Why the 'Pass-Through' Myth of Some Stablecoins Creates Entity-Level Tax Risk

Protocols treat stablecoin reserves as off-balance-sheet pass-throughs, but tax authorities see a centralized issuer holding $100B+ in assets. This creates a massive, opaque entity with direct tax obligations on interest income and capital gains.

• IRS Notice 2014-21 treats convertible virtual currency as property for tax purposes.
• SEC's Howey Test scrutiny applies to the enterprise, not just the token's function.
• Withholding Tax Risk: Failure to report reserve earnings triggers penalties.

Move from quarterly PDF reports to real-time, cryptographically verifiable attestations of segregated reserves. This transforms liability from a black box into a transparent, auditable structure.

• Chainlink Proof of Reserve: Provides real-time, on-chain verification of collateral.
• Segregated Bankruptcy-Remote Vaults: Isolate user funds from issuer operational risk, following money transmitter trust models.
• Automated Tax Reporting Feeds: Generate immutable logs of income for direct integration with enterprise systems.

PayPal USD (PYUSD) is issued by Paxos, a NYDFS-regulated trust company. It explicitly treats reserves as Paxos's balance-sheet liability, not a pass-through. This establishes a clear regulatory perimeter and tax entity.

• Regulator: Directly supervised by the New York Department of Financial Services (NYDFS).
• Reserves: Held in U.S. Treasury bills and cash deposits, with monthly public attestations.
• Model: Sets a benchmark for entity-first compliance that pure-DeFi stablecoins lack.

$50B+ in stablecoin reserves are parked in short-term Treasuries. Mark-to-market gains on these bonds create taxable income for the issuing entity, not the token holders. Most protocols have no mechanism to track or provision for this liability.

• FASB ASC 320: Requires reporting of unrealized gains/losses on available-for-sale securities.
• Cash Flow Trap: Interest is earned in fiat, but obligations are in crypto, creating a complex forex and timing mismatch.
• Audit Trigger: A 20%+ portfolio gain in a rising rate environment becomes a glaring audit target.

Stablecoin issuers like Tether (USDT) and Circle (USDC) treat user-held tokens as direct claims on reserve assets, avoiding corporate income tax. Regulators now argue the issuing entity controls the reserves, generating taxable income from $150B+ in treasury yields.\n- IRS Notice 2024-27 directly targets this model.\n- Creates a $3B+ annual tax liability for major issuers.\n- Liability is not on the token holder, but on the corporate entity itself.

An entity-level tax bill doesn't just hurt a company's bottom line; it triggers a systemic cascade. To pay a massive, unexpected liability, the entity must liquidate reserve assets, breaking the 1:1 peg guarantee.\n- Forced asset sales create de-pegging pressure (see UST collapse).\n- Loss of user trust triggers bank-run dynamics on-chain.\n- Contagion risk spreads to DeFi protocols with $10B+ in stablecoin TVL like Aave and Compound.

The only defensible models are those where the issuing entity has zero discretionary control over reserve assets or where all activity is transparently on-chain. This shifts the tax event to the token holder.\n- MakerDAO's sDAI: Yield accrues directly to the token via Spark Protocol on-chain.\n- Mountain Protocol's USDM: Uses SEC-regulated money market fund shares as passive, transparent reserves.\n- Frax Finance's sFRAX: Yield is generated and distributed via on-chain AMO strategies.

The IRS and SEC are coordinating to close the stablecoin tax loophole. The era of claiming 'pass-through' status while actively managing a T-Bill portfolio is finished. Future models must be designed for regulatory primitives, not against them.\n- IRS Notice 2024-27 is the opening salvo.\n- SEC may classify yield-bearing stablecoins as securities.\n- Survival requires legally-robust architecture, not just smart contract audits.

Protocols treat stablecoin holdings as cash equivalents, assuming the issuer (e.g., Circle, Tether) bears all tax/regulatory liability. This ignores the entity's direct control and beneficial ownership of the asset on-chain. The IRS sees a digital asset you own, not a pass-through note.

• Key Risk: Unrealized taxable events on treasury holdings.
• Key Risk: Liability for issuer malfeasance (e.g., USDC depeg, regulatory seizure).

Treat the treasury as an active, liability-aware balance sheet. This means moving beyond simple DAI or USDC pools to instrument-level risk assessment and hedging.

• Key Action: Segregate operational cash (short-term, high-quality) from reserve assets.
• Key Action: Implement real-time accounting hooks for MakerDAO's sDAI or Aave's GHO to track accruals.

Protocols like Maple Finance and Goldfinch already treat stablecoin inflows as loanable assets, not cash, with explicit provisioning. Compound Treasury and MakerDAO's RWA modules show the path: direct, auditable legal claims on off-chain assets bypass the pass-through myth entirely.

• Key Benefit: Clear, defensible tax treatment.
• Key Benefit: Regulatory arbitrage via RWAs and licensed entities.

The next primitive is a vault that abstracts tax liability. Think Yearn Finance for compliance: it auto-converts yield into tax-efficient forms (e.g., staked ETH, Lido's stETH) and generates necessary reporting. This requires deep integration with oracles like Chainlink for fair market value and protocols like Sablier for streaming.

• Key Feature: Automated tax lot accounting.
• Key Feature: Yield transformation engine.