Behind the Meme Coin Craze: Tax Risks Cannot Be Ignored

In 2024, Bitcoin is迎来了重要机遇, while meme币 has also迎来了狂欢. Data shows that approximately 75% of meme币 were born this year, and by early December, the trading volume of meme币 had increased by over 950%, with a total market capitalization exceeding $140 billion. The popularity of meme币 has not only brought a new wave of enthusiasm to the crypto market but also attracted more ordinary investors into the realm of crypto assets.

The recent wave of meme coin frenzy reminds people of the ICO boom around 2017. In 2017, the emergence of the ERC-20 standard significantly reduced the cost of issuing tokens, leading to an influx of hundreds and thousands of projects, with billions of dollars pouring into the ICO wave; this year, a new batch of launch platforms has made issuing tokens even simpler and fairer, triggering a meme coin storm that continues to this day. Despite the many technical and logical differences between ICOs and meme coins, the tax compliance risks faced by investors and projects may be similar. In the last ICO boom, many investors and projects encountered tax issues related to ICOs. Now, as the meme coin frenzy continues, tax compliance issues will once again become a core concern for crypto asset investors and meme coin issuers. This article will review the Oyster case and the Bitqyck case, using these two ICO-related tax evasion cases as examples to provide cold reflections on tax compliance for crypto investors amid the meme coin craze.

1. Two Typical ICO Tax Evasion Cases

1.1 Oyster Case: Coin sales revenue not reported, 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, the Oyster Protocol began its ICO, issuing the token Pearl (PRL). The Oyster Protocol claims that the issuance of PRL is intended to create a win-win ecosystem, allowing both websites and users to benefit from data storage and facilitating value exchange and incentive mechanisms through PRL. Founder Bruno Block has also publicly committed that the supply of PRL will not increase after the ICO, and the smart contract for creating PRL will be "locked".

Through the ICO, the Oyster Protocol initially raised about $3 million and launched its mainnet, starting data storage services. However, in October 2018, Bruno Block exploited a vulnerability in the smart contract to mint a large amount of new PRL privately and sold it on the market, causing the price of PRL to plummet, while Bruno Block personally gained enormous profits.

The sharp drop in the price of PRL has drawn the attention of regulatory authorities, ultimately resulting in the SEC filing a civil lawsuit regarding fraudulent investor issues, while prosecutors have initiated a criminal lawsuit against Bruno Block over tax evasion issues. On the tax matters, prosecutors believe that Bruno Block not only undermined investor trust but also violated tax obligations on millions of dollars in cryptocurrency profits. During the period from 2017 to 2018, Bruno Block only submitted a tax return for 2017, claiming he earned about $15,000 from his "patent design" business, and did not submit a tax return for 2018, nor did he report any income to the IRS, yet spent at least $12 million on purchasing properties, yachts, and more.

Ultimately, Bruno Block admitted to tax evasion in court and signed a plea agreement in April 2023, being sentenced to four years in prison and ordered to compensate the tax authorities approximately $5.5 million to make up for the tax loss.

1.2 Bitqyck case: ICO transfer income not taxed, the two founders combined served eight years in prison.

Bitqyck is a cryptocurrency company founded by Bruce Bise and Samuel Mendez. The company first launched the Bitqy coin, claiming to provide an alternative way to wealth for "those who missed Bitcoin," and conducted its ICO in 2016. 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 have always been held by founders Bise and Mendez and have never been allocated to investors as promised, along with the corresponding profits. Soon after, Bitqyck launched the BitqyM coin, 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 do not exist. Through false promises, Bise and Mendez raised $24 million from over 13,000 investors and used most of the funds for personal expenses.

The SEC filed a civil lawsuit against Bitqyck for defrauding investors. In August 2019, Bitqyck acknowledged the facts and reached a civil settlement with the SEC, jointly paying approximately $10.11 million in civil fines. The prosecution continued to press tax evasion charges against Bitqyck: from 2016 to 2018, Bise and Mendez earned at least $9.16 million by issuing Bitqy and Bitqy, but underreported related 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 file any tax returns.

Ultimately, 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 was held jointly liable for $1.6 million.

2. Detailed Explanation of the Tax Issues Involved in the Two Cases

In the cases of Oyster and Bitqyck, one of the core issues is the tax compliance of ICO revenues. In this emerging form of fundraising, some issuers have obtained huge revenues through fraudulent means against investors or other improper methods, while underreporting their income or failing to file tax returns, leading to tax compliance issues.

How does U.S. law determine tax evasion?

