"Crypto Winter" has been the theme of 2022 as bearish market trends have brought negative volatility and a host of new issues for the digital asset industry. Meanwhile, state taxing authorities and legislatures have started to answer the call for more guidance when it comes to taxing digital assets (i.e., cryptocurrencies and non-fungible tokens (NFTs)).

Several states and jurisdictions, such as Arizona, Kansas, New York State, New Jersey, Pennsylvania, Washington and Puerto Rico, have recently issued some form of state tax guidance around digital assets. Below is a summary of the guidance issued in each of these jurisdictions.

Arizona (AZ)

HB 2204 (enacted July 6, 2022) creates favorable state tax rules for individual taxpayers transacting in digital assets. Effective for tax years beginning on and after December 31, 2022, an individual taxpayer computing AZ adjusted gross income is required to subtract from that income:

• Virtual currency and non-fungible tokens received via "an airdrop at the time of the airdrop"¹
• Gas fees paid on the purchase of the virtual currency or non-fungible token if the individual taxpayer did not (1) include such fees in the basis of such digital asset or (2) otherwise deduct such fees previously²

The law defines the terms "airdrop," "gas fee," "non-fungible token" and "virtual currency."³

Kansas (KS)

In July 2022, the KS Legislative Division of Post Audit issued a limited-scope performance audit report (hereinafter "Report") comparing KS's cryptocurrency tax policies "to federal policies and best practices."⁴ The Report summarized and reviewed policy documents and publications from the IRS, the KS Department of Revenue, the Uniform Law Commission, the Treasury Department and the National Conference of State Legislatures. The Report found the following:

• KS's cryptocurrency tax policies generally align with federal policies but there have been difficulties in enforcing some policies in recent years
• KS's income tax code aligns with federal tax policy, which means KS should receive tax revenue from cryptocurrency transactions as reported to the federal government
• Due to the lack of federal reporting guidelines, KS is unlikely to receive 100% of the tax revenue it should from cryptocurrency transactions
• Interstate organizations, like the Uniform Law Commission, have issued guidance for states on the regulation of digital assets, but taxation is not specifically addressed because "a major hurdle to the creation of best practices has been the complexity and instability of the cryptocurrency industry"⁵

The KS Legislative Division of Post Audit did not have any recommendations. Further, agency officials from the Kansas Department of Revenue "generally agreed with [the Division's] findings and conclusions."

New Jersey (NJ)

On March 21, 2022, the NJ Division of Taxation (Division) released revised technical advice memorandum (TAM) 2015-1(R), which provides rules for taxing transactions involving convertible virtual currency for purposes of NJ's corporate business tax, sales and use tax, gross income tax and inheritance tax. TAM 2015-1(R) does the following:

• Conforms NJ's tax treatment of convertible virtual currency, such as Bitcoin, to the federal tax treatment of property as reported in Notice 2014-21, Revenue Ruling 2019-24 and IRS Chief Counsel Memorandum 202114020
• Clarifies that P.L. 86-272 does not protect against nexus for a company selling digital assets to NJ customers because such assets are intangible property⁶
• Provides that NJ's sales or use tax does not apply to the purchase of digital assets for investment purposes but does apply if a taxpayer uses digital assets to purchase taxable goods or services
• Sets forth rules for determining fair market value, recordkeeping requirements and wage reporting/withholding requirements

The Division intends to form a working group to further review cryptocurrency transactions and release guidance on taxing fungible tokens and NFTs. In addition, the Division will evaluate exchanging information regarding such transactions with the IRS and other states.

New York State (NYS)

On July 1, 2022, the NYS Department of Taxation and Finance (DOTF) included in its draft apportionment regulations the proposed corporate franchise tax treatment of "cryptocurrency or similar asset[s] digitally delivered." These assets would be included in the definition of "digital products."⁷ Under NYS law, corporate taxpayers are required to apportion receipts from the sale of, rental of, license to use or granting of remote access to digital products based on where the taxpayer's customer derives value from the digital product,⁸ which is determined based on a hierarchy of methods, first looking to the "customer's primary use location."⁹ Alternatively, taxpayers may be able to apportion receipts from "digital products" to its customer's customer if the transaction meets the definition of an "intermediary transaction."¹⁰ The intermediary transaction rule may be beneficial for people selling digital assets through cryptocurrency exchanges.

