Pennsylvania and Washington became the first two states to provide official guidance on how existing tax regimes apply to non-fungible token (NFT) trading. Their approach provides two blueprints for other states to follow. States are just beginning to address the taxation of NFTs, but sellers may already be subject to various state sales tax regimes. Time should be taken now to set procedures for gathering and analyzing responsibilities. NFT sellers may also seek an informed legal opinion or a binding ruling from the state to help determine their tax liability. Even if you wait until the consumption tax investigation, it may be too late.
Pennsylvania and Washington offer different blueprints for taxing NFT transactions. Simple Pennsylvania guidance indicates that NFTs are subject to sales tax in the Digital Services and Products category. No further explanation was provided as to how the NFT would fit within the regime.
Washington, on the other hand, has provided a thorough but rudimentary study of how NFTs interact with the tax system.Unlike Pennsylvania, Washington treats all NFTs as digital products. not. Washington considers the underlying components of an NFT to determine taxability. If the NFT only allows access to a standalone digital product (e.g., digital artwork, photos, video clips, etc.), the NFT is classified as a digital product subject to retail sales tax. On the other hand, if the NFT allows access to a stand-alone product or service (for example, access to a concert), the NFT is subject to retail sales tax only if that product or service represents a retail sale. In addition to NFT taxability, Washington’s guidance also covers other topics such as selling prices, record keeping, and market facilitators.
Two other jurisdictions have recently joined the fray. Minnesota provided guidance on taxing NFTs in line with Washington’s blueprint. Meanwhile, Puerto Rico has added NFTs to its taxable list, following Pennsylvania’s blueprint. More states are expected to provide guidance on taxing NFTs.
An important note about these blueprints is that they provide an interpretation of existing law, not a change in law. This means Pennsylvania, Washington, Minnesota, or Puerto Rico can apply the guidance both retrospectively and prospectively. Additionally, this also means that states may not need to issue guidance before claiming tax authority over NFT transactions. About 30 states already impose sales tax on digital goods or electronically delivered software, so those states could claim retroactive tax authority over her NFT transactions.
Addressing state tax compliance
Collecting customer data
To address potential state tax liabilities, NFT sellers should focus on collecting and maintaining transaction records. These records not only help NFT sellers determine their tax liability, but also serve as evidence during sales tax audits. His NFT Guidance in Washington says taxpayers are responsible for retaining the documents necessary to determine the amount of tax they owe. This means that NFT sellers must maintain documentation proving the nature, nature, time and place of each sale, the consideration received, and the taxability of each transaction.
Collecting buyer information, especially location data, is an important aspect that NFT sellers should not overlook. However, this information may prove difficult to collect due to the anonymous or pseudo-anonymous nature of blockchain. Many buyers are embracing the anonymity of blockchain and may be reluctant to provide personal information. Especially since this information is typically not required to complete a blockchain-based transaction. Additionally, NFT marketplaces that facilitate payments from anonymous buyers may be reluctant to collect buyer data, especially if their competitors do not. However, many states tax digital assets based on the buyer’s location or address, so this information is important to his NFT seller. At a minimum, the NFT seller must collect the buyer’s 5-digit zip code. As an NFT seller, work with marketplaces that collect location data, or come up with steps to collect the necessary data.
Identify State Tax Obligations
Once an NFT seller completes a transaction, the seller must assess each state’s tax obligations, including any sales tax collection and remittance obligations. NFT sellers may not have in-state tax liability unless they create sufficient ties (or “nexus”) with the state. In general, sellers do not need to be physically present in the state to obtain sales tax nexus. In most states, a nexus is created when a seller completes a certain number of transactions with buyers in that state, or when a seller earns a certain amount of income from sales in that state. Once the nexus is established, the NFT seller is subject to state taxation and may be required to collect and remit sales tax on her NFT transactions with buyers located in the state. NFT sellers should generally be aware of each state’s nexus threshold and sales tax requirements, as the seller remains responsible for sales tax regardless of whether or not they have collected tax from the buyer.
take a taxable position
If the NFT seller develops sufficient relationships with the state to be subject to the state sales tax system, it will be important for the seller to determine how the NFT will be taxed by the state. Will the state, like Pennsylvania, tax all her NFTs as digital goods, or will taxpayers, like Washington state, have to determine the taxability of the underlying components of her NFTs? By the way, the states are evenly divided on this issue. For states that have not yet determined how to tax NFTs, sellers can request a binding ruling from their state tax authorities. State tax authorities must comply with the rulings they issue, so obtaining a ruling protects her NFT sellers, especially if there are outstanding issues with the state’s tax system.
All of this may sound overwhelming to the average NFT seller, but you don’t have to do this alone. Sellers can seek the help of a competent attorney who can navigate each state’s tax system. Legal advisors can not only analyze the current tax liability arising from the seller’s operations, but also track any new guidance created by the state. If there are unresolved issues with the state tax system, an attorney can provide an opinion on what the seller should do or help the seller file a binding letter ruling.
You can access the final installment of Today in Tax here. Digital assets in M&A — 3 things every seller should know.