A Wyoming decentralized autonomous organization (DAO) LLC is a new type of limited liability company that operates on blockchain technology through smart contracts. Wyoming passed legislation in 2021 allowing for the formation of DAO LLCs. This allows a DAO, which is a distributed network of participants that collectively operate an entity through software, to obtain formal legal status and liability protections under US law. DAO LLCs allow decentralized blockchain networks and organizations to hold assets, enter into contracts, and essentially take on the capabilities of a traditional LLC or corporation. A key benefit is that it provides legal protections to decentralized organizations lacking formal structure. Members of a Wyoming DAO LLC obtain limited liability protections similar to a standard LLC.
When it comes to paying taxes as a DAO LLC, first thing you need to consider is your tax reporting structure. The main options are C corp, S corp, sole proprietorship or partnership. The partnership/sole proprietorship structure is default for Wyoming DAO LLCs and offers pass-through taxation, but requires owners to pay self-employment taxes. The alternative C-corp or S-corp tax regime can be elected within 75 days after forming the DAO LLC.
Partnership or Sole Proprietorship
The partnership structure is default for Wyoming DAO LLCs and offers pass-through taxation, but requires owners to pay self-employment taxes.
For federal taxes, single member DAO LLCs are taxed as sole proprietorships by default, while multi-member DAO LLCs are taxed as partnerships. Members report their share of DAO income, deductions, credits and losses on their personal tax returns.
The DAO itself does not pay federal income tax. Members must pay self-employment tax on their DAO earnings. For state taxes, Wyoming does not impose an income tax on individuals or businesses, including DAO LLCs. DAO LLCs may need to register in other states where they conduct business activities and pay taxes accordingly.
Multi-member DAO LLCs treated as partnerships need to file Form 1065 federal return and provide K-1 schedules to members to report their share. Single member DAO LLCs report business income on Schedule C with the owner’s Form 1040 return, no separate DAO return is filed. DAO LLCs have the same tax filing and reporting requirements as traditional LLCs when electing pass-through taxation. Proper record-keeping of income, expenses, assets/liabilities is important.
1. Partnerships are pass-through entities, no taxes paid at entity level.
2. Owners pay taxes on their share of income annually.
3. Pass-through of losses to owners.
4. Owners pay self-employment tax on guaranteed payments and proportional income.
5. Partnerships file Form 1065 for federal taxes.
Pros: Avoid double taxation, pass-through losses, default for DAO LLCs
Cons: Self-employment taxes for owners
If a Wyoming DAO LLC only has foreign, non-US resident members, the DAO LLC would generally be treated as a foreign partnership if it does not conduct business in the US. It would not have to file a US partnership return or issue K-1s.
The DAO LLC’s foreign members would not have to report US income or pay US taxes on their share of DAO earnings if there is no effectively connected US business income. However, if the DAO LLC conducts business activities in the US or generates income treated as US-source, then it may have to file US partnership returns and foreign members may have to report their share of effectively connected income.
For state taxes, Wyoming does not tax foreign non-resident DAO LLC members. But the DAO LLC may need to register and pay taxes in other states where it has a business presence. The DAO LLC may be subject to 30% federal withholding taxes on certain US-source income like dividends, royalties, interest etc paid to the foreign members, unless tax treaties provide reduced rates.
Foreign DAO LLC members would need to file US individual returns and report income if engaged in a US trade or business personally.
Withholding Taxes: U.S. partners in a foreign partnership are subject to withholding taxes on income that is effectively connected to a U.S. trade or business. The withholding tax rate is generally the highest individual tax rate (37% for 2022). Withholding applies to both fixed and determinable income (e.g. interest, dividends) as well as income effectively connected to a U.S. trade or business. The partnership is required to withhold these taxes from distributions to U.S. partners.
Foreign partnerships with U.S. partners or U.S. activity generally must file Form 8865. This form reports information about the partnership’s partners, assets, liabilities, income, expenses, etc. Form 8865 also reconciles the partnership’s book income with taxable income. In some cases, Form 1065 may also need to be filed. Additional requirements apply if the foreign partnership has a permanent establishment in the United States.