It is unclear whether the phrase "cryptocurrency or similar asset[s] digital delivered" includes more than just cryptocurrencies because such fungible assets are different from NFTs.

The NYS DOTF plans to enter these draft regulations into the state's administrative procedures act process starting in the Fall of 2022 with the goal of finalization soon thereafter.

Pennsylvania (PA)

On June 11, 2022, the PA Department of Revenue (PA DOR) updated its list of taxable and exempt property for sales and use tax purposes(PA's Rev-717).¹¹ NFTs were added as a new taxable item to the list of digital products subject to the state's sales and use tax.

Puerto Rico (PR)

On June 30, 2022, Governor Pedro Pierluisi of PR signed PR Act 52-2022 (HB 1367) into law, which, among other things, specifies PR's treatment of digital products for sales and use tax purposes. The new law includes within the definition of taxable digital products, "digital products in the format or medium of a … NFTs"; thereby subjecting them to sales and use tax in the jurisdiction.

Washington (WA)

On July 1, 2022, the WA Department of Revenue (WA DOR) issued interim guidance on the taxability of certain transactions involving NFTs for purposes of its sales and use tax and business and occupation (B&O) tax.¹² The guidance:

• Defines key terms, such as "token," "non-fungible," "NFT," "digital automated services" and "digital code"
• Makes clear that for purposes of determining the taxability of an NFT, it is important to consider "(a) whether the transaction is comprised of multiple components or merely a digital code which grants the owner access to a digital good, (b) the taxability of each underlying component, and (c) the identity of the parties to the transaction"
• Requires a seller that receives cryptocurrency when selling an NFT to convert the value of the cryptocurrency tendered into US dollars as of the time of the sale
• Describes the tax treatment under four basic types of arrangements involving NFTs
• when the object of the purchase is a standalone digital product
• when the object of the purchase is a standalone good or service classified as a retail sale
• when the object of the purchase is a standalone good or service not classified as a retail sale
• when the sale of an NFT includes a royalty payment to the NFT minter
• Provides rules for mixed transactions and marketplace facilitators
• Provides sourcing or apportionment rules for both sales tax and B&O tax
• Includes examples

The WA DOR indicated that this guidance is not meant to be all encompassing and acknowledged that "[t]here are many types of NFTs available today." The WA DOR instructs taxpayers who purchase NFTs different from those discussed in the guidance to seek from it a "binding letter ruling." More permanent, comprehensive guidance is expected as the WA DOR works with stakeholders.

Implications

States continue to enact legislation, promulgate regulations and issue administrative guidance on taxing fungible and nonfungible digital tokens on distributed ledger technology. Policy and administrative approaches regarding these digital assets vary by state and tax type. Considering the broad array of participants in the crypto ecosystem, differences in terminology should be tracked across the states. Furthermore, while guidance issued by state taxing authorities clarifies their positions on these complex issues, that guidance may leave open or pose new questions given the rapid evolution of the technology. Affected companies should consider collaborating with state taxing authorities to develop administrative policies and interpretations on taxing these digital assets.

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ENDNOTES

¹ Ariz. Rev. Stat. Section 43-1022(29).

² Ariz. Rev. Stat. Sections 43-1022(30) and 43-1028(A).

³ Ariz. Rev. Stat. Section 43-1028(B).

⁴ "Reviewing Issues Related to State Cryptocurrency Tax Policies," Kansas Legislative Div. of Post Audit, Report Number: L-22-013, p. 1 (July 2022).

⁵ Id. at page 7.

⁶Generally, P.L. 86-272 only protects taxpayers that are selling tangible personal property into the jurisdiction.

⁷ NYS draft regulation Section 4-3.1(c).

⁸ Id. at Section 4-3.2(a).

⁹ Id. at Section 4-3.2(b).

¹⁰ Id. at Sections 4-3.1(f) and 4-3.8.

¹¹ PA Dept. of Rev., Retailer's Information - State and Local Sales, Use and Hotel Occupancy Tax - Public Transportation Assistance Fund Taxes and Fees - Vehicle Rental Tax (REV-717) (updated June 11, 2022).

¹² Wash. Dept. of Rev., Interim statement regarding the taxability of NFTs (July 1, 2022).