How are DAOs Taxed?
There’s a lot of uncertainty about how DAOs are taxed—and how they might be taxed in the future. Learn more.
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Although there is no current method for reporting your share of a DAO’s entity-level profits, there could be in the future. For this reason, you should keep detailed records on your share of the DAO and its profits.
If you receive crypto from a DAO for goods or services, you should report it as income.
Distributions of governance tokens or NFTs are taxed as income. Profits made from their sale are subject to crypto capital gains tax.
Decentralized autonomous organizations, or DAOs, pose a problem for the IRS: how do you tax an entity that is, by definition, decentralized? With no fixed address or owner, how does one determine where a DAO is taxed and who is liable for its crypto taxes? How does one account for income or governance tokens from such an organization?
At this time, two things are certain:
Direct crypto payments from DAOs for goods or services are taxed as income.
Profits from the sale of governance tokens are subject to crypto capital gains tax.
However, although there is a reasonable case to be made for DAOs being taxable entities themselves, it has not yet been determined how or where those taxes would be levied. Nevertheless, the possibility of DAOs’ profits being taxed at an entity-level is a real one, especially as they become more popular.
Read on to know more about what we know about DAO taxes today and how they might change in the future.
What is a DAO?
DAO stands for decentralized autonomous organization. In plainer terms, a DAO is an entity whose decisions and rules are not enforced by a central authority, but rather by smart contracts. It’s kind of like a blockchain co-op; members hold governance tokens or NFTs that give them the ability to propose and vote on DAO initiatives.
Recently, we’ve seen rapid growth in the number of DAOs. These range from financial projects (Olympus DAO), to social communities (Friends with Benefits, Mega Gamma Delta), to location-centric organizations (ATX DAO). However, amidst this boom of DAOs, the IRS has still not provided any guidance about how DAO taxes work.
How are DAOs taxed?
As pointed out by crypto tax law specialist David J. Shakow, the criteria for being a taxable entity have little to do with local classification as a business. Rather, entities are considered taxable when partners agree to work together and divide their profits. DAOs pretty clearly fit this definition; participants in a DAO collectively agree to the smart contracts that govern it and in return might receive a share of its income. This situation could reasonably be interpreted by tax agencies as constituting a taxable entity.
There’s already some legal precedent for this in the United States. In 2017, when considering The Dao’s governance tokens, the SEC ruled that the tokens were offered by a ”virtual organization,” and therefore subject to securities law.
Furthermore, following Biden's 2022 crypto executive order, SEC Chair Gary Gensler made remarks suggesting that most crypto tokens fit the criteria of securities, and should be classified as such.
However, as stated above, although there seems to be a relatively clear argument that DAOs could be taxed, so far no country has passed any measures to do so. This means that right now, there is no clear method for reporting crypto taxes on entity-level profits DAOs make through fees, investment strategies, or other means.
How are DAO payments taxed?
If a DAO’s blockchain address sends you crypto in exchange for goods or services, those assets are taxed as income in the country/state in which the sale was made or the work was performed. For example, if a social DAO paid a graphic designer in crypto, they would need to claim those funds as income subject to tax in the state and/or country where they performed the work.
How are governance tokens taxed?
If you receive governance tokens or NFTs as part of a DAO’s launch or as an incentive or reward, you likely need to report them on your crypto taxes as ordinary income.
Additionally, when and if you sell those governance tokens or NFTs, any profit would be subject to crypto capital gains tax.
Governance token example
A member of peer-to-peer software development DAO Radicle receives 1,000 RAD from the community treasury when RAD is valued at $3 (1,000 x $3 = $3,000).
He sells two years later when RAD is selling for $5. He would need to report $2,000 ($5,000 -$3,000) of capital gains.
For example, let's say a member of peer-to-peer software development DAO Radicle receives 1,000 RAD from the community treasury when RAD is valued at $3 and then exits the position two years later when RAD is selling for $5. They would need to report $2,000 of capital gains.
How will DAOs be taxed in the future?
No one’s sure how DAOs will be taxed going forward, particularly when it comes to identifying who is liable for the entity’s taxes and where those taxes would be levied. Is everyone with a wallet, or sub-address, liable for a share of the entity’s tax burden? If the DAO has participants from across the globe, is the DAO liable to be taxed by dozens and dozens of countries?
Some speculate that in the U.S., pass-through entity tax may serve as a model for any future entity-level DAO tax. A pass-through entity doesn’t generally pay federal taxes at the entity level; rather its owners and/or members file 1040s and pay individual income taxes on their share of any profits. Pass-through entities include partnerships (including some limited liability companies ), and S-corporations.
Although DAOs doesn’t necessarily have the expectation of profit, if they became treated as pass-through entities for tax purposes, members would need to report their share of the DAO’s earnings from fees, investments, etc. on their personal income tax returns, regardless of whether or not that income had been distributed to them.
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Last reviewed by Arthur Teller, CPA on September 8, 2022 · Sources