Blockchain and cryptocurrency technologies offer platforms for investing and conducting transactions such as mobile payments and transfers that bring reporting requirements and regulatory restrictions. If you are an investor or business already using crypto or digital currencies, Susan can advise on reporting requirements and help you with achieving compliance.
For example, the CFTC, IRS, FinCEN, and SEC are agencies that have scrutinized virtual currencies in recent years. Susan can help you with the analysis of the reporting requirements and understand what is applicable to your use of cryptocurrencies for investment purposes or using and engaging in crypto transactions and businesses. Should you already have received an audit letter or notice from the IRS, U.S. Department of Treasury or FinCEN inquiry, Susan can help you prepare an appropriate response.
Data Privacy and applicable laws also impose certain responsibilities on blockchain and crypto businesses that conduct mobile payments and transactions. Blockchain and cryptocurrency technologies lend themselves to better data privacy protections because of the transparent nature to transactions; however, for financial transactions, especially mobile payments and transfers, there continue to be responsibilities and reporting obligations under various consumer privacy and financial regulations governing operations. Susan can help you can understand your obligations, and achieve compliance in these areas. Should you already have received an inquiry from a regulator, Susan can help respond and/or diffuse further enforcement action.
If you're starting a blockchain or crypto business, Susan can advise on the agencies and extent of the laws and regulations that apply to OSS, SaaS and FinTech products and services. Some of the questions for you to consider when forming a business are listed below. Remember, it is always wise to consult with counsel before formation and operation of a business to maximize legal protections and minimize financial risks. Susan would be happy to visit with you about your goals and legal and compliance needs for your blockchain, crypto, digital, mobile payments, or FinTech innovations.
A startup business is usually organized as a corporation or a limited liability company ("LLC"). The primary differences between a corporation and an LLC are as follows:
|Documents||Certificate of Incorporation and Bylaws.||Articles of Organization and Operating Agreement.|
|Ownership||Stockholders own shares of stock.||Members own units of membership interest.|
|Management||Stockholders annually elect one or more directors. Directors (i) appoint officers of the corporation to manage the corporation and (ii) review and approve the actions of the officers.||Members may (but are not required to) elect one or more managers of the LLC. Members may either (i) directly manage the LLC, (ii) elect one or more managers to manage the LLC, or (iii) elect a Board of Managers that appoints one or more officers to manage the LLC.|
|Available Tax Treatment||C Corporation or S Corporation.||Disregarded Entity (for single member LLC), Partnership (for multiple member LLC), C Corporation or S Corporation.|
|Advantages||Investors usually prefer investing in shares of stock of a corporation, instead of investing in units of membership interest in an LLC. A corporation that chooses to be taxed as a C Corporation can issue preferred stock, convertible notes (convertible into preferred stock), simple agreements for future equity ("SAFE"), and keep it simple securities ("KISS"), which are the types of investments that are usually preferred by angel investors and venture capital firms.||Permits a business to have the benefits of pass-through partnership taxation without the stockholder restrictions of Subchapter S corporations. Permits owner-operators to manage a small business without the need to designate directors and officers. The flexibility in both tax treatment and formality of corporate governance makes an LLC a particularly good choice for family-owned businesses.|
The choice of income tax treatment is an important one. It should be carefully considered at the time of the organization of the startup. In general, the different federal income tax treatments available to businesses are as follows:
|Disregarded Entity||Pass-through tax treatment for a single member of LLC. This offers the advantages of not requiring the additional cost of preparing an annual IRS Form 1065 information return for the LLC.||A popular tax treatment for a single owner to operate a small businesse or manage a real estate investment property.|
|Partnership||Pass-through tax treatment for a multiple member LLC. Requires the annual preparation of an IRS Form 1065 informational tax return and Form K-1 to each member.||Has the advantage of permitting pass-through tax treatment, without having the ownership restrictions of a Subchapter S corporation.|
|S Corp||Pass-through tax treatment that is available for both corporations and LLCs. An entity with S corporation tax treatment is prohibited from having (i) more than 100 owners, (ii) more than one class of stock and (iii) owners who are nonresident aliens. In addition, the owners of an S corporation entity are generally limited to individuals, estates, certain types of trusts, and certain types of charitable organizations. Requires the filing by a corporation or LLC of an IRS Form 2553 to make the Subchapter S election. Requires the annual preparation of an IRS Form 1120S informational tax return and Form K-1 to each member or stockholder.||An LLC or corporation that has elected to be taxed as an S corporation is a popular structure for businesses that have a steady income of at least $50,000 a year and are owned by a small number of individual investors (and no entity investors). This tax election usually reduces the amount of social security taxes and medicare taxes paid by owner-employees, because distributions in excess of reasonable salary are not subject to payroll or self-employment taxes.|
|C Corp||This tax treatment results in corporate income tax being paid by the corporation or LLC (if the LLC elects to be taxed as a C corporation). Permits a corporation or LLC to grow without having to make distributions to its owners, as the owners are not subject to income tax on any undistributed income. An LLC electing C Corporation tax treatment must file an IRS Form 8832. Requires the annual preparation of an IRS Form 1120 tax return and Form 1099-DIV to each member or stockholder.||A Delaware corporation with C Corporation tax treatment is commonly used by (i) startup companies that require significant amounts of investment from venture capital firms to scale and (ii) publicly traded companies.|
A summary of the 2019 and 2020 federal income tax brackets, deductions and credits for businesses is here: PDF.
