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April 14, 2022

FY2023 Budget proposals may have state income tax implications for companies holding and transacting with digital assets

The Treasury Department's FY2023 explanation of President Biden's revenue proposals (Budget proposals) includes four provisions, described as "modernization rules," that would apply to digital assets. These proposals would:

  • Extend the nonrecognition rules for securities loans to loans of actively traded digital assets
  • Increase information reporting by certain financial institutions and digital asset brokers for purposes of exchanging information with other jurisdictions
  • Require taxpayers to report foreign digital asset accounts under IRC Section 6038D
  • Amend the mark-to-market rules for dealers and traders to include digital assets

In addition to the federal income tax consequences described in Tax Alert 2022-0540, these proposals could affect state and local corporate income taxes.

State impact of proposals to apply securities lending rules to actively traded digital assets and to amend mark-to-market rules

The Budget proposals would expand the securities lending nonrecognition rules to include loans of "actively traded digital assets recorded on cryptographically secured distributed ledgers." In addition, dealers or traders of digital assets could elect to use the mark-to-market method of accounting for actively traded digital assets and their derivatives or hedges. For purposes of this latter rule, the Budget proposals would add a third category of assets that may be marked-to-market at the election of a dealer or trader in those assets. The proposal also provides that "a digital asset would not be treated as a security or commodity for purposes of the mark-to-market rules."

For businesses engaging with digital assets, these proposals could affect taxpayers' industry classification for state income tax purposes. Most states have unique definitions of "financial institution," with associated tax rules. Generally, a taxpayer may be deemed a financial institution for state income tax purposes if it (1) earns a majority of its income from activities such as dealing in or selling securities, commodities contracts or other financial instruments; (2) receives a majority of its income from activities in which banking corporations can engage; or (3) predominately deals in money or moneyed capital in substantial competition with the business of national banks. Being classified as a financial institution can disqualify taxpayers from the traditional corporate income tax regime and, instead, subject them to special taxes, with potentially higher tax rates and different tax bases. This classification also may require taxpayers to use special apportionment rules to source income.

By applying the securities lending nonrecognition rules to loans of "actively traded digital assets" and allowing digital assets to be marked-to-market, the Budget proposals could prompt some state and local tax jurisdictions to view digital assets as financial instruments, meaning businesses transacting in those financial instruments would be regarded as financial institutions. Several state and local jurisdictions look to federal income tax provisions when determining whether an asset is a financial instrument and, by implication, whether the entity engaged in transactions with those assets is a financial institution.

The Budget proposals could also influence the way states tax activities using virtual currency and other digital assets. IRS Notice 2014-21 treats virtual currency as property, not as currency, for federal income tax purposes. Taxing authorities in New York,1 New Jersey2 and Wisconsin3 have conformed to this federal guidance and treat virtual currency as property while some other states are considering treating certain digital assets as legal tender or currency or proposing to accept virtual currency as payment for taxes. These actions suggest a potential future conflict between federal and state classification of digital assets and related transactions.4

State impact of proposals to enhance information reporting

The Budget proposals would expand the scope of the IRS rules on foreign account reporting to require reporting of certain accounts that hold digital assets maintained by a foreign digital asset exchange or other service provider of foreign digital assets. Additionally, the proposals would amend the reciprocal information-sharing rules under the Foreign Account Tax Compliance Act (FATCA) to bring digital assets within the scope of those rules. This would build on the 2021 Infrastructure Investment and Jobs Act, which broadened the definition of a "broker" to include various participants in the digital asset ecosystem (See Tax Alert 2021-1538). The call for expanded US information reporting is timely, given (1) President Biden's Executive Order ("Ensuring Responsible Development of Digital Assets" (March 9, 2022)) on the US government's approach to digital assets, and (2) a recent request for public consultation by the Organisation for Economic Co-operation and Development (OECD) on a proposed Crypto-Asset Reporting Framework.

While these enhanced information reporting rules would not automatically affect state reporting obligations, states could piggyback off federal requirements in the future. For example, New Jersey recently issued guidance stating: "The New Jersey Gross Income Tax Act follows the federal treatment of the gain or loss from the sale or exchange of property … [a] payment made using convertible virtual currency is subject to information reporting requirements to the same extent as any other payment made in property."5

The enhanced reporting requirements in the Budget and OECD proposals could make apportioning revenue from digital asset transactions more accurate for state income tax purposes, even if states do not adopt the enhanced information reporting rules. Many state and local jurisdictions require multistate taxpayers to apportion taxable income to the state using a market-based sourcing method, such as the location of their customers or counterparties. Businesses engaging in digital asset activities may have difficulty determining the location of "customers" or counterparties due to the anonymity of many market participants. For example, many digital wallet providers that lend fiat currency using digital assets as collateral or lend digital assets to third parties (as contemplated in the securities lending provisions of the Budget proposals), may not know the identity or location of the counterparty to these transactions when that individual or business uses a pseudonym or "doing business as" (DBA) or does not accurately report their location. These practices, which are essential to the decentralized nature of the digital asset industry, make it difficult to accurately determine revenue sourcing for purposes of apportioning the state income tax base. Enhanced information reporting can help assist companies with identifying their customers and their locations, which in turn assists with proper apportionment for state income tax purposes.


While the digital asset provisions of the Budget proposals have clear implications for federal income taxation, these proposals also may indirectly affect state income taxation. Affected businesses should monitor both the continued federal legislation in this area and ongoing state legislative efforts to address digital assets. Like President Biden's Executive Order, state governments are establishing state commissions to study and understand digital assets and to determine how to apply their current tax regimes to companies transacting in digital assets. State proposals can affect all companies engaged in these transactions, including mining companies, exchanges, brokers and dealers, custodians, private equity and hedge funds, and entities holding digital assets for their own account.


Contact Information
For additional information concerning this Alert, please contact:
State and Local Taxation Group
   • Scott Roberti (
   • Matthew Musano (
   • Jess Morgan (
   • David Sawyer (


1 N.Y. Dept of Tax. and Finance, Technical Memorandum TSB-M-14(5)C (Dec. 5, 2014).

2 N.J. Div. of Tax., Technical Advisory Memorandum TAM-2015-1(R) (Mar. 21, 2022).

3 Wis. Dept. of Rev., Wisconsin Tax Bulletin No. 213 (Apr. 2021).

4 See, e.g., Arizona SB 1341 (2022), California SB 1275 (2022), Louisiana HB 741 (2022), Oklahoma HB 3279 (2022).

5 Technical Advisory Memorandum TAM-2015-1(R).