Withholding taxes and reporting requirements may be reduced or exempt under certain tax treaties. There are also exceptions for minimal U.S. partners/activity. The partnership must provide documentation to qualify for treaty benefits or exceptions.
1. Partnerships formed outside the US may be treated as foreign partnerships.
2. Subject to withholding taxes on income sourced from US.
3. May need to file Form 8865 under some conditions.
Pros: Limit US tax exposure
Cons: Withholding taxes, reporting requirements
A DAO LLC can elect to be treated as a C corporation by filing Form 8832 with the IRS within 75 days of formation. This is known as a “check-the-box” election. The election can also be made when filing the DAO LLC’s first tax return, such as Form 1120.
A C corporation must file an annual income tax return, Form 1120, by the 15th day of the 4th month after the end of its tax year. The DAO LLC will be required to make estimated quarterly tax payments if expected tax for the year exceeds $500. Estimated payments are submitted via Form 1120-W. Taxable income is calculated at the entity level. Net business income is subject to tax. Owners pay individual income tax on any dividends issued by the C corporation.
C corporation income is taxed at marginal corporate tax rates. The rates are 21% for taxable income up to $400,000 and 35% for income above $400,000.
Individual owners pay taxes on dividends at their individual income tax rates up to 20% for qualified dividends, plus 3.8% Net Investment Income Tax.
If the DAO LLC retains earnings rather than distributing dividends, the 21% corporate tax rate applies. However, retained earnings increase potential gain upon sale of the business.
1. C corps are taxed separately from their owners. The DAO would pay taxes on its net income.
2. Owners pay taxes on any dividends received. This leads to double taxation.
3. No pass-through of losses to owners. Losses remain within the C corp.
4. C corps file Form 1120 for federal taxes.
Pros: Limited liability protection, no self-employment taxes for owners, potential lower corporate tax rates
Cons: Double taxation, no pass through of losses
Electing S corporation status avoids double taxation but requires shareholder compliance. The DAO LLC pays no entity-level tax but flow-through items are reported by members annually. A DAO LLC elects S corporation status by filing Form 2553 with the IRS within 2 months and 15 days of formation.
S corporation election is also open within the first 2.5 months of each tax year.
The DAO LLC must meet all eligibility requirements. S corps can have no more than 100 shareholders. Shareholders must be individuals, certain trusts, or estates. Partnerships, corporations or non-resident aliens cannot be shareholders. An S corp can only have one class of stock. Differences in voting rights are permitted, but disproportionate ownership interests are not.
Shareholders must be U.S. citizens or residents. Non-resident aliens cannot be shareholders. All shareholders must consent to the S election. This is done by signing Form 2553. An S corp cannot be a foreign corporation. It must be a domestic entity. No more than 25% of gross receipts can come from passive sources like rents, royalties, interest, etc. An S corp cannot be 100% owned by a single owner. There must be two or more shareholders.
1. S corps are pass-through entities, owners pay taxes on their share of corporate income.
2. No double taxation like C corps.
3. Pass-through of losses to owners.
4. Owners pay self-employment taxes on income.
5. S corps file Form 1120S for federal taxes.
Pros: Avoid double taxation, pass-through of losses
Cons: Self-employment taxes for owners
Disclaimer: This article provides general information about potential tax classifications and requirements for Wyoming DAO LLCs. The information contained herein is for educational purposes only and not intended as legal, tax, or financial advice. The tax code contains complex rules and regulations that must be examined closely with the help of a competent tax professional. Any entity considering forming a DAO LLC should consult with legal, tax, and accounting advisors to determine the proper tax treatment for their specific situation. This article does not constitute legal or tax advice and cannot be relied upon as such. Individuals and entities must conduct their own due diligence and/or consult with professional advisors familiar with their personal circumstances before making business or tax decisions.
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