At a Glance
Web3 companies operate in a fast-moving environment where digital asset innovation has outpaced tax guidance at nearly every level. This article explores current challenges and planning considerations across key tax domains:
The rise of decentralized technologies has outpaced tax authorities’ ability to define, regulate, or even classify the activities that drive the Web3 economy. What began as a debate over whether cryptocurrency is property or currency has evolved into a far broader challenge: how to apply legacy tax rules to entirely new modes of economic activity. Web3 businesses must contend with a landscape in which income can be algorithmically generated, users are pseudonymous, and geographic presence is fluid. Tax authorities already assert jurisdiction, even though formal guidance is still limited.
Inaction is not an option. Businesses that wait for regulatory clarity may find themselves exposed to audit risk and penalty regimes. Strategic tax planning, rigorous documentation, and operational alignment are critical for compliance and sustainable scaling in a global environment.
At the federal level, tax treatment of digital assets remains anchored in traditional concepts—most notably, the IRS’s classification of digital assets as property. But as business models evolve, so too do the complexities around income recognition, character, timing, and classification.
Web3 businesses generate revenue in ways that challenge traditional tax classifications. Each stream carries specific implications tied to the IRS’s property treatment of digital assets:
Mining and Staking Operations: Tokens earned from mining or staking are taxed as ordinary income when received. The basis of each token is its fair market value on that date. Tracking becomes challenging across protocols and tokens.
Protocol Participation Rewards: Airdrops, governance token distributions, and forks all generate taxable income when received. The challenge lies in determining fair market value for newly issued tokens and establishing when receipt occurs in decentralized environments. In the case of forks, the IRS distinguishes between hard forks (which can trigger income recognition upon receipt of the new token) and soft forks (which generally do not create new assets and therefore may not result in taxable income).
Some cryptocurrency and digital asset companies engage in frequent trading as part of treasury management, arbitrage, or liquidity strategies. This activity creates realization events each time an asset is exchanged, sometimes resulting in thousands of taxable transactions. The associated administrative burden is significant, particularly when systems are not built to capture lot-level cost basis and gain/loss data in real time.
High-volume trading can even change a company’s overall tax status. Although trader tax status may offer benefits such as ordinary loss treatment and mark-to-market accounting, qualification requires that trading be a business’s primary focus. Most Web3 companies do not meet this threshold. That said, firms with high trading volumes should evaluate whether a Section 475(f) election or a dedicated trading entity may offer planning flexibility.
As digital assets expand, they test the limits of existing tax frameworks.
Utility Tokens raise questions about timing and character for both issuers and users. When tokens are redeemed for services, businesses generally recognize ordinary income equal to their fair-market value. For users, redemption may also trigger gain or loss if the token appreciated or depreciated since acquisition.
Security tokens, often structured to represent equity or debt-like interests, present classification challenges that affect eligibility for dividend treatment, foreign tax credits, and withholding. Depending on how the token is issued and transferred, nonrecognition provisions under Subchapter C or K may be unavailable, particularly if tokens lack sufficient rights or if the issuer is not a qualified entity.
NFTs and crypto-based derivatives require tracking gain or loss on each transaction and classifying income from royalties, trading fees, or platform incentives. NFTs may be taxed at higher collectibles rates (28%) if deemed art or similar property under IRC § 408(m)(2), though IRS guidance remains limited.
The intersection of traditional reporting rules and digital innovation leaves Web3 businesses operating in ambiguity.
While FinCEN has indicated that guidance is forthcoming on whether digital asset wallets must be reported on the FBAR (FinCEN Form 114), no formal rules have been issued. In contrast, Form 8938 (Statement of Specified Foreign Financial Assets), a FATCA form used for “specified domestic entities” and individuals, uses broader statutory language and is more clearly understood to apply to foreign digital asset holdings.
As a result, many companies take a conservative approach: reporting holdings on Form 8938 when applicable and, in some cases, disclosing foreign wallet balances on the FBAR as well, despite the lack of definitive regulatory direction.
The Infrastructure Investment and Jobs Act of 2021 expanded digital-asset information reporting. The Treasury has now finalized regulations for custodial brokers, which include most centralized exchanges. These businesses must file the new Form 1099-DA for sales that occur on or after January 1, 2025. Cost-basis reporting first applies to 2026 sales (reported on 2027 forms), giving custodial platforms two full tax years to refine data capture. A separate rule set intended for DeFi and other non-custodial platforms was repealed in April 2025, so those platforms have no federal reporting duty at present. Custodial businesses should ensure that their systems capture cost basis, wallet addresses, and counter-party data well before the first filing deadline.
