Cryptoasset issues in state and local taxation

Editor: Carolyn Quill, CPA, J.D., LL.M.

Co-editors: Richard Mather, E.A., MSA, CAA; Jonathan McGuire, CPA; and Kathleen Moran, CPA, MBA, MT

Interest surrounding the use of cryptoassets has greatly increased in recent years for several reasons, including its ease of transferability and finite supply. Since bitcoin’s description in a white paper posted on Halloween 2008 and creation the following January, over 20,000 other cryptocurrencies had sprung into existence by July 2022. In the last few years, more institutions and merchants have begun accepting cryptoassets as payment. Additionally, several states have been looking into possibly accepting cryptoassets as payment for taxes due. However, the recent price crash of summer 2022 has caused a few of those states to put these plans on hold for now. (The price of bitcoin fell from $46,296 on April 1, 2022, to $20,298 on Aug. 29, 2022.) With the rise in popularity of these new alternative “currencies,” states are having to address issues concerning cryptoasset transactions across multiple tax types. This item highlights a few issues taxpayers should consider in income taxation, sales taxation, and unclaimed property/escheat reporting.

Income taxation

Character of cryptoassets: For federal income tax purposes, the IRS considers cryptoassets, which it generally refers to as “virtual currency,” to be property, potentially, a capital asset in the hands of the taxpayer. Accordingly, the rate of tax paid on capital gains or the ability to deduct capital losses will be affected by the holding period of the cryptoasset. To date, only a handful of states have either enacted direct legislation or issued direct guidance regarding the income tax treatment of cryptoassets, although most states follow federal treatment by considering cryptoassets to be property instead of currency.

Apportionment considerations: Taxpayers regularly engaged in cryptoasset transactions across state lines should consider how the states apportion sales of these assets. Some states apportion consistent with how they apportion the sales of services, by using either a market-based method (generally meaning sales are apportioned based on where the customer receives the service) or a cost-of-performance method (sales are apportioned based on where most of the costs are incurred to effect the sale). Other states may treat these assets in a comparable manner to how they apportion sales of tangible personal property, assigning those sales to their destination.

Nexus considerations: For states that consider cryptoassets to be intangible assets, the physical presence requirement to establish nexus under the Interstate Income Act of 1959, P.L. 86-272, does not apply. Therefore, it is likely that cryptoasset sales to customers in those states would be considered “doing business” for income tax purposes. Additionally, similar to the economic nexus–type laws developed as a result of South Dakota v. Wayfair, Inc., 138 S. Ct. 2080 (2018), several states have enacted factor-based nexus legislation that establishes nexus for taxpayers that exceed specific dollar thresholds of business activity in terms of sales, property, or payroll in the state.

Sales taxation

Purchase of taxable goods and services: When cryptoassets are used to purchase taxable goods and/or services, a key issue to consider is how the state where the transaction is taxed determines the sales price of the item or service being purchased. Although many states have yet to provide guidance, most that have issued instructions say sales tax should be determined based on the value of the cryptoasset in U.S. dollars at the point the transaction occurs. Thus, sellers that do not immediately convert cryptoassets received into cash will need to maintain accurate records to track historical valuations.

Alternatively, some states could choose instead to define “sales price” as the listed price for the item expressed in U.S. dollars by the seller.

Cryptoassets as investments: Given the virtual nature of cryptoassets, as guidance continues to be released, it is expected that most states will treat the purchase of cryptoassets as the purchase of an intangible asset and thus not subject to sales tax.

Unclaimed property/escheat reporting

Unclaimed property is property held by one party (typically, an insurance company, bank, other financial institution, or company) that is owned by another party, where the property has been dormant, with no activity from the owner for an extended period. Unclaimed property can be either tangible or intangible, although the vast majority of unclaimed property is intangible in nature, such as securities, checking/savings accounts, uncashed checks, security deposits, and similar items. After a specific amount of time has passed with no activity (called a dormancy period), the unclaimed property must be remitted to the state, which will attempt to find the rightful owner (all while earning interest on the property). The dormancy period can vary by state and depend on the type of property.

A number of states are starting to address whether cryptoassets are subject to unclaimed property reporting, either by specifically listing them and providing an applicable dormancy period or including them as part of an otherwise intangible catch-all category. It is notable that some states expressly requiring the escheatment of cryptoassets also require the holder to liquidate the cryptoasset position first before remitting the proceeds to the state (e.g., Illinois and Kentucky). Considering the ultimate goal is to return the property to its rightful owner, these same states have often enacted laws to eliminate any recourse against the holder by the owner for any loss of value after the cryptoasset was liquidated.

Despite recent price volatility, cryptoassets are here to stay. Accordingly, practitioners should continue to monitor emerging guidance in the coming months and years, particularly as it relates to the various tax types covered under the umbrella of state and local taxation.

Editor Notes

Carolyn Quill, CPA, J.D., LL.M., is the lead tax principal at Thompson Greenspon in Fairfax, Va. Richard Mather, E.A., MSA, CAA, is a director at EFPR Group in Rochester, N.Y.; Jonathan McGuire, CPA, is senior tax manager at Aldrich Group in Salem, Ore.; and Kathleen Moran, CPA, MBA, MT, is a director at Pease Bell CPAs in Cleveland. Unless otherwise noted, contributors are members of or associated with CPAmerica Inc. For additional information about these items, contact Carolyn Quill at taxclinic@cpamerica.org.