What is a DAO? 

DAO stands for “Decentralized Autonomous Organization.” A DAO is an entity whose decisions and rules are not enforced by a central authority but rather by smart contracts. In crypto, DAOs are a kind of blockchain co-op. Members hold governance tokens or NFTs that allow them to propose and vote on DAO initiatives. 

The number of DAOs has grown rapidly. These range from financial projects to social communities to geographically oriented organizations. Amidst this boom of DAOs, the IRS has still not provided clear guidance about how DAO taxes work, so DAO taxes remain an area of speculation.

How are DAOs taxed?

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 the agency determine where a DAO is taxed and who is liable for its crypto taxes? How can the IRS account for income or governance tokens from such an organization?

At time of writing, 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 widespread and popular. 

As crypto tax law specialist David J. Shakow notes, 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 in crypto pretty clearly fit this definition, as participants in a DAO collectively agree to the smart contracts that govern it and might, in return, receive a share of its income. Tax agencies could reasonably interpret this situation as constituting a taxable entity. 

There is legal precedent for this in the United States. In 2017, when considering the governance token for “The Dao” project, the SEC ruled that the tokens were offered by a ”virtual organization” and, therefore, subject to securities law.

Furthermore, following President 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. In June of 2023 the SEC filed lawsuits against Binance and Coinbase declaring numerous cryptos (including Cardano, Solano, and Binance Coin) to be securities.

That noted, there is still no clear method to report crypto taxes on entity-level profits DAOs in crypto make through fees, investment strategies, or other means. 

How are DAO payments taxed?

If a DAO sends you crypto in exchange for goods or services, those assets are taxed as income in the country and state in which the sale was made or the work was performed. 

For example, if a social DAO pays a graphic designer in crypto, they will need to claim those funds as income subject to tax in the region where they performed the work. If this crypto later appreciates and is sold, any realized profit will also be subject to capital gains tax.

International taxpayers will benefit from our helpful country guides for further crypto tax guidance in regions outside the United States.

Are governance tokens taxable?

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, if you sell those governance tokens or NFTs, any profit would be subject to crypto capital gains tax.

The latest updates on DAO taxes

No one is certain how DAOs in crypto 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 of countries?

Some speculate that in the US, 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. Instead, 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 in crypto do not necessarily expect profit, if the IRS comes to treat them as pass-through entities for tax purposes, members will 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.

DAOs as legal entities

As a general rule, establishing a legal entity provides a foundation for operations, liability protection, and tax obligations. In contrast, entities without legal status, whether labeled as DAOs, companies, or communes, face the legal classification of a general partnership, which results in several issues.

Firstly, individuals in a general partnership bear personal liability for the organization’s actions, leaving them vulnerable to lawsuits and financial repercussions. Secondly, lacking corporate personhood hinders a partnership’s ability to engage in essential activities like signing contracts or owning property. Additionally, tax obligations fall on individual partners, a reality often overlooked by many DAOs. 

In 2023, new legal options emerged for DAOs. Various jurisdictions, including Wyoming, Tennessee, and the Republic of the Marshall Islands, now offer specialized legal entities like DAO LLCs designed to cater to their unique needs. Some DAOs have also chosen to incorporate as Limited Cooperative Associations or Unincorporated Nonprofit Associations in Colorado or have established foundations offshore. 

The incorporation of DAOs in these jurisdictions not only grants legal recognition but also provides access to banking services, shields members from personal liability, and helps to ensure tax compliance.

How TokenTax can help

TokenTax is more than just another crypto tax calculator. We’re a full-service accounting firm that streamlines the entire crypto tax process, ensuring accurate and compliant crypto tax filings for DAO governance token and NFT holders. Here’s how our team of crypto tax professionals at TokenTax can assist you.

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