Digital-asset-based loyalty and reward programs allow companies to create a tailored customer experience across multiple brands without introducing the tax uncertainty that exists elsewhere in the digital asset and blockchain ecosystem. Digital assets, such as cryptocurrency and non-fungible tokens (NFTs), are treated by the Internal Revenue Service as personal property. While digital assets may have a relatively short history, their taxation follows well-established property taxation principles. For example, when someone purchases goods or services with cryptocurrency, property law treats that as a “barter exchange,” as if the cryptocurrency were sold for cash and then that cash was then used to purchase goods or services. This effectively requires taxpayers to account for and report two transactions for a single purchase. The technology around digital assets has spawned many new tax questions. One unanswered question is whether “wrapping” a token to enable it to migrate from one chain to another is a taxable event. Most practitioners agree that wrapping a token is not a taxable event. While the IRS has not explicitly clarified the income tax treatment of wrapping and unwrapping transactions, the agency is not requiring that this transaction be reported. Notice 2024-57, released on June 27, 2024, states that brokers are not required to file information returns or furnish payee statements for the following transactions: wrapping and unwrapping transactions, liquidity provider transactions, staking transactions, transactions described by digital asset market participants as lending of digital assets, transactions described by digital asset market participants as short sales of digital assets, and notional principal contract transactions. This article aims to clarify how companies can get involved in digital assets while steering clear of activities without established IRS guidelines.
Although loyalty and reward programs may seem to differ from digital assets, they actually have an established body of tax guidance that can be applied to digital assets. In retail transactions, a rebate in the form of a coupon is treated as a reduction in the purchase price at the time of sale. Rebates to customers that are treated as purchase price adjustments are not subject to IRS information reporting rules, which generally govern payments to an individual of $600 or more. In these cases, payers must file information returns with the IRS and furnish statements to the person paid. Accordingly, payers of rebates below $600 need not file information returns with the IRS or furnish statements to purchasers, although prizes and rebates exceeding the $600 threshold must be reported to both the IRS and the purchaser. One way to transfer loyalty programs from traditional paper coupons into rewards in the digital world is through nonfungible tokens, or NFTs. An NFT is a unique digital asset stored on a blockchain. A blockchain is a decentralized ledger that records transactions across a network of computers and ensures transparency, security, and authenticity—and thus legitimate ownership of the NFT. With NFTs, counterfeit coupons or fake rewards are a thing of the past. Even NFTs that seem similar due to being digitally imprinted with a common image or logo are coded with a unique string of data that acts as a fingerprint to ensure the individual NFT’s authenticity. The security framework of a distributed ledger makes NFTs ideal for offering customers tokens that can be redeemed for products, services, and special offers.
Numerous open-source platforms exist that companies can use to explore and test NFT technology to use in their own operations with minimal overhead. When launching a new rewards or loyalty program, one crucial factor to consider is which blockchain to use. The choice of blockchain can significantly affect cost. For example, launching an NFT program on Ethereum can be more expensive due to higher gas fees, which are transaction costs users pay to transact on a blockchain. In contrast, using a Layer 2 scaling solution like Base or Polygon can be more cost-effective. These open-source tools may be lower-cost alternative blockchains for experimenting with small-scale projects. For large-scale NFT programs, companies can consider hiring developers or engaging a boutique firm to customize their specific loyalty program. The digital asset space has seen several narratives explode in popularity, and a well-designed digital asset rewards program could easily give a product or service exponential exposure at minimal cost.
Starbucks was one of the first major companies to integrate NFTs into its loyalty program. In 2022 the company introduced the Starbucks Odyssey Experience, a Web3-based customer loyalty reward program, as an extension of an existing loyalty program. This program allowed customers to earn and purchase NFTs (“collectible stamps,” in Starbucks lingo) that unlocked new and immersive coffee-related experiences. Members participated in interactive activities and challenges called “journeys” to accumulate stamps. The stamps held point values based on the rarity of the image or logo on them and the level of the journey the customer had completed. For example, a stamp earned for reaching level 4 in the loyalty program earned customers more points than a stamp earned for reaching level 1. With accumulated points, customers could redeem the stamps for benefits such as virtual classes and in-store merchandise. Individuals reaching the highest levels of Starbucks Odyssey won trips to a Starbucks coffee farm. Although the Starbucks Odyssey beta program ended on March 31, it remains a valuable case study in differentiating loyalty programs that create a digital community that fosters engagement among its members and the company.
The integration of NFTs into a loyalty program goes beyond traditional rewards; it gamifies the experience. This experience taps into the inherent desire for achievement and competition, encouraging members to check their accounts more frequently, engage in virtual activities, and track their progress. Unlike standard coupon programs, digital assets can add an element of fun and exclusivity. Customers are not just collecting points; they are embarking on a virtual journey where each NFT has a unique value and meaning. Furthermore, the social aspect of such a program allows members to share their achievements, trade NFTs, and participate in events, enhancing their sense of belonging.
Since a blockchain secured ownership and authenticity of each NFT, customers could trade the stamps in secondary marketplaces. Starbucks did not operate its own marketplace, thus avoiding the information-reporting obligations associated with being a broker or operating a barter exchange. Last year, the IRS released proposed regulations that expanded the definition of a broker and imposed reporting requirements for individuals who assisted in the sale of digital assets. With final regulations now released, the IRS has confirmed that they do not apply to merchants who redeemed NFTs issued as coupons in exchange for nondigital goods or services, provided that the digital asset is not capable of being transferred, exchanged, or otherwise used outside the cryptographically secured distributed ledger network of the loyalty program.
One additional aspect of its loyalty program allowed Starbucks customers to buy NFTs directly from the company for “fiat” currency, rather than earning them by completing Odyssey “journeys.” These sales would create taxable events no different from sales of any other tangible products. Besides the income tax considerations due the sale of NFTs, the company could also be potentially subject to sales and use tax or value-added tax (VAT) reporting when it sold the NFTs for fiat currency directly to customers. If Starbucks had limited the Odyssey program to NFTs earned through Odyssey journeys, there would have been no further taxation or reporting issues. However, by allowing the direct sale of NFTs for fiat, Starbucks triggered actual taxation obligations. This illustrates that blockchain loyalty and reward initiatives provide the opportunity to avoid taxable impacts.
Engaging with digital assets may involve tax complexities that can be overcome with appropriate planning. Loyalty and reward programs in the blockchain ecosystem present a new opportunity for companies to develop, test, and experiment with this new technology, while enriching their customer community and building brand awareness without significant risk. By leveraging NFTs and blockchain technology, companies can create innovative and engaging customer experiences while complying with established tax guidelines.
Michael Graber is a partner, John Cardone is senior director, Washington national tax, and Bassel Elbetanony and Nick Juffer are senior blockchain associates, all with RSM US.
