Publicly Traded Partnerships & Potential Tax Implications
You down with PTP? No, not really…
The cryptoverse is always discussing whether and how tokens might be securities, especially so-called “governance tokens” that are, at least initially, designed to be a coordination mechanism for a DAO but often end up seeming closer to a TradFi equity - bestowing certain voting rights on its holder and potentially economic claim on DAO’s treasury. This is an important area of focus since securities laws are complex and dangerous if not handled with proper care, but on-chain organizations shouldn’t put blinders on and think that securities considerations are the only legal landmine waiting on the field. Potentially more disastrous for these groups is tax law.
Let’s assume for a minute that you accepted that your token will probably be considered a security, so you took every step to ensure your new token fit into the securities laws exemptions that let you not register with the SEC. You breathe a sigh of relief confident that Gary Gensler’s shadow isn’t looming over every word you’re typing on Discord. Be careful, though. Someone set up a liquidity pool for that token and now Charles Rettig smells some blood in the water. It turns out someone was setting up a big sign by your DAO that says “publicly traded partnership found here - please tax us at corporate rates.”
A publicly traded partnership, or PTP, is a loosely-defined concept in US tax law that results in the organization being taxed as if it were a corporation instead of passing income through to its members, where they’ll deal with the taxes on their own terms and circumstances. PTP status is typically triggered when interests in a partnership (which would actually be a limited partnership, LLC or even a general partnership or other unincorporated association) is either traded on the public market or there is otherwise a readily available secondary market. That secondary market is typically deemed to exist if there are regular price quotes and there is a readily available mechanism to buy, sell or exchange an interest in the partnership. In a more traditional context, this usually comes up with private companies and investment funds when investors are looking for some early liquidity. In crypto, this could possibly be triggered if there’s a deep enough pool on a DeFi exchange or other automated market maker.
Probably not surprising for anyone who’s dealt with the internal revenue code before, but there are a lot of caveats, exceptions, tests and other considerations when trying to determine whether something is actually a PTP, including (but very much not limited to) the volume of interests being traded relative to total organization value, whether the organization helped facilitate any of those transfers and the type of income generated by the organization. Securities laws are important but tax law could be a lurking monster for the crypto ecosystem.
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To be continued…..