Do you need to pay taxes on Crypto Points you earn?

Maybe! For crypto projects issuing points or rewards, the key to compliance lies in understanding the nature of the rewards and the context in which they are earned. There are a few key points that any organization must consider when issuing crypto points:

• If rewards or points are earned in a manner that the IRS considers taxable, it is crucial to report these on personal and business tax returns. 
• If crypto points are used to compensate people for work or performing some action, they may be considered as compensation or miscellaneous income, depending on the specific circumstances.
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What are crypto points?

"Crypto points" refer to a system that crypto projects use to assign value to certain behaviors with digital rewards. Projects and companies may give out crypto points to incentivise people to use their protocol, engage with governance or voting, reduce gaming token airdrops, transact more with certain crypto tokens and more. Unlike tokens, crypto points are centralized with a specific crypto company disseminating and tracking their point system rather than necessarily recording those points on a blockchain. These points can also be a bridge to a cryptocurrency payment or other rewards.

Examples of web3 projects using crypto points

The Crypto.com exchange offers a Rewards+ loyalty program that provides benefits based on our users' trading activity. Learn and earn programs exchange accumulated points from learning about crypto related subjects, and are offered by Coinbase, Binance, Cake, Revolut and Robinhood among others. Wallet provider Rainbow gave out points for behaviors such as interacting with Ethereum, swapping assets using Rainbow and referring a friend to the platform. Friend.Tech, a web3 social networking app, supplies points to users to interact with the platform. These points could convert into tokens should Friend.Tech developers opt to do one. The NFT marketplace Blur gives points to users who list and bid on items, as well as lend their assets. An individual's points will determine what kind of reward called a 'Care Package' they receive, which includes items of different rarities.

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What does the US government think about crypto points?

The Internal Revenue Service (IRS) has issued guidance that generally exempts personal use rewards, such as those earned from credit cards and frequent flyer miles, from being taxed as income. The reasoning behind this stance is that these rewards are typically viewed as discounts or rebates on purchases, rather than as income or gifts. 

For example, if you use a credit card that offers cashback rewards, the IRS does not require you to report the cashback as income, considering it a rebate on spending rather than taxable income.

How this position applies to points or rewards for crypto projects is a matter of interpretation based on this limited guidance from the IRS. When considering the taxation of crypto points and rewards, keep in mind scenarios that could trigger a tax liability for any points or rewards, including those associated with crypto. As always, state level tax determinations, or those of other countries, may differ from the federal one as well.

Tax Situations to Consider

Some exceptions to this general rule of non-taxation for rewards and points that could trigger tax obligations include:

Compensating with Points: A crypto business or project may decide to compensate or reward people with points for performing some action or service. Depending on the relationship of the person to the business, whether employee, contractor or customer, this can trigger tax consequences to the business, particularly if the points are taxable to the individual.

Sign-Up Bonuses: If a crypto reward or bonus is received without the requirement of an initial expenditure (for example, a sign-up bonus for enrolling in a new wallet that is not contingent on spending crypto or fiat), it may be considered taxable income. The IRS could view these bonuses as an incentive rather than a rebate, making them subject to taxation.

Business versus Personal Rewards: Points or rewards earned through spending crypto can have different tax implications depending on if they are used for personal business purposes. While these rewards might still be considered nontaxable rebates on a personal level, their treatment can change if they provide a discount for business purposes. This reduction in cost can indirectly affect the amount of expense that a business can deduct, thereby influencing taxable income.

Converting Points to Cash: The method of redeeming the crypto points can also impact the taxability of rewards. Converting points or rewards directly into fiat might create a taxable event, especially if the conversion is not linked to a specific purchase or if it's considered outside the realm of typical rebates or discounts.‍

Tax Reporting and Compliance

For crypto projects issuing points or rewards, the key to compliance lies in understanding the nature of the rewards and the context in which they are earned. If rewards or points are earned in a manner that the IRS considers taxable, it is crucial to report these on personal and business tax returns. For instance, if crypto points are used to compensate people for work or performing some action, they may be considered as compensation or miscellaneous income, depending on the specific circumstances.

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