DAO Taxes: The Ultimate Guide

Over the past few years, decentralized autonomous organizations (DAOs) have become an inherent part of the Web3 community.

With the number of participants increasing 130 times to 1.6 million in 2021 alone, DAOs offer a decentralized and transparent way to govern Web3 organizations. This is achieved by enabling the community to take charge of the project's governance.

However, it's also important to consider DAO tax implications, which can be complex due to a general lack of guidance. In this guide, we will explore this topic and touch on the following key points:

• An overview of DAOs and what they are

• The tax implications of DAOs and how authorities treat the

• The taxation of DAOs

• Record-keeping for DAOs

What Is a DAO?

A decentralized autonomous organization (DAO) is a blockchain-based community collectively owned by its members, who are working towards a shared goal. The latter can be anything from supporting an environmental cause, collecting NFTs for a fund, to investing in web3 startups.

In contrast to traditional enterprises, DAOs govern Web3 projects without any centralized authority. DAOs are based on the blockchain, where all the organization's activity is transparent and publicly recorded on the distributed ledger. Members, contributed and core team members are distributed tokens through rewards programs or airdrops. Members utilize their tokens to create new proposals or vote on existing ones to shape the future of the DAO. The organizations' smart contracts enable the outcome of the votes to be automatically implemented in a decentralized manner. 

DAOs: Incorporation and Tax Implications

Without legal incorporation, the tax treatment of a DAO is unclear, leaves room for the IRS and other tax agencies to decide, and increases members' personal liability.

To avoid the above issues, participants could decide to establish a legal entity for their DAOs in a jurisdiction. Examples of such include unincorporated non-profit associations (UNAs), foreign foundations, limited cooperative associations (LCAs), and limited liability companies (LLCs).

Source

Wrapping DAOs into a legal entity provides regulatory clarity in terms of both taxation and personal liability. However, as the above table illustrates, there could also be some downsides based on the chosen structure.

For example, tax optimization strategies are only available for DAOs incorporated as foreign organizations, which can become challenging for members to manage. UNAs are generally less complex structures with minimal formality and the lowest risks of censorship resistance but may face difficulties in distributing profits to participants.

In any case, we recommend consulting with a tax expert to avoid common pitfalls and determine the best DAO structure.

How Do DAOs Pay Taxes?

During a token generation event (TGE) of the DAOs governance tokens, the issuing organization distributes the newly-minted tokens to various stakeholders. The latter group can include crowdfunding contributors, early investors, the core development team, active community members, and others based on the project's allocation structure.

From the issuer's perspective, the TGE doesn't generally result in a taxable event if it lacks the sale or exchange of tokens. This likely applies to the part of the asset's supply the DAO entity allocates to its treasury wallets for the organization's own use.

But the DAO will become subject to capital gains taxes as soon as it generates a profit by disposing of some of its governance tokens at a later date. The same applies to all participants and DAO members selling their assets at a fair market price higher than the cost basis.

Based on the jurisdiction, holders of governance tokens receiving their assets as part of the DAO's TGE or crypto airdrop could also be subject to income tax:

• US taxpayers who exercise dominion and control over the received assets based on the IRS' 2019 guidance

• UK taxpayers receiving the assets in return for a service or in expectation of a return, or as receipts of an existing trade or business related to exchange tokens or mining

In general, any direct payments from DAOs for goods or services are taxed as income. This means that certain stakeholders, such as team members earning their salaries in governance tokens, as well as other external partners, must pay income taxes after the received assets.

If the DAO's TGE involves a token sale, it must also pay income taxes after the proceeds. Income taxes also apply in case the organization generates revenue from its (other) business activities.

As a business entity, Web3 organizations can report this revenue in the annual tax return (Form 1120, Form 1120-S, or Form 1065) in the US and as corporation tax filed online or via the CT600 form in the UK.

Besides disposing of their own governance tokens, DAO entities also become subject to capital gains taxes when they sell any other digital asset held on their balance sheets for a profit.

While DAOs based in the UK can file their CGTs using the same forms as above (online or the CT600 form), organizations incorporated in the US can report capital gains and losses via Form 8949 and Form 1040 Schedule D via the information from their K-1 box 8 or 9a (assuming the organization is a partnership).

How to pay taxes on individual DAO activity?

Members and contributors of DAOs have more to think about when it comes to tax season. For core contributors, investors or members, DAO governance tokens you own should be anticipated to be taxed similarly to normal cryptocurrencies.

For example, if you receive an airdrop of governance tokens from a DAO, you need to record the earnings and track the fair market value of the tokens when you received them. Depending on how you liquidate your tokens, there can be a capital gain or loss associated with the transactions, which are dictated by the asset’s value from the time you were airdropped them.

Record-Keeping for DAO Transactions

Based on the DAO's corporate structure, organizations and their individual members need to maintain up-to-date records for tax purposes. These can include:

• Personal records (such as the full legal names, ownership percentage, and distribution details of each DAO member)

• Income records and previous tax returns

• Current financial statements and bookkeeping records (including P&L statements, balance sheets, and journal entries)

• General business expenses

• Deductions

As some DAOs handle a massive number of transactions every day, manually keeping track of the corresponding documentation consumes significant resources.

With Integral, DAOs can reach blazing-fast month-ends with automatic transaction classification and capital gains/losses calculations. They can also generate compliant and detailed reports for digital asset P&L, cost basis, position closures, and other purposes.

Besides saving time, DAOs and their contributors can also leverage Integral's powerful accounting stack to gain real-time visibility into their treasuries. By seeing all their assets, positions, and balances in one place with minute-by-minute pricing and live P&L, DAOs can make better and faster decisions.

To learn how Patrick Camuso can help your team navigate DAO Tax implications, please visit here.

For a live demo of Integral and our crypto accounting platform, please visit here.