Tax Risk Warning Under the Meme Coin Craze

In 2024, Bitcoin took center stage on the world financial stage, while also witnessing the frenzy of meme coins. Data shows that about 75% of meme coins were born this year, and by early December, meme coin trading surged over 950%, with a total market cap exceeding $140 billion. This wave of enthusiasm not only brought a new round of heat to the crypto market but also attracted more ordinary investors into the realm of crypto assets.

The rise of meme coins is reminiscent of the ICO boom around 2017. At that time, the emergence of the ERC-20 standard significantly reduced the cost of issuing tokens, with hundred-fold and thousand-fold projects emerging one after another, and billions of dollars pouring into the ICO market. This year, launch platforms represented by Pump.fun have made token issuance simpler and fairer, triggering an ongoing meme coin storm. Although ICOs and meme coins differ technically and logically, the tax compliance risks faced by investors and projects may be similar.

In the previous ICO boom, many investors and project parties encountered tax issues related to ICOs. Now, with the ongoing excitement around meme coins, tax compliance has once again become a core issue that crypto asset investors and meme coin issuers need to pay close attention to. This article will review the Oyster case and the Bitqyck case, two tax evasion cases related to ICOs, to provide crypto investors with considerations for tax compliance during the meme coin frenzy.

1. Two Typical ICO Tax Evasion Cases

1.1 Oyster case: Coin sales revenue unreported, founder sentenced to four years in prison

In September 2017, Bruno Block (real name Amir Bruno Elmaani) founded the Oyster Protocol platform with the aim of providing decentralized data storage services. In October 2017, the platform began its ICO, issuing a token named Pearl (PRL). Oyster Protocol claims that the issuance of PRL is to establish a win-win ecosystem, allowing both websites and users to benefit from data storage, and achieving value exchange and incentive mechanisms through PRL. Bruno Block publicly promised that the supply of PRL would not increase after the ICO, and the smart contract would be "locked".

Through the ICO, Oyster Protocol raised approximately $3 million and achieved the mainnet launch. However, in October 2018, Bruno Block exploited a smart contract vulnerability to privately mint a large amount of new PRL and sell it on the market, leading to a drastic drop in the price of PRL, while he personally made huge profits.

This incident has attracted the attention of regulatory authorities, with the U.S. Securities and Exchange Commission (SEC), the Internal Revenue Service (IRS), and the Federal Bureau of Investigation (FBI) among the relevant departments conducting investigations. The SEC has filed a civil lawsuit regarding the fraudulent investor issues, while the prosecutor's office has initiated a criminal tax evasion case against Bruno Block. Prosecutors believe that Bruno Block has not only undermined investor trust but also violated tax obligations on millions of dollars in cryptocurrency profits.

Between 2017 and 2018, Bruno Block only submitted a tax return in 2017, claiming to have earned approximately $15,000 from his "patent design" business. In 2018, he did not submit a tax return and did not report any income to the IRS, yet he spent at least $12 million on purchasing properties, yachts, and other items.

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

1.2 Bitqyck Case: ICO transfer income not taxed, two founders sentenced to a total of 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 an 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's shares have always been held by the founders Bise and Mendez, and the promised shares and corresponding profits have never been distributed to investors.

Soon after, Bitqyck launched a new cryptocurrency called BitqyM coin, claiming that purchasing this coin would allow investors to participate in the "Bitcoin mining business" by paying to power Bitqyck's Bitcoin mining facilities in Washington State, but such mining facilities do not actually exist. Through these 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 admitted to the facts and reached a civil settlement with the SEC, with Bitqyck and its two founders jointly paying approximately $10.11 million in civil penalties to the SEC.

The prosecution continues to accuse Bitqyck of tax evasion: from 2016 to 2018, Bise and Mendez earned at least $9.16 million by issuing Bitqy and BitqyM, but underreported the related income to the IRS, resulting in a tax loss of over $1.6 million; in 2018, Bitqyck earned at least $3.5 million from investors but did not submit 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 combined total of about eight years), and each bore joint liability of 1.6 million dollars.

2. Analysis of Tax Issues Involved in the Two Cases

One of the core issues in the cases of Oyster and Bitqyck is the tax compliance of ICO revenues. In this emerging fundraising method, some issuers obtain huge revenues through fraudulent means or other improper methods, yet underreport their earnings or fail to file tax returns, raising tax compliance issues.

How does US law determine tax evasion?

In the United States, tax evasion is considered a felony, referring to the deliberate use of illegal means to reduce the amount of tax owed, typically manifested through actions such as concealing income, falsely reporting expenses, failing to file, 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 individuals may face up to 5 years in prison and a fine of $250,000, while entities may face a fine of up to $500,000, with specific penalties depending on the amount and nature of the tax evasion.

