April 18, 2024

At the moment, there is not enough information on tax considerations for a decentralized organization. 

A DAO (Decentralized Autonomous Organizations) refers to an organization under computer software or program management, run by blockchain technology and controlled by a set of individuals. 

These individuals decide on proposals that affect the organization by voting. Meanwhile, the voting power depends on the percentage of interest in the organization. Hence, percentage interest is the digital assets of a member divided by the digital assets in the organization.

A DAO can often operate without having a governing body or board of directors. On its own, it can gather individuals and capital to reach a particular goal. 

The activity of a DAO begins with the investors sending digital assets, which is usually Ethereum, to the organization so they can be given DAO tokens. These tokens represent their interest in the organization. Sometimes, the token may not be an actual ownership interest in the organization but a mere representation such as the right to control the assets of a DAO. It is the job of the DAO to define the token.

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Now, those who have tokens will vote on different investment options submitted. For every successful investment, they will share the profit and vice versa. With proper operation, a smart contract is enough to handle the activities. 

Taxation and Legislation For DAOs

It might seem a DAO has no formal character, but it is an entity. According to tax regulation in the US, a joint business or contract agreement can create another entity if they carry out a business, trade, or financial operation and share the profit. 

Therefore, a DAO with investors who decide to put their funds in a project and share the profit is considered a tax entity. Once a DAO becomes a separate tax entity, for tax, it can be classified as either a partnership or corporation. A partnership is an entity with two members and above and unlimited liability. 

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Another way to classify a separate entity is by using terms such as foreign or domestic. The partners will have to report their income and losses every year for a domestic and foreign partnership. In a foreign corporation, their losses and income can not be levied until they have paid a dividend.

Apart from tax, one primary concern for investors is the legal liability they are exposed to from investing in a DAO. , their assets are at risk if the organization incurs any debt or lawsuit. Presently, two states, Wyoming and Vermont, allow DAOs to register their organization as limited liability companies, which separates their assets from the business. Such an organization can be treated like a domestic partnership or domestic corporation for tax.

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Contributions Of DAOs

According to the Internal Revenue Service, if a token is given in exchange for another token, there will be a loss or gain. This means the event can be levied. However, it is free of tax when a property is given to a partnership to get partnership interest or to a corporation to get corporate stock. A DAO token can represent a corporate stock or a partnership interest to the point that it will give the owner the right to vote and share in the DAO profit.

Although DAOs are an excellent opportunity to change how business is carried out, they present tax complications that may be difficult to handle. It is recommended that anyone thinking of joining or creating a DAO see an advisor on tax matters first.


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