The implementation of digital assets recorded on the blockchain has grown exponentially in the past decade. Individuals and businesses are using digital assets such as cryptocurrency to buy goods and services. Non-fungible tokens (NFTs)—unique digital assets representing a contract right for purposes such as art, admissions and documentation, among others—are being sold, traded or used for numerous other purposes. Much like traditional digital goods and services, the states continue to lag behind the pace of digital asset growth in providing guidance on taxability for all state and local tax types. 

Both states and revenue authorities have recently taken action on the taxation of digital assets just as most state legislative sessions come to an end. A high-level summary of a few of these developments follows below.

Arizona addresses airdrops and gas fees

On July 6, 2022, Arizona Gov. Doug Ducey signed House Bill 2204, excluding certain digital asset transfer transactions from the state income tax to the extent they are not already excluded under the Internal Revenue Code. The bill provides that the value of virtual currency and NFTs received by taxpayers pursuant to an airdrop is not taxed at the time of the airdrop. “Airdrops” are defined as the receipt of virtual currency through a means of distribution to the blockchain addresses of multiple taxpayers. The airdrop exclusion does not apply to any appreciation in value of the digital asset occurring after the initial receipt from the airdrop. House Bill 2204 also provides a subtraction for gas fees not included in a taxpayer’s virtual currency or NFT basis. “Gas fees” are fees paid to the operator of a virtual network for the use of the network to facilitate the purchase, sale or exchange of virtual currency or an NFT. The new provisions are effective beginning Jan. 1, 2023. 

NFTs subject to sales tax in Pennsylvania

In Pennsylvania, NFTs were recently listed as taxable for sales and use tax purposes in the commonwealth’s Retailer’s Information guidance, REV-717, which discusses the application of sales and use tax to a variety of common items across a number of categories. The May 2022 update did not include any explanation or reasoning behind the revision. It has also been reported that the enforcement of the tax on NFTs could potentially be retroactive to 2016 when the commonwealth expanded the sales tax to include digital goods and products.

New Jersey looks to form cryptocurrency work group

Comments made by a spokesperson for the New Jersey Division of Taxation during the annual Federation of Tax Administrators meeting in late June suggest that a cryptocurrency or digital asset work group may be formed as early as July. The work group could be used to identify transactions using cryptocurrency for sales tax purposes, as well as other related developments. New Jersey previously issued guidance on virtual currency through TAM-2015-1(R) on March 21, 2022. 

New York final draft guidance explains sourcing cryptocurrency gains and losses

On July 1, 2022, the New York Department of Taxation and Finance posted final draft guidance clarifying that cryptocurrency and other similar assets digitally delivered are included in the definition of digital products for state franchise tax purposes under Article 9-A. The explicit inclusion of cryptocurrency should provide taxpayers additional certainty for apportionment and sourcing purposes. Comments from the public on the final draft guidance are due by Aug. 26, 2022. 

Washington state releases comprehensive NFT taxation guidance

On July 1, 2022, Washington state issued a guidance statement on the taxability of NFTs. The statement provides the most comprehensive explanation from a state revenue authority on NFT taxation to date, including a background on NFTs, definitions, price determination guidance, record retention guidance, a discussion of mixed transactions, gross income sourcing and apportionment guidance and several examples. Specifically, the department identifies four basic NFT transactions:

• The purchase is a standalone digital product, the NFT itself, such as artwork, video or autographs. The statement explains that digital products are subject to sales tax, and the retailer is subject to the retailing business and occupation (B&O) tax.
• The purchase is a standalone good or service, other than a digital product and the NFT itself, classified as a retail sale under the state tax code. The statement explains that sales of goods or services defined under the state tax code are subject are subject to retail sales tax, and the seller is subject to the retailing B&O tax.
• The purchase is a standalone good or service not classified as a retail sale under the state tax code. The statement explains that sales of undefined goods or services are not subject to retail sales tax, but the seller may be subject to B&O tax.
• The sale of an NFT includes royalty payments to the NFT creator or other party who retains royalty rights. The statement explains that gross income from royalties is subject to the royalties B&O tax.

The statement also explains that more permanent guidance is anticipated. 

Takeaways

Most states have provided little, if any, guidance on the taxability of digital asset transactions, such as cryptocurrency or NFTs. With both Pennsylvania and Washington taking affirmative actions on NFTs, it is likely more states will begin addressing digital assets, especially following Washington’s comprehensive NFT analysis. 

Taxpayers selling, purchasing or otherwise implementing digital assets continue to struggle with comporting blockchain technology with existing state and local tax codes. Taxpayers should not assume digital assets are treated in the same manner as other digital goods and products like traditional software, digital music or streaming movies. However, many of the same state tax concerns exist for digital assets, including whether nexus has been established, how the asset is characterized for sales tax or income tax purposes and how the sale or income should be sourced. The increased prevalence and ubiquity of digital assets in everyday commerce may encourage states to act quickly and provide certainty for taxpayers. Ultimately, taxpayers should carefully consider the state and local tax consequences of digital assets. For more information specifically on indirect taxation of NFTs, please read RSM’s article, What you should know about indirect taxation of NFTs. For more information on digital assets generally, please see RSM’s Blockchain and digital asset consulting services.