Last Thursday at Insider Sources, instead of talking to a business management firm we decided to submit to the inevitable and have a round table discussion on NFTs — how they are taxed, how they are created, and what legal pitfalls to beware of.
NFT Deep Dive: the tax, the law, and the financials
While we had great contributors (Jake Burack from SME and Shekinah Apedo from the famous RTFKT Studios), our main speakers were JTM Tech Law Managing Attorney Jacob T. Martin, VP of ODI Financial Julian Schubach, and Tax CPA Alex Roytenberg.
Martin and Schubach wrote a great guide on taxing crypto and NFTs, in which they detail the potential conflicts artists will inevitably run into with regards to NFT revenue. The two look into how wallets — in regards to artist collabs — work in cryptocurrency, and how each contributor to the NFT gets paid.
Steven Hamilton, SVP of Banc of California asked the panel: what are the basics needed for an artist to create an NFT? For Insider Sources, Martin, Rottenberg, and Schubach brought their expertise together to offer insight on the three essential problems business managers are running into with NFT creation and trading:
- How is the revenue taxed?
- How is the money made?
- And of course, how is ownership determined?
How is the income taxed?
Roytenberg joined us a few sessions ago with Sally Velazquez, in which he stated that taxation largely depends on the source of the collectible. Often he finds that clients attempting to make NFTs reach out to their CPAs at the very end of the process.
“In reality, we are probably the first two people that need to be called: the accountant and the attorney, in the sense of hey, how do we set up NFTs correctly from day one, so things are done appropriately,” Roytenberg said. “The moving parts are: what are you trying to put into an NFT, and what is it you are doing with an NFT.”
For example, assigning NFT income into a taxable category can be tricky. Sometimes, when it comes to music clients, the NFT is not taxed as a collectible or an investment: since they are selling their own music, it is taxed as ordinary income.
However, there are also instances in which NFTs are taxed as collectibles: i.e. NBA Top Shots. Then there are individuals who take the crypto value behind the NFT itself, and either try to continuously flip the NFTs themselves and create wealth in the form of cryptocurrency.
Considering how new the NFT business is, many go into it thinking the business is largely unregulated. To some extent, they are right — the IRS and other governing bodies are having a hard time figuring out what to do with this convention-defying revenue stream. But Roytenberg said that the IRS is catching up.
How is revenue generated?
Schubach, who is a financial advisor and Head of the Entertainment Division at ODI Financial, agrees with Roytenberg: when you are new in the NFT space, the two most important people in any NFT dealing would be the attorney and the accountant.
“You’re going to want to talk creating an entity; a business entity between collaborators, or even, even if you’re doing something on your own,” Schubach said. “The CPA is going to understand what the actual implications are, whether you are selling an NFT in a primary or secondary market.”
Most of the clients Schubach works with use crypto only as a way to supplement their traditional income — because clients don’t have 99% of their net worth in cryptocurrency, he generally advises artists not to transition back into US dollars to invest, as this transition would trigger a taxable event.
Instead, Schubach advises to set aside at least a third of crypto revenue for taxes. By estimating, Schubach states that you leave somewhat of a safety net: it is better to be a little over, rather than not saving enough for taxes and having trouble paying the IRS what they’re due.
How is ownership determined?
Martin has been working with the blockchain in various ways for the past five years. Over the last year or so he has been working with startups and entrepreneurs on several blockchain projects — most notably now NFTs.
For artists considering creating an NFT, Martin states that the best way to educate yourself is to talk to other artists and get connected on the right platform.
“We’ve had $2 billion worth of NFT transactions this year, yet I would say at least half of the artists that have released an NFT did so as a collaboration, and had no attorneys or entities,” Martin said. “There is going to be a real struggle when it comes to the IRS and what they owe for taxes.”
Martin believes it can be difficult to bring attorneys in early because of how disruptive NFTs are — the market seems to change almost daily, with very little insight from regulators.
Apedo, who works as a legal attorney at RTFKT studios, states that she often runs into the same problem: because it is such a new space, it can be difficult to determine who has control — the platform or the creator.
When it comes to educating new clients with NFTs, Apedo states that the easiest thing for clients to do on their own is to get copyright.
“I worked at a law firm to figure out how to create ICOs, because I knew we needed to learn cryptocurrency litigation because of how grey it was. We knew litigation was coming, and I built a company based on the underlying blockchain technology,” Martin said. “There are a lot of people who are self-proclaimed experts, who may give poor information, so you have to be careful to figure out who is for real and who isn’t.
For more reading about NFTs please see the piece written here by Jacob Martin and Julian Schubach, and our NFT Guide here.