Colorado Accepts Crypto For Tax Payments – It Could Be A Mess Or A Shining Example

Colorado now accepts crypto for tax payments — but choosing to use that option could change the amount you owe.

Colorado accepts crypto as payment for any taxes owed by the state as of September 1st. It was the result of a promise made earlier this year by Colorado Governor Jared Polis, who has proven his commitment to establishing the state as pro-cryptocurrency.

Colorado is not the only US state trying to encourage cryptocurrency investment within its borders, as lawmakers in Arizona, Wyoming and Utah have all previously introduced bills to accept tax payments in the form of digital currencies to varying degrees.

There is much to be gained economically for states that embrace blockchain technology and the crypto sector. Experienced governments are starting to present their premises as the next center of the crypto economy, hoping to attract new businesses and smart, young, wealthy constituents involved in crypto.

However, taxpayers should be warned about the tax implications of making payments with crypto, as making such a payment is a taxable event that has the potential to further increase the amount of tax payable.

Let’s hope more states follow Colorado’s lead, but they should also learn from where Colorado’s initiative falls short. If states in the future want to succeed in accepting crypto as payment, they must understand the tax dilemma inherent in making payments with crypto and lean towards the solution of accepting stablecoins as a means of payment.

The problem with paying with crypto

The big knock on states accepting taxes paid in crypto is that using crypto to pay state taxes is considered a taxable disposition for individuals – making a payment triggers its own income event.

The IRS treats cryptocurrency as property, meaning that if the price of the crypto you use to pay government taxes has increased in value over time, you have taxable income equal to how much the price appreciated since you bought it.

It is important for people to know that paying off their tax bill with crypto will trigger another taxable event for the following tax year.

For example, let’s say that after calculating your 2022 taxes, you have a $10,000 tax bill for your state of residence. You pay this with $10,000 in Bitcoin (BTC $20,033) by the maturity date of April 15, 2023. If you bought that Bitcoin for $2,000, you have now triggered a gain of $8,000 by disposing of that Bitcoin. You now have to pay taxes on the $8,000 gain for the 2023 tax year – solely from paying your taxes with appreciated crypto.

Most people who are invested enough to want to use crypto as their primary form of payment have probably increased their wealth in crypto. These individuals may be hesitant to use their valued crypto to pay government taxes to avoid the additional tax.

If those who have the option to pay their taxes in crypto are unlikely to do so, states may find that their initiatives never gain the traction they expected. Thus, these programs can end up being more expensive than they are worth.

How states can make it possible to pay taxes in cryptocurrency

Currently, the only way to pay your Colorado taxes in crypto is via PayPal’s “Cryptocurrencies Hub”, which does not include stablecoins as a means of payment. If states decide to accept stablecoins as a means of payment, there is the potential for payments with crypto to succeed across the country.

Cryptocurrency tokens pegged to the price of the US dollar remove tax from the conversation when you use crypto to make payments. Although disposal of these stablecoins must still be reported on the tax return, stablecoins do not fluctuate significantly in value.

Any gain or loss is likely to be zero or only a few dollars at most and will not materially affect how much tax you pay.

Of course, converting any Bitcoin or other cryptocurrency into a stablecoin is a taxable transaction in itself. Nevertheless, it is very likely that as the crypto-ecosystem matures, it will be common for crypto-natives to have a more significant percentage of stablecoins in their overall portfolio.

These crypto-natives are looking to cryptocurrencies and decentralized finance as an alternative to the banking system. It is realistic that in this alternative system people will have a certain amount of liquid assets with which they can pay, including government tax payments.

When stablecoins are used and no tax bill is involved, paying government taxes with cryptocurrency will no longer be discouraged by our tax system and these programs can begin to gain the traction they deserve. Many people may decide that the best way to pay taxes is through crypto.

These states have a lot to gain – if the acceptance of crypto, especially stablecoins, for tax payments is implemented correctly and is successful, the states have an opportunity to grow into centers of crypto trading, while bringing in additional revenues from a growing economic sector.

Will Colorado and other states find success in accepting crypto tax payments? Or will the tax implications and crypto being in the middle of a bear market stop any potential enthusiasm for such government initiatives?

Let’s root for these states and hope they plan to accept stablecoins. Blockchain technology has the potential to play a significant role in how our governments operate in the future. Before our local governments can secure our elections through blockchain, they must first dip their toes in the water and successfully accept tax payments in crypto.