Notice 2025-33 extends the IRS backup-withholding grace period. Custodial brokers do not need to withhold on digital-asset sales in 2025 or 2026, and the relief continues through 2027 for accounts opened before January 1, 2026, provided the broker completes TIN matching.
Digital asset businesses must contend with a fragmented and evolving state tax landscape. Because there is no unified federal framework governing how states should treat digital assets, each jurisdiction is free to apply its own rules on nexus, revenue sourcing, and apportionment.
Below are two foundational areas where state tax law and digital business models frequently collide:
Many states apply a Wayfair-style threshold, often $100,000 in receipts or 200 transactions, when deciding whether a digital-asset business has tax nexus. Traditional nexus concepts were built for brick-and-mortar businesses, not decentralized protocols. Today, some states argue that operating validator nodes or mining equipment creates a physical presence, while others apply economic-nexus thresholds based on user location or transaction volume. As a result, companies must evaluate their footprint in each jurisdiction where users interact with their platform or where digital infrastructure may be interpreted as creating presence.
Even once nexus is established, determining how to source digital asset revenue can be equally complex. State apportionment formulas often rely on property, payroll, or sales; all of which translate poorly to digital economies. For example, sourcing revenue from an NFT marketplace or a DeFi yield protocol may require novel allocation methods based on user IP addresses, smart contract locations, or protocol-level analytics. These models should be documented and consistently applied to reduce audit risk.
Global tax systems were designed for centralized enterprises with fixed locations; not for decentralized networks or digital-first operations. As token-based business models cross borders, long-standing rules around permanent establishment, source of income, and withholding struggle to keep pace. Companies operating internationally in this space must carefully evaluate their structure, transactions, and reporting obligations to stay compliant across jurisdictions.
Beginning in 2026, the EU’s Directive on Administrative Cooperation (DAC8) and the OECD’s Crypto-Asset Reporting Framework (CARF) will require exchanges, wallet providers, and other crypto-asset service providers to identify account holders, capture the value of each trade, and report the information to their local tax authority. More than fifty jurisdictions have pledged to adopt the rules, and those authorities will begin automatically exchanging the 2026 data in 2027, giving governments a consolidated view of cross-border crypto gains and balances.
Smart contracts, remote teams, and decentralized governance structures strain traditional permanent establishment rules. These rules rely on concepts like a fixed place of business or dependent agent.
While blockchain infrastructure may not in itself create PE, associated activities, such as U.S.-based personnel managing a protocol, could be deemed to create one. Businesses should carefully document operational substance and develop treaty-based positions on tax residence and PE exposure in each relevant jurisdiction.
Paying foreign contractors in tokens raises complex tax characterization issues. While the payment is made in property (i.e., digital assets), it is treated as payment for services or royalties once converted to fiat value. This distinction affects both source-of-income rules (e.g., whether it’s U.S.-source income) and whether withholding obligations apply under Sections 1441 and 1442. Classifying the nature of each payment correctly is essential for determining treaty eligibility, appropriate withholding rates, and required reporting.
To mitigate risk, businesses should adopt a classification framework aligned with IRS and OECD principles, clearly document the nature of each payment, and collect appropriate withholding certificates (e.g., Form W-8BEN or W-8BEN-E). In uncertain cases, conservative withholding, along with proper Form 1042/1042-S reporting, can reduce audit exposure. Companies should also assess whether the token-based transactions create U.S.-source income for foreign recipients or trigger broader reporting obligations, particularly where contracts are executed or services rendered in the U.S.
The digital asset tax landscape is evolving rapidly, and businesses operating in this space can no longer treat tax as a secondary concern. Every wallet transfer, protocol interaction, and token issuance has the potential to trigger taxable events, often across multiple jurisdictions. Building scalable systems to track fair market value, asset basis, and transaction details is essential. The same is true for maintaining defensible documentation and designing flexible entity structures that can adapt as regulations shift.
Reconstructing transaction histories after the fact is costly, time-consuming, and often incomplete. By contrast, a proactive tax strategy can help avoid penalties, unlock planning opportunities, and support long-term growth. That’s where a specialty tax advisor makes the difference.
At Sapowith Tax Advisory, we work with cryptocurrency and digital asset businesses to anticipate risk, navigate ambiguity, and build tax strategies that scale with innovation. If you’re managing complex digital asset operations, contact us today to discuss a tailored strategy.