DAOs & Taxation – Understanding Regulations In Crypto’s Next Frontier

The modern cryptocurrency landscape is filled with uncertainty, even though prices for Bitcoin and Ethereum are seeing a marginal increase. Decentralized autonomous organizations (DAO) are another mystery, as no one is sure if they'll be targeted for taxation in the next few years.

What is a DAO?

A decentralized autonomous organization or DAO is an entity whose rules or decisions aren't enforced (and, for now, controlled) by a central authority. Instead, they're governed by small contracts and act similarly to a blockchain co-op, as members hold governance tokens or NFTs.

Similar to other worker's co-ops, its members are allowed to vote on DAO initiatives. DAOs like Mega Gamma Delta, Olympus DAO, and ATX are key representatives in this market. However, the IRS hasn't been able to provide guidance to these companies on how they should be taxed.

Will a DAO be Taxed in the Future?

Yes, it's very likely that DAOs will be taxed in the future; there just isn't an exact date for when this may happen. The IRS issued Notice 2014-21 in 2014, declaring that all cryptocurrency will be taxed starting from the moment it was used by an individual, which could date back to 2009.

What Kind of Entity is a DAO?

Token-holders of a DAO isn't anonymous, even if a party's personal details aren't visible. That means if an employer hires employees to work in their DAO, they'll have to pay employer taxes as well as anything else that may be taxed as if you own an LLC, partnership, or S or C corp.

While there isn't any method for reporting your share of a DAO's entity-level profits, it's likely the structure will resemble other traditional business structures. DAO owners and members should keep a detailed record of their share of the DAO and its profits to make tax compliance easier.

How Are Regular DAO Payments Taxed?

If a DAO entity sends you crypto in exchange for goods or services, they're treated as taxable income based on the income tax laws within the state or country you reside. If you earn cryptocurrency by mining it, you should report it on Form 1099-NEC issued by the IRS.

How Are Governance Tokens and NFTs Taxed?

The IRS is clear that NFTs and governance tokens you receive as a reward or incentive in congruence with a DAO's launch should be treated as income. If you sell NFTs or governance tokens, they will be subjected to capital gains tax, typically as a short-term investment.

What is Short and Long-Term Capital Gains Tax?

A short-term capital gain occurs when an individual sells an owned asset in less than a year. A long-term capital gain is held for longer than a year and is taxed more favorably than a short-term capital gain. Unfortunately, most crypto is bought and sold in less than a year.

Short-term gains are taxed similarly to regular taxable income and are therefore subject to your current income tax bracket. These range from 10% to 37%. Long-term gains are subject to three brackets: 0%, 15%, or 20% and over, meaning holding on to investments is a better choice.

Will Everyone's Wallet Be Liable for an Entity's Tax Burden?

That's unlikely to be the case. If this were to happen, it would mean that DAOs would be taxed by dozens of countries. This wouldn't be a feasible taxation model for any business, so the IRS is looking at implementing a pass-through entity tax where they won't pay federal taxes. 

If a DAO does make a profit, members would need to report their share of the DAO's earnings from investments, fees, and more on their personal income tax returns. This rule would apply regardless if the income from a DAO business is distributed amongst its members.