How do online retailers handle sales tax with NFT sales?

In July 2022, the Washington State Department of Revenue (WDOR) published detailed guidance on the sales tax consequences of selling non-fungible tokens (NFTs), the first such guidance in the US, and other state tax agencies can look at how to collect NFT sales tax as well. Washington’s sales tax law already covers the sale of digital goods, such as video and music recordings, so WDOR could extend the sales tax to NFTs that can be seen or heard. Given that other states also tax digital product sales, Washington’s statement could become a guide to taxing the new universe of NFTs.

The big question is how WDOR will source the sales – meaning which jurisdiction’s sales tax will apply. The guide points to the state’s existing procurement rules for the sale of digital goods, which follow the order below:

1. First, if the customer receives the digital goods at the seller’s place of business, the sale will come to the place of business.
2. Second, to the place where receipt by the buyer occurs;
3. Third, if the first two procurement rules do not apply, to the place indicated by an address of the customer available from the seller’s business register, when the use of such an address does not constitute bad faith;
4. Fourth, if the first three rules do not apply, then to the location of the customer obtained during the completion of the sale, including the address of the customer’s payment instrument (for example, credit card billing address); or,
5. Finally, if none of the above rules apply, the location of the sale will be determined by the address from which the digital code was first available for transfer by the seller, or from which a digital automated service was provided (but without regard to any location that only provides the digital transfer of the product).

The examples given do not address a situation where the seller does not know the customer’s location; however, the implication appears to be that if the seller does not take steps to determine the location of the customer, the location of the sale for Washington sales tax purposes will likely be considered the location of the seller’s server. In such a case, if the seller’s server is located in the state of Washington, state sales tax would be payable on NFT sales unless the seller could prove that it knew the customer was located in another state. Therefore, a Washington-based NFT seller may wish to take steps to document the customer’s location to avoid having to charge Washington sales tax—even though such a step may obligate the seller to collect sales tax in the customer’s state if that state also taxes digital goods. Obtaining the customer’s location may not be practical under current industry practices, but these sales tax rules may force such industry practices to change and lift the veil of anonymity that currently surrounds NFT sales.

Although this guidance only applies to Washington, most states that tax digital product sales have similar procurement rules, and there is a chance that other states will copy this Washington guidance. Accordingly, NFT sellers may wish to take steps to document the customer’s location in order to determine whether sales tax should be charged, based on the customer’s location, given that knowing the customer’s location may obligate the NFT seller to collect the sales tax if the customer’s state taxes digital products.

These rules will apply to third party marketplace facilitator sites that sell NFTs on behalf of others – such as OpenSea. Such third-party sites (rather than the seller) will be required to collect the sales tax, but some states may go after the seller as a party to the transaction if the marketplace operator fails to collect the tax. This depends on the state’s marketplace facilitator rule.

NFT sellers based in a state that taxes digital products should be careful to simply locate their server in a state that does not tax digital products in the hope that if they don’t know where the customer is, they will be free for the duty to collect the fee. Such a step may be challenged as a travesty by the seller’s state tax agency, or the tax agency may claim that the location of the digital code is the seller’s “commercial domicile” (essentially its headquarters), which is the location used to determine the location of intangible property for government income tax. Similarly, NFT sellers should be discouraged from asking about the customer’s location, but state that customers located in certain states will be required to pay VAT. Such “coaching” of a customer to tell them that they are in a state that does not tax digital products could be seen by a state tax agency as a clear tax avoidance measure, shifting to the standard of the place where the digital code was sent.

In addition to sales tax, NFT sellers should be aware that sales to customers in another state may subject them to income tax (or similar taxes). The Washington guidance states that NFT sellers will be subject to the state’s gross receipts tax (called the business and occupation tax). Washington and several other states require companies with a certain threshold for sales to customers in the state to file state tax returns there. Although there is a federal preemption law—called PL 86-272—that does not allow a state to impose its income tax on a corporation without a presence in the state, this federal preemption does not apply to the sale of intangible personal property, so this federal rule would not be some help for NFT sellers to avoid state income tax.

State and local tax considerations for NFT sellers

There are several important state and local tax issues for NFT sellers to consider. As already mentioned, many states have statutes that will allow them to tax NFT sales, even if they do not specifically mention NFTs. Some of these states may eventually take the position that NFTs have always been subject to their sales tax (and possibly their income tax as well). Pennsylvania, without any fanfare, simply listed NFTs as a digital product subject to the sales tax (but with no other guidance regarding the mechanics). The Washington guidance provides no effective date, and the implication is that NFT sales have been taxable since the inception of NFTs. The Washington guidance states that it is not a comprehensive discussion of NFT sales tax issues, that it is developing additional guidance, and that interested parties are invited to participate in the process by contacting WDOR.

Companies and individuals involved in NFT sales can be frustrated by the unanswered questions and the potential tax exposure for past and future NFT sales. Such potential exposure can become a significant problem when an NFT business is sold, even if it is structured as an asset deal, since all but a few states impose sales taxes on a buyer of the assets of a business.

Other states may publish similar guidance. Furthermore, the impending federal income tax reporting rules for cryptocurrency sales – which should also apply to NFT sales – will provide additional guidance in the sales tax arena, as such income tax reporting rules may require crypto exchanges to obtain the addresses of their customers. . In such a case, NFT sellers will be required to obtain the address of their customers, resulting in the collection of VAT if the customer’s state taxes digital products.

This sales tax environment is similar to the beginning of the e-commerce revolution, when states weren’t quite sure how to handle internet sales. But today is different for one crucial reason. At the beginning of e-commerce, the law was clear that a state could not compel a seller to collect sales tax unless the seller had some form of physical presence in the state where the products were received. That all changed in 2018 when the United States Supreme Court stayed South Dakota v. Wayfair that it was no longer necessary for a seller to have a physical presence in the state where the goods were delivered, as long as the seller had a certain threshold for total sales to customers in the state. Now that every state that imposes a sales tax has passed a law requiring collection of the tax when a certain activity threshold is reached (usually either $100,000 in gross revenue or 200 separate sales transactions over a 12-month period), NFT sellers will not be able to to rely on the old “no physical presence” safe harbor, and will have to face the reality that they will be required to collect sales tax on sales to customers in states that tax digital products.

* Greenberg Traurig is not licensed to practice law in the State of Washington and does not provide advice on Washington State law. Specific Washington State law and Washington State compliance issues will be referred to attorneys licensed to practice law in Washington State.