In the United States, tax evasion is a felony, referring to the deliberate use of illegal means to reduce the taxes owed, usually manifested as concealing income, inflating expenses, failing to report, or failing to pay taxes on time. According to Section 7201 of the United States Federal Tax Code, 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 a fine of up to $500,000. The specific penalties depend on the amount and nature of the tax evasion.

To constitute tax evasion, the following conditions must be met: (1) a substantial amount of tax 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, asset movements, and so on. Especially in the field of cryptocurrency, 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, various aspects of an ICO may involve tax obligations, and both project parties and investors bear different tax responsibilities at different stages. The project party must comply with tax regulations when raising funds through an ICO. The funds raised in an ICO can be regarded as sales revenue or capital raised. For example, if the funds raised in an ICO are used to pay for company operating expenses, develop new technologies, or expand the business, these funds should be considered company income and taxes must be paid according to the law. Investors also have tax obligations after obtaining tokens through an ICO. Especially when the tokens obtained through the ICO bring rewards or airdrops, these rewards will be considered capital gains and subject to capital gains tax. In the United States, the value of airdropped and reward tokens is usually calculated at market value for tax reporting. When investors hold tokens for a period and then sell them for profit, these profits will also be subject to capital gains tax.

Objectively speaking, whether it is the Oyster case or the Bitqyck case, the actions of the parties not only infringed on the interests of investors 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 the same.

Tax evasion in the Oyster case 2.2.1

In the Oyster case, after the ICO of PRL, Bruno Block, the founder of the Oyster Protocol platform, exploited a smart contract vulnerability to privately mint a large amount of PRL and sell it, gaining huge profits. Bruno quickly accumulated wealth by selling PRL, but failed to fulfill his tax obligations. This behavior violated the relevant provisions of Section 7201 of the Federal Tax Code.

In this case, Bruno Block's actions are peculiar because he engaged in minting Pearl before selling it. It goes without saying that capital gains tax should be paid on the proceeds from the sale of tokens, but whether the act of minting tokens should be taxed remains inconclusive. Some argue that minting tokens and mining both create new digital assets through computation, and therefore the income from minting tokens should also be taxable. Whether the income from minting needs to be taxed should depend on the market liquidity of the tokens. When there is no market liquidity, the value of the minted tokens is difficult to determine, making it impossible to calculate the income clearly; however, if the market has a certain level of liquidity, these tokens acquire market value, and the income from minting should be considered taxable income.

2.2.2 Tax Evasion in the Bitqyck Case

Unlike the Oyster case, the Bitqyck case involves tax evasion related to false promises made to investors and the illegal transfer of raised funds. After successfully raising funds through an ICO, Bitqyck's founders Bise and Mendez failed to fulfill their promised investment returns and instead used most of the funds for personal expenses. This transfer of funds is essentially equivalent 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 during the ICO and the unreported 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 usually do not report this type of income because reporting illegal income could trigger an investigation by the relevant authorities into their illegal actions. Bise and Mendez failed to report the illegal income transferred from funds raised through the ICO as required, directly violating the relevant provisions of tax law, and ultimately bore criminal responsibility for this.

3. Tips and Suggestions

With the popularity of meme coins, many people in the cryptocurrency industry have made huge returns. However, as indicated by previous ICO tax evasion cases, in the meme coin market where wealth myths are created every day, we need to pay attention not only to technological innovation and market opportunities but also 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 generate profits directly from fundraising like an ICO, meme coin issuers and early investors should still pay taxes on relevant capital gains when selling their appreciated tokens. At the same time, even though anyone can anonymously issue meme coins on the blockchain, 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 methods.

Second, focus on the trading process of meme coins and ensure that transaction records are transparent. Due to the higher speculative nature of the meme coin market and the continuous emergence of various new projects, investors may engage in meme coin trading very frequently, leading to a multitude of transaction records. Cryptocurrency investors need to keep a detailed record of a series of transactions, especially by using professional cryptocurrency management and tax reporting software, to ensure that all buys, transfers, and profits are traceable, and to obtain the correct tax classification during tax reporting, thereby avoiding potential tax disputes.

Third, keep up with tax law developments and collaborate with professional tax experts. 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 impacting actual tax burdens. Therefore, investors and issuers of meme coins should maintain a high level of awareness of the tax law developments in their respective countries and seek the advice of professional tax experts when necessary to assist in making optimal tax decisions.

In conclusion, the meme coin market, which has reached as high as 140 billion USD, 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 understand the related tax risks and maintain...