If a U.S person is involved with virtual currency—whether as an investor, a miner or as a merchant accepting cryptocurrency as payment—it is likely to face tax issues. On the federal income tax front, many questions may come up: Does a crypto transaction trigger ordinary income or a capital gain/loss? Is the taxpayer tracking his/her cost basis to properly manage gains/losses? Is there a gift tax issue, such as with an airdrop?
The Internal Revenue Service (IRS) has a keen interest on cryptocurrency developments. For example, the 2021 federal income tax form for individuals now asks: “At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?”
In addition to the federal tax issues mentioned above, do crypto transactions raise state sales taxes issues? The short answer is yes. Navigating the intricacies of federal taxes can be challenging, but it involves just one taxing body. Conversely, In the world of sales/use taxes, the laws may differ from state to state, and may sometimes vary at the local level within a state.
Would a federal income tax practitioner be able to provide advice on the ins and outs of sales tax issues and crypto transactions? Maybe not. The sales and use tax laws are a completely separate field of taxation. Following are some common sales tax issues that may arise with virtual currency transactions.
Assume you want to make a purchase using virtual currency. How much would you owe in sales tax? Specifically, would sales tax be imposed on the value of the item purchased or, instead, on the value of the virtual currency on the date of purchase? In the world of sales tax, it depends.
In various states, including New Jersey and New York, when a retailer makes a taxable sale and receives virtual currency as payment, the sales tax measure is based on the fair market value of the virtual currency in U.S. dollars as of the date of payment. The seller needs to maintain records of the value of such virtual currency accepted at the time of each transaction, converted into U.S. dollars. When selling cups of coffee to a winding line of customers, fluctuating crypto prices may not have a material impact on the sales tax due. But in a car sale transaction, the answer may be different.
In contrast, the Washington Department of Revenue has advised that, for example, if you sell an item with an advertised price of $50, the measure of the sales tax remains $50, even if the customer pays in Bitcoin. Washington has stated that the measure of the tax is not affected by the virtual currency fluctuations before the business redeems it. As for recordkeeping, Washington stated, “if you accept virtual currency as payment, you need to keep records that show what the seller would accept in dollar amounts.”
Let’s assume that, unlike in the examples above, you want to purchase an intangible—an NFT, such as digital art or a video clip—that is recorded on the blockchain, a digital ledger that provides proof of ownership of assets. In general, states impose sales tax on the retail sale of tangible personal property and enumerated services. Both the NFT and virtual currency are intangibles. Would any sales tax be due? Yes! Around 30 states extend their sales/use tax to cover digital goods or products, which can include digital audio-visual works (like a movie), digital audio works (music) and digital visual works (such as a book or artwork). So the transaction may be subject to sales/use taxes. And the same issue arises as in the examples above: Is the tax measure the NFT’s list price or the value of the virtual currency at the time of the transaction?
One practical issue, if you are making payment with a virtual currency on an online transaction, is whether the seller will know to which state to source the transaction. If you were making payment with a credit card, you would provide the seller with your ZIP code, which would be used for sales tax sourcing purposes. But when making payment via virtual currency, customers might wish to maintain their anonymity, including by not sharing any address. States may maintain that, absent collecting a customer address, the sale should be sourced to the state of origination. However, commencing with certain transactions in 2023, it would be prudent for NFT sellers to collect the customer’s name, address, phone number and other information, because IRS Form 1099 reporting may apply to those transactions. That information would also be critical for properly sourcing sales for sales tax purposes.
Could sales tax be imposed on the purchase or sale of virtual currency, or perhaps the transfer of Bitcoins through an ATM? In general, states impose sales and use taxes on the retail sale of tangible personal property and enumerated services. Insofar as cryptocurrency is “virtual” (not tangible), there should not be any sales tax imposed on the transaction solely because the purchase, sale or barter is effectuated via cryptocurrency, rather than with U.S. currency, right? The Missouri Department of Revenue reached that conclusion in a letter ruling, reasoning that Bitcoins are intangible property. However, care should be exercised because the laws differ from state to state (e.g., Hawaii extends its use tax to the value of intangible property acquired from an unlicensed seller and imported or used in the state).
Cryptocurrency generally serves as a medium of exchange that is built on blockchain and is decentralized, not reliant on a central issuing authority but, instead, reliant on code to manage issuance and transactions. The process of confirming transactions on the cryptocurrency’s network, which makes them trustworthy, is referred to as the mining process. That process involves using computing systems with specialized chips to solve mathematical puzzles, and it uses a tremendous amount of computing power and electricity. In the U.S., Texas currently has the most cryptocurrency miners. What draws miners to Texas? Texas does not regulate cryptocurrency mining, it has low energy costs and it offers sales tax incentives.
Other states want a piece of the action, and they are offering tax benefits to attract businesses that operate data centres used for crypto-asset mining. Some states, including Michigan, Ohio and Wyoming, offer sales tax incentives for data centre equipment purchases. Others exempt from sales tax the electricity used or consumed in the commercial mining of cryptocurrency.
Angela Acosta
aacosta@bdo.com
Eric Fader
efader@bdo.com