To constitute tax evasion, the following must be met: (1) a significant amount of unpaid taxes; (2) the implementation of active tax evasion behavior; (3) the existence of subjective intent to evade taxes. Tax evasion investigations typically involve tracing and analyzing financial transactions, sources of income, asset flows, and more. In the cryptocurrency field, due to its anonymity and decentralized characteristics, tax evasion is more likely to occur.

2.2 Tax-related activities in the two cases

In the United States, various stages of an ICO may involve tax obligations, with project parties and investors bearing different tax responsibilities at different stages. Project parties must comply with tax compliance requirements when raising funds through an ICO. The funds raised in an ICO can be regarded as sales revenue or capital fundraising. For example, if used to pay for company operating expenses, develop new technologies, or expand the business, these funds should be considered company income and must be taxed according to the law.

Investors have tax obligations after acquiring tokens through an ICO. Especially when the obtained tokens come with rewards or airdrops, these rewards will be considered capital gains and are subject to capital gains tax. In the United States, the value of airdropped and rewarded tokens is typically calculated based on market value for tax reporting. Profits obtained from selling tokens after holding them for a period of time will also be regarded as capital gains for taxation.

Objectively speaking, the actions of the parties in the Oyster case and the Bitqyck case not only infringed upon the interests of investors and constituted fraud, but also violated U.S. tax laws to varying degrees.

Tax evasion in the Oyster case 2.2.1

In the Oyster case, after the ICO of PRL, founder Bruno Block exploited a vulnerability in the smart contract to privately mint a large amount of PRL and sell it off, earning huge profits. Bruno quickly accumulated wealth by selling PRL, but failed to fulfill related tax obligations, violating Section 7201 of the Federal Tax Code.

In this case, Bruno Block's actions are special because he minted before selling Pearl. It goes without saying that capital gains tax should be paid on the proceeds from the sale of the token, but there is no conclusion on whether the act of minting tokens is taxable. Some believe that minting tokens is similar to the mining process, which creates new digital assets through computation, and therefore should also be taxed. Whether the earnings from minting need to be taxed should depend on the market liquidity of the tokens. When market liquidity has not yet formed, it is difficult to determine the value of the minted tokens, making it impossible to clearly calculate the earnings; however, if the market has a certain level of liquidity, these tokens will have market value, and the earnings from minting should be considered taxable income.

2.2.2 Bitqyck's tax evasion behavior

The tax evasion behavior in the Bitqyck case involves false promises to investors and the illegal transfer of raised funds. After successfully raising funds through the ICO, 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' money into personal income, rather than being used for project development or fulfilling investor interests. The key tax issue in the Bitqyck case lies in the illegal transfer of funds raised through the ICO and the unreported income.

According to the U.S. Internal Revenue Code, both legal and illegal income are considered taxable income. The U.S. Supreme Court confirmed this rule in the case of James v. United States (1961). U.S. citizens must report illegal gains as income when filing their annual tax returns, but such taxpayers often do not report this income, as reporting illegal income may trigger investigations by relevant authorities into their illegal activities. Bise and Mendez failed to report the illegal gains transferred from the funds raised through the ICO as required, directly violating tax law provisions, and ultimately faced criminal liability for this.

3. Tips and Suggestions

With the popularity of meme coins, many individuals in the crypto industry have reaped huge returns. However, as evidenced by previous ICO tax evasion cases, in the meme coin market, we should not only focus on technological innovation and market opportunities but also pay attention 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 directly generate profits through fundraising like an ICO, issuers and early investors should still pay taxes on capital gains when the tokens they hold appreciate in value and are sold. 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 seeking more effective means of anonymity on the blockchain.

Secondly, focus on the trading process of meme coins and ensure that transaction records are transparent. The meme coin market has strong speculative characteristics, with new projects constantly emerging, and investors' trading may be very frequent, leading to numerous transaction records. Crypto asset investors need to properly maintain detailed transaction records, especially by using professional crypto asset management and tax reporting software, to ensure that all purchases, transfers, and profits are traceable, and to obtain correct tax classifications during tax reporting, thereby avoiding potential tax disputes.

Finally, keep up with the dynamics of tax laws and collaborate with professional tax experts. The tax law systems regarding crypto assets in various countries are still in the early stages and are subject to frequent adjustments, with key changes potentially impacting the actual tax burden directly. Therefore, both investors and issuers of meme coins should maintain a high level of attention to the tax law dynamics of their respective countries and seek the advice of professional tax experts when necessary to assist in making optimal tax decisions.

In summary, the meme coin market, which has reached 140 billion USD, has a huge wealth effect, but this wealth also comes with a new round of legal challenges and compliance risks. Issuers and investors need to fully recognize the related tax risks, remain cautious and alert in the complex and ever-changing market, and reduce unnecessary risks and losses.