Is your Web3 asset taxable? The answer may change post-election

A Trump presidency, Musk in the mix, and a new SEC chair: Web3 regulatory landscape is about to undergo its biggest shift yet. Here’s what finance leaders need to know about digital asset taxability.

The Web3 community has operated in a regulatory gray area for years. With Gary Gensler’s resignation and a new SEC chair to step in in January, a lot might be about to change when it comes to regulatory guidance and the future of Web3.

What we know about the incoming Presidential position

On October 15th, Trump’s cryptocurrency token, World Liberty Financial, went live. This was a first for a US presidential candidate, and now a first for the incoming president. His cabinet picks include bitcoin bulls like Elon Musk, who is associated with tokens like Dogecoin.

Notably, such actions are a departure from prior comments around cryptocurrency. Back in 2019, he tweeted, “I am not a fan of Bitcoin and other Cryptocurrencies, which are not money, and whose value is highly volatile and based on thin air.” This skepticism continued after his presidency with similar statements on Fox News guest appearances.

However, his position has clearly evolved, and the market has listened. Bitcoin is now at an all-time high, and we continue to see more Web3 startups looking to navigate the changing regulatory landscape.

The digital asset vs. security divide

While innovation in the Web3 space has proven unstoppable, businesses face a critical challenge: determining whether their digital offerings qualify as securities or digital assets. This distinction carries major implications for tax obligations and compliance requirements.

A digital asset is something you can use, like a subscription, license, or collectible. Think of it like buying software or an e-book. Securities, on the other hand, are investments where you’re betting on future profits from someone else’s work, similar to buying stocks. Many Web3 products blur these lines and interestingly, your marketing and business model can influence classification.

With digital assets, one may need to consider indirect tax if the product is taxable in the purchase location. Several states like Pennsylvania and Washington provided guidance as early as 2022 to incorporate NFTs in their definition of taxable digital goods. With securities, one may need to consider capital gains tax or income tax depending on the specifics of the transaction.

So, how do you know which category your token falls into? Enter the Howey Test—the decades-old framework that’s now the key to unlocking Web3 tax compliance.

Meet the Howey Test

The Supreme Court’s 1946 case about Florida orange groves might seem far removed from cryptocurrency, but it created the four-question framework that determines if you’re dealing with a security today.

Here’s the Howey Test—answering yes to some or all of these questions indicates your asset is a security:

1. Is there an investment of money?

2. Is there a common enterprise?

3. Is there an expectation of profit?

4. Do profits come primarily from others’ efforts?

The more centralized your project’s development and decision-making, the more likely it is deemed a security.

How does this apply to Web3? Let’s see it in action. Gaming tokens that only function within a specific game environment and can’t be traded externally? Likely a digital asset. Tokens sold with promises of future platform development and value appreciation? You’re probably looking at a security.

This test has been central to the cryptocurrency regulatory debate. While the SEC has provided limited guidance, many startups have structured their tokens and business models specifically to function as true digital assets, avoiding the characteristics that would trigger securities registration requirements.

It’s important to note that while the Howey Test is informative particularly at the federal level, states can and have been taking independent regulatory actions against digital assets, even when those assets might not clearly meet the Howey Test criteria. This results in state security laws potentially being applied more broadly than federal, making compliance even more inconsistent and difficult.

Tax implications for the Web3 community

Let’s cut through the complexity and focus on what this means for your bottom line. If your offering qualifies as a digital asset, you’re looking at a different set of tax obligations than securities.

For digital assets, sales tax obligations kick in when your digital asset is deemed taxable in the customer’s jurisdiction. You’ll need to:

• Register for sales tax in states where you have nexus

• Collect and remit sales tax on applicable transactions

• Keep detailed records of each sale’s jurisdiction and tax status

For securities, your obligations shift to securities regulations, requiring:

• Form 1099-B reporting for traders

• Capital gains tracking for investors

• Documentation of basis and holding periods

Keep in mind that assets potentially classified as securities under the Howey Test are also subject to sales tax in some jurisdictions. So knowing what an asset qualifies as at the federal level is not determinative when you get down to state-level taxation.

Given how nascent the Web3 space is, it is prudent to call in the experts early. The key moments include initial product classification decisions prior to launching the product and entering into new jurisdictions.

At Anrok, we are the trusted platform with many Web3 companies, including Alchemy, CoinGecko, and Magic. Our platform and network of experts can help you get it right from day one. Reach out today if you’re building in Web3. ⊞