In addition to choosing federal income tax treatment, you will need to set up professional accounting and payroll software for your business. You will need to (i) track the income and revenue for federal, state and local tax purposes, (ii) have payroll tax payments automatically withheld from payroll, and (iii) ensure overall tax compliance. If your business sells products or has offices in multiple states, your business will likely be subject to complex multi-state income tax return filing requirements.
Determining whether a worker should be properly classified as an independent contractor or an employee is important for federal income tax purposes. How a worker is classified affects both the worker and business in terms of who handles the payment and withholding of federal income tax, social security and medicare taxes. A company will issue a Form W-2 to each of its employees and issue a Form 1099 to each of its independent contractors. In the event that the IRS reclassifies an independent contractor as an employee, the IRS can assess the company for unpaid payroll taxes, interest and tax penalties. The IRS has strict requirements as to when a worker can be deemed an independent contractor, instead of any employee. The IRS analyzes the behavioral control, financial control, and type of relationship between the company and the independent contractor. See IRS Publication 15-A. In addition, employees of enterprises having workers engaged in interstate commerce, producing goods for interstate commerce, or handling, selling, or otherwise working on goods or materials that have been moved in or produced for such commerce by any person, are subject to the wage and overtime requirements of the federal Fair Labor Standards Act.
The founders of a startup should consider whether it would be beneficial to the company to utilize software services to streamline the company's accounting, payroll and human resources functions. Examples of providers of such software services include (i) ADP, Gusto, Insperity and Trinet (for payroll and human resources management), (ii) Freshbooks and Quickbooks (for accounting), and (iii) Carta, Certent and KoreConx (for cap table and equity plan management).
It is important to protect a startup's intellectual property rights. For tech companies, it is customary for (i) the founders to assign their intellectual property rights to the company as part of their Founders Stock Purchase Agreements, (ii) the company's employees to sign a Confidential Information and Inventions Assignment Agreement, and (iii) the company's independent contractors who assist in product development to assign or license all pertinent intellectual property as part of their contracts. At the time of a startup's founding, it is important to review the intellectual property of the company, and confirm whether federal copyright, trademark or patent registrations need to be made. In addition, prior to non-public records of the company being reviewed by potential investors, independent contractors and acquirers, Non-Disclosure Agreements should be signed.
The proposed terms of seed capital investment by outside investors will need to be carefully reviewed and negotiated. Certain provisions of convertible notes, seed series preferred stock, SAFE instruments, and KISS instruments can result in the significant dilution of ownership of the founders. The dilution would usually be triggered in the event of the issuance of a Series A Round of preferred stock or the sale of the business. It is important that the founders understand the effect of the provisions governing valuation caps, discount rates, liquidation preferences, pro rata rights, and note defaults.
The issuance of securities is subject to complex federal and state securities laws. A summary of the legal issues for private securities offerings is on the securities page of our website. There are certain online platforms available, such as SeedInvest and StartEngine, which permit a startup to offer its securities to the public under the SEC Rule 506(c) and CrowdFunding securities offering exemptions.
It is customary for startups that require significant outside investment and employees to provide equity incentives. For startups funded by venture capital firms, it is customary for (i) the founders to receive restricted stock and (ii) employees to receive incentive stock options. The most frequently utilized types of equity incentives are as follows:
|Equity Incentive||Description||Tax Treatment|
|Restricted Stock||Restricted Stock is stock that is subject to vesting restrictions (with vesting customarily occuring over a four year period of time). Restricted stock is frequently issued to employees who are the founders of the company. The holder of restricted stock cannot sell their shares until the shares vest. Additionally, a company can retain the right to repurchase shares upon the termination of the holder’s employment.||Restricted Stock is taxed at vesting, unless the employee makes a Section 83(b) election to be taxed on the date the shares are granted.|
|Restricted Stock Units||Restricted Stock Units ("RSUs") are an unsecured promise by a company to give the value of a specific number of the company’s shares in the future to an employee or consultant, based upon completion of a vesting schedule. Settlement of RSUs can occur in stock or the equivalent cash value.||RSUs are taxed as ordinary income at vesting.|
|Stock Options||Stock Options represent the right to buy a company’s stock at some future date at a set exercise price.||Nonqualified Stock Options require that the employee pay taxes on the spread on exercise of the option, even if the shares are not sold. Incentive Stock Options offer tax deferral to the employee until the date of the sale of shares of stock, but are subject to more regulatory requirements and restrictions.|
In the event that you decide to close the startup company, you will need to file certain federal and state business termination documents. From a federal income tax standpoint, you will need to file a final federal income tax return and cancel your company's employer ID number. The IRS website on federal income tax responsibilities for closing a business is here. In addition, you will need to file termination documents with applicable state government authorities.
This website provides general information about legal issues and developments in the law. Such materials are for informational purposes only and may not reflect the most current legal developments. These informational materials are not intended, and must not be taken, as legal advice on any particular set of facts or circumstances. You need to retain an attorney for advice on specific legal issues.