Today in Taxes: How NFT Sellers Can Prepare for State Taxes | Miller Nash LLP

Pennsylvania and Washington became the first two states to offer official guidance on how their existing tax regimes apply to nonfungible token (NFT) transactions. Their approaches offer two blueprints for other states to follow. Although states are just beginning to address the taxation of NFTs, sellers may already be subject to the sales tax regimes of various states. NFT sellers should now take the time to manage their potential tax liabilities and establish procedures for gathering information and analyzing liability. NFT sellers may also wish to request opinion letters from informed counsel or binding letter rulings from a state to help determine their tax obligations. Waiting for a sales tax audit may be too late.

The government’s guidance

Pennsylvania and Washington offer different blueprints for taxing NFT transactions. Pennsylvania’s simple guidance states that NFTs are subject to sales tax under the digital services and products category. No further explanations were offered as to how NFTs fit into the regime.

Washington, on the other hand, offered a thorough, but basic, examination of how NFTs interact with the tax system. Unlike Pennsylvania, Washington does not treat all NFTs as digital products. Washington considers the underlying components of the NFT to determine tax liability. If the NFT only provides access to a stand-alone digital product (digital artwork, photograph, video clip, etc.), the NFT will be categorized as a digital product subject to retail sales tax. On the other hand, if the NFT provides access to a stand-alone good or service (for example, access to a concert), the NFT will only be subject to retail sales tax if the good or service represents a retail sale. In addition to the tax liability of NFTs, Washington’s guidance covers other topics such as sale price, record keeping and marketplace facilitators.

Recently, two other jurisdictions joined the fray. Minnesota offered guidance on taxing NFTs in line with Washington’s blueprint. Meanwhile, Puerto Rico followed Pennsylvania’s blueprint by adding NFTs to a list of dutiable goods. More states are expected to offer guidance on the taxation of NFTs.

An important note about these drawings is that they offer interpretations of existing law, not changes to the law. This means that Pennsylvania, Washington, Minnesota or Puerto Rico can use their guidance both retroactively and prospectively. Moreover, it also means that states may not need to provide guidance before claiming tax authority over NFT transactions. About 30 states already impose a sales tax on digital products or electronically delivered software, so these states can claim retroactive taxing authority over NFT transactions.

Addressing State Tax Compliance

Collect customer data

To cope with potential government tax liabilities, NFT sellers should focus on collecting and retaining transaction records. These records will not only help the NFT sellers to determine their tax liabilities but will also serve as evidence in the event of a sales tax audit. Washington’s NFT guidance states that taxpayers are responsible for maintaining the documentation necessary to determine the amount of tax for which the taxpayer is liable. For NFT sellers, this means that they must retain documentation to support the nature, nature, time and place of each sale, consideration received and tax liability for 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 the blockchain. Many buyers embrace the anonymous aspects of the blockchain and may be reluctant to provide their personal information, especially since this information is not usually required to complete blockchain-based transactions. In addition, NFT marketplaces that facilitate payments from anonymous buyers may be reluctant to collect buyer data, especially if their competitors do not collect the data. However, this information is important for NFT sellers because many states tax digital property based on the location or address of the buyer. At the very least, an NFT seller should collect the buyer’s 5-digit postal code. As an NFT seller, be sure to work with marketplaces that collect location data or come up with procedures to collect the necessary data.

Identify state tax liabilities

When completing transactions, NFT sellers must consider their tax obligations for each state, including the obligation to collect and pay sales taxes. An NFT seller cannot have any tax liability in a state unless they create a sufficient connection (or “nexus”) with the state. Generally, a seller does not need to be physically present in a state to have a sales tax. In most states, nexus is established if a seller completes a certain number of transactions with buyers located in the state, or if the seller receives a certain amount of income from sales in the state. Once nexus is established, NFT sellers will be subject to the state’s tax regime and may be required to collect and pay turnover taxes on NFT transactions with buyers in the state. NFT sellers must be aware of each state’s sales tax thresholds and requirements, because sellers typically remain liable for sales taxes regardless of whether the taxes were collected from the buyer.

Take a decision on tax liability

If an NFT seller creates sufficient nexus with a state and is subject to the state’s sales tax regime, it becomes important for the seller to determine how their NFTs should be taxed by the state. Does the state tax all NFTs as digital products like Pennsylvania, or must taxpayers determine the taxability of the underlying components of the NFT as in Washington? So far, the states are evenly divided on this issue. For states that have not decided how to tax NFTs, sellers can request a binding letter from the state’s tax authority. Obtaining a letter ruling is a protection for NFT sellers, especially when there are open issues with the state tax regime, because the state tax authority is required to comply with any letter it issues.

All of this may sound overwhelming to the average NFT trader, but this does not have to be done alone. Sellers can seek help from competent legal counsel who can navigate each state’s tax regime. Legal counsel will not only analyze any applicable tax liabilities arising from a seller’s business, but may track new guidance produced by the states. When there are open questions in a state’s tax regime, legal advisors can provide opinions on what the seller should do or help the seller apply for a binding letter ruling.

Access the latest installment of Today in Tax here: Digital assets in mergers and acquisitions – three things every seller should know.

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