors appreciate in value, they should still pay taxes on the relevant capital gains upon sale. Additionally, 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 seek more effective on-chain anonymity measures.

Second, pay attention to the meme coin trading process to ensure transaction records are transparent. Due to the speculative nature of the meme coin market and the constant emergence of new projects, investors may engage in meme coin trading very frequently, leading to numerous transaction records. Crypto asset investors need to maintain detailed records of a series of transactions, especially by using professional crypto asset management and tax reporting software, to ensure that all buying, selling, transfers, and profits are traceable and correctly classified under tax law during tax reporting, thereby avoiding potential tax disputes.

Third, keep up with tax law developments and collaborate with professional tax personnel. 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 impacting actual tax burdens directly. Therefore, both meme coin investors and issuers should remain highly attentive to the tax law dynamics in their respective countries and, if necessary, seek the advice of professional tax personnel to assist in making optimal tax decisions.

In summary, the meme coin market, which has reached $140 billion, has a significant wealth effect, but this wealth also comes with a new round of legal challenges and compliance risks. Issuers and investors need to fully recognize the associated tax risks, remain cautious and alert in a volatile market, and minimize unnecessary risks and losses.

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