How are DAOs taxed?

VAT & Tax
August 16, 2021

Decentralized autonomous organizations, or DAOs are relatively new and the tax implications have not yet fully been laid out by tax agencies. 

Many DAOs are formed to make investments. Investors will transfer their digital assets, such as Ethereum or Solana, to a DAO in exchange for DAO tokens, which usually represent ownership in the DAO. There are situations where DAO tokens do not represent ownership but for example a right to govern a DAO’s assets.

Token holders then vote to pick an investment. If the investment is successful, token holders share the profits; if not, they share the losses. This is all done via smart contracts built within the DAO. 

The two types of DAO memberships are:

  1. DAOs based on sharing
  2. DAOs based on tokens

DAOs based on sharing

Any potential member can make a proposal to join the DAO in exchange for tokens or labor. Direct voting power and ownership are represented by shares. Members can withdraw their fair part of the treasury at any moment. These are viewed as more legal. 

DAOs based on tokens

DAOs based on tokens are mostly exchanged on a decentralized exchange without the need for any authorization therefore no proposal needed. 

Other DAOs based on token memberships must be gained either with the help of liquidity or a different form of 'proof-of-work.' In any case, if you have the token you will be able to vote. 

How are DAOs taxed?

DAOs could be taxed in the future however at this point, March 2022,, no country has outlined a plan to do so. This means that right now, there is no clear method for filing taxes on profits DAOs make through fees, investment strategies, or other means. 

Currently some countries view it as a pass through entity, meaning the partners and owners of the DAO pay individual income taxes on their share of any profits received from the DAO. 

I own a part of a DAO, do I need to pay taxes?

If you received governance tokens as part of a DAO launch, you will likely need to report the value of those tokens upon receipt as an income and pay income tax on those tokens. Subsequently, if you sell those tokens, you will need to report it as capital gains and pay capital gains tax. 

I received payment from a DAO, do I need to pay taxes?

If you received payments in the form of DAO tokens through an airdrop, you will need to report your earnings as income based on its fair market value at the time when it was received and pay income tax.

Similar as governance tokens, when you sell those tokens, you will need to report capital gains and pay capital gains tax.  

In addition, if a DAO distributes rewards to token holders you will report that income on your personal income tax statement based on its fair market value at the time it was received. 

What type of entity is a DAO? 

Most DAOs typically bring a group of individuals together to make collective investments. Each country and local government will have their own ways to classify a DAO. 

In the U.S case the likely tax classification of the DAO would be a foreign partnership because it can’t be treated as a corporation unless formed under state law as a corporation. 

What is a DAO LLC?

There are two U.S states that allow a DAO to register as an LLC under their state law: Wyoming and Vermont. A DAO LLC, because it is registered under state law, may be treated as a domestic partnership for tax purposes which would cause pass through taxation for any U.S resident a part of that DAO. 

A DAO LLC can elect to be treated as a domestic corporation for tax purposes, which would prevent passthrough taxation, but subject the DAO’s income to U.S. corporate tax.

Do I need to report I’m part of a DAO?

This differs by country but in the U.S, since a DAO is treated as a foreign entity, a U.S person must report their ownership stake to the IRS otherwise could face penalties ranging from 10,000 USD to 50,000 USD. 

Are types of DAOs taxable? 

DAOs formed for the purpose of raising funds to purchase an asset such as  a copy of the U.S. Constitution, are likely not considered tax entities.

How can a Web 3.0 Accountant help with DAO accounting and taxes?

The regulations of DAO are constantly evolving. A Web 3.0 accountant stays on top of these regulatory changes and ensures that your DAO is legally set up. We also provide monthly financials and file taxes on behalf of the DAO is applicable otherwise assist the partners of the DAO with their individual filings. 

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