Cryptoassets And State Taxation

Wally Hellerstein of the University of Georgia Law School discusses the emerging state guidance for taxing cryptoassets.

This transcript has been edited for length and clarity.

David D. Stewart: Welcome to the podcast. I’m David Stewart, editor in chief of Tax Notes Today International. This week: State of crypto.

The emergence of cryptocurrency and NFTs [non-fungible tokens] has forced policymakers to develop responses to novel questions. We’ve previously taken a look at how cryptoassets are treated at the federal level, which we’ll link to in the show notes. So today we’re narrowing the scope to take a look at the state level. How are states handling the ever-changing nature of this new class of assets?

Here to talk more about this is Tax Notes State Editor in Chief Audrey Pollitt. Audrey, welcome to the podcast.

Audrey Pollitt: Thanks for having me, Dave.

David D. Stewart: Now I understand you recently talked to someone about this. Who’d you talk to?

Audrey Pollitt: The man who needs no introduction, who literally wrote the book on state and local taxation, Wally Hellerstein.

David D. Stewart: All right, now what did you get into?

Audrey Pollitt: We talked about his Tax Notes State article, “State Taxation of Cryptoassets: Key Concepts and Emerging Guidance,” which teases the latest chapter of a state taxation treatise. That’s right, those two volumes are about to get a little longer.

While the article offers a granular examination of emerging guidance on the state level, income and sales tax treatment of transactions involving virtual currencies and NFTs, it was the [enormousness] of the cryptoasset universe and its necessarily interjurisdictional nature that rung out as our conversation’s refrain.

David D. Stewart: All right, let’s go to that interview.

Audrey Pollitt: Wally, thank you so much for joining me today for a discussion about state taxation of transactions involving cryptoassets, which given the rapid evolution of and unique complexities attendant to the space, will likely end with us checking our respective inboxes only to find numerous notifications of new developments that have already changed the conversation.

Wally Hellerstein: I’m just delighted to be here. And just as a way of introduction, most of my waking hours are spent these days dealing with the problem of taxation of digital assets, cryptoassets, not only at the state level but also at the international level. I just wanted to start by saying, of course, the first thing I do in the morning is open my screen. And today I was delighted to see, I was reading a headline, “Digital Products Subject to Georgia Sales and Use Tax, Effective January 1, 2024.” That was news to me.

And then of course I’m not going to get into the details of my critique of that, but it just shows you what happens every day. But just also, where I’m coming from, which is that this is not only state, but also national and international, I was wondering what was going on in the country of Georgia, and I noticed that it’s probably a better place to be than the state of Georgia because for VAT purposes, the tax code of Georgia treats cryptoassets like money and it’s something that’s not goods, and therefore it’s not going to be taxable, at least under the sales, under their VAT.

So anyway, other things that cross my screen of course on Tax Notes, which shows you how important it was. For example, this morning there was a Tax Notes headline that crossed my screen that I’m sure others will appreciate. It says, “Crypto Community Clobbers Proposed Broker Reporting Regs.” In other words, the federal government has recently proposed regulations, and I really want to talk about this because there are 99 pages of proposed regulations dealing with not just tax aspects but all kinds of aspects. And it is of enormous importance. It has generated 13,000 comments by people who bill by the hour and are likely to be affected or their clients will be affected by it. So I’m just saying that this is — we’re just talking about the tax aspects, but there are regulatory aspects, reporting aspects, and we’re talking about just one tip of the iceberg. That’s where I’m starting from and I’m delighted to be here.

Audrey Pollitt: Oh, I think that referring to it as just the tip of the iceberg reflects how this is the sort of subject that rightfully draws analogies to natural phenomena. There are avalanches of information. A recent article by one of our reporters, Jonathan Curry, mentioned that the IRS was expecting to receive some 8 billion crypto information returns. It’s staggering.

Wally Hellerstein: Right, and again, to use an analogy, tip of the iceberg, this is just the one example of a number of analogous developments happening globally, the U.S. level. And I’ll just point to two of them. I would point that at the international level, and again referring to a Tax Notes headline called, “OECD Cryptoasset Framework to Come Into Force in 2027.” Forty-eight countries have formally signed on to that cryptoasset reporting framework, including the United States. So again, that’s more work for all of us.

And in addition, I would notice, and this is a U.S. domestic point, but again, national and in terms of general income taxation, the FASB, the Financial Accounting Standards Board, plans to publish around mid-December final accounting standards on breaking down details of income taxes and how to record cryptocurrency holdings. So this is just, it’s across the board and very important.

Audrey Pollitt: There’ll be more interpretive gymnastics to be applied in 2024 with Georgia subjecting digital products to sales tax starting Jan. 1. Crypto is a digital product, but not all digital products are crypto. And that just seems to speak to the internal contradictions and some of the confusing language that seems inextricable from any conversation that we have about cryptoassets.

Wally Hellerstein: The guidance that we have at the national level would be federal taxes, federal income taxes, which may or may not be relevant to how you treat something for consumption taxes or sales and use taxes or VAT. And so I think it’s very important to keep that in mind, especially as we go through the guidance that’s emerging on a daily, if not hourly basis.

But let me just start with, in terms of cryptoasset definitions, starting at the international level, and I think most people listening to this I hope are familiar with the OECD, which is a global organization and focuses on tax and I spend a certain amount of time working with them. The OECD has a definition of a cryptoasset, and I suppose I can just to — they’re all fairly simple. It says it defines a cryptoasset as a “digital representation of value that relies on a cryptographically secured distributed ledger or similar technology to validate and secure transactions.”

I’ll parse that out a bit once I get through the definitions. The U.S. Department of Treasury, again, we’re going down from international to national, also says for tax purposes, broadly and generically defines it as “all types of representations of value are claimed in digital form that rely on the use of a method of distributed ledger technology.” And finally, again, talking globally, the European Commission has defined cryptoasset as “a digital representation of value or rights which may be transferred and stored using distributed ledger technology.” The one point I want to make about all that, it’s very interesting that many jurisdictions insist that a digital asset that’s taxable will be one that is on the distributed ledger technology. That’s a cryptoasset.

But that to me, I think in some ways, is misleading because you can have a digital asset that is not on the distributed ledger chain and you may or may not want to tax it. And just to drive the point home, in the most recent set of draft regulations by the United States government, by the Fed, they specifically define a digital asset, which is for tax purposes, as one that is in effect a cryptoasset. So I think we need to keep that vocabulary, those problems in mind, because you may not think of them that way when you see the legislation or the regulation or the proposals.

Audrey Pollitt: From a threshold vocabulary standpoint, for anybody who doesn’t have a thorough background in crypto, you’ve mentioned distributed ledgers, distributed ledger technology — maybe just a quick primer on what that means and how it’s different.

Wally Hellerstein: OK. Well, a distributed ledger technology, those who are familiar with bitcoin may know that the idea is that it is the right, whatever it may be, let’s assume it’s a right to a bitcoin, is reflected in a distribution of digital representation. Something in the digital universe in many different places. It’s a distributed ledger, it’s very hard to replicate, and that gives you the right to whatever is associated with that distributed ledger. But again, I think for purposes of talking to somebody who’s never heard of this, a digital asset would be something that’s just, I have a right to digitals. If I have the right on the web to click on a button, which is not distributed, and to see a movie, well that would not be a cryptocurrency or a cryptoasset because it’s not distributed.

Audrey Pollitt: Sure. And relatedly, could you talk us through what a token is, as it’s been historically and as it is within this context?

Wally Hellerstein: I think before we got into the metaverse, we all knew what a token was. It’s something that stands for something else, a token of affection. You may give your spouse some flowers or beer, whatever it is, it’s a token, what you think about them. Fast-forward to the digital universe, when we talk about tokenization, we’re talking about a cryptographically reflected intangible representation of something that gives you — that’s the token that gives you the right to something else. And what that underlying something else is, it could be a lot of different things.

Audrey Pollitt: When we’re talking about tokens and tokenization, that necessarily imputes the OECD’s three principal token-related categories of cryptoassets. So we’ve got payment tokens or virtual currencies, which are maybe the most recognizable to most of our listeners who may not be in the tech or tax spaces. So that’s bitcoin, that’s ethereum. Then second category, security tokens, which are tradable assets held for investment purposes and classified as securities. And then utility tokens, which can be fungible or non-fungible. So some folks have heard of NFTs, they’ve been receiving increased attention. Just for level setting, talk to us about the difference between a fungible utility token and a non-fungible utility token.

Wally Hellerstein: A fungible token, I would give you an example, would be a bitcoin, something that can be used and distributed. There’s nothing unique about that. A non-fungible token is one that only represents one particular thing and that you have. Nobody else can sort of have access to that because that is non-fungible. It’s not like every other bitcoin. It is the unique something and that we have to talk about what that something is that the token reflects, which could be something tangible or it could be something else.

Audrey Pollitt: So to that point, what sort of interplay, mirroring, are you seeing on the global stage as reflected in U.S. Treasury Department guidance? Are you seeing a lot of commonality? Are you seeing key divergences?

Wally Hellerstein: That’s a great question, and I think the answer is obviously the federal guidance. We don’t yet, maybe you never will, have a national consumption tax. So unlike most of the countries in the world, we don’t have a national value added tax or something that’s equivalent to a value added tax, but that’s a tax on transactions and ultimately in principle on consumption. So therefore, all the federal guidance we have is directed at income taxes, direct taxes, and of course the related regulations. That’s why that 100 pages of regulations that the IRS has suggested for the crypto community as they call it, that’s all related to federal tax and related reporting obligations because there’s lots of crime associated with this. We know people going to jail who have not been quite honest about their dealing with their cryptoassets. So it’s not just taxation, but at the federal level, the only tax issues that concern you are direct or income taxes.

So obviously the states have always and will continue to conform generally to the federal tax treatment. So most of the state tax treatment that you see at the direct tax or income tax level is going to reflect the federal tax treatment. What’s interesting and complicated and keeps people who go by the hour busy is to what extent that federal direct tax guidance, income tax guidance, should be incorporated when you’re dealing with sales and use taxes? And that’s also a global problem because when I go to the OECD, it’s for indirect OECD dealing with VAT, but there obviously are other parts of the OECD that are concerned about the income tax. So that’s another issue here, is how does it fit or not fit? And if you characterize something as tangible for income tax purposes, maybe it should or shouldn’t be taxable for sales tax purposes.

All the state tax people on this podcast will be very familiar with Public Law 86-272. Now, Public Law 86-272 is a statute that says that unless the out-of-state business selling tangible personal property exceeds a certain threshold of activity, they cannot be subject to tax. Now, most of the guidance we have here says, “Look, when you’re selling a non-fungible token, for example, and the underlying cryptography is a Picasso or an asset, we look through it to see what that underlying thing is and that’s how we tax it.” And indeed, that’s exactly what happens at the federal level with regard to something that most people probably weren’t aware of until the federal government regulations of this: collectibles. If your IRA distributes to you a cryptoasset reflecting a Picasso, it will be treated as a collectible, a real thing, and taxable to your IRA. That’s a highly technical point, but the state’s generally, you say, “Well, they’re going to follow the federal guidance.”

I thought this was pretty interesting. And that’s a direct tax. You follow the direct tax guidance as to how you characterize it. New Jersey has just said that from — they will not consider a collectible that’s tangible to be anything other than the transfer of the intangible, that is the non-fungible token, whatever it is, and why do they do this? They don’t want Public Law 86-272 to be applicable to that. So ironically, just such a good example of what you do for federal purposes and normally conform. Here’s New Jersey saying we won’t conform. Why won’t they conform? They want the money.

Audrey Pollitt: So in one of our previous planning discussions, you mentioned how state conformity to federal provisions in certain respects is by analogy, and I’d imagine that being particularly applicable in the indirect tax space. Would you agree with that?

Wally Hellerstein: Normally when you start to fill out your state tax return, the first thing you do is, it’s all based on the federal, all of the decisions about what is income, what isn’t income. And obviously there are differences when you’re dealing with the state income tax return, but they’re relatively minor. You don’t usually find a deviation from a federal tax principle as to what is income at the state level.

But now when you start to talk about whether or not you use federal tax, direct tax, guidance for purposes of your indirect tax, your sales tax, that’s a much more complicated question. And the answer, which is good for tax, is “sometimes.” I mean, it’s easier to do it, but you don’t always want to do it. And again, just because the IRS has decided that for purposes of section 408 to the Internal Revenue Code, a collectible is to be treated effectively as a tangible personal property that’s distributed from — the acquisition of property distributed from your IRA, it doesn’t mean that the states are going to follow that if it doesn’t make sense for the sales and use tax.

Audrey Pollitt: Well, would you recommend that at the subnational U.S. level, states look to international guidance on indirect tax instead of federal? Are there any lessons that you would draw and recommend?

Wally Hellerstein: A very short answer to that question, which is absolutely yes. If you look at what the OECD is now doing, they are looking at indirect tax treatment of these issues. And guess what jurisdictions are included in just assessing what the appropriate guidance should be, the U.S. subnational states. Because they have an analogous problem, again. A VAT is not the same thing as retail sales tax, but there are analogous problems. I always tell people when I go to these international meetings, well, guess what? You should care about what the states are doing.

If California were a country ranked by GDP and you rank countries and states together, California would be fifth in the world. So what they do for tax purposes is important economically, and therefore the OECD has recognized that what the states are doing with regard to how they’re doing it, obviously, everybody’s just struggling with this, with regard to treatment of cryptoassets for indirect tax or sales tax purposes is very important. But what the OECD is doing is important to the states, what the states are doing is important to the OECD, and there are often U.S. tax representatives when the business community is involved attending these meetings. So I think that’s very important to recognize.

Audrey Pollitt: So we’ve hit maybe the worst-ofs, mentioning New Jersey, but instead of recapping each state’s guidance, our readers will have the benefit of referencing your forthcoming article coauthored with Andrew Appleby. Please tell me about some of the state practice best-ofs that you’ve observed in terms of guidance issued pertaining to either income or sales tax treatment of payment tokens and/or NFTs.

Wally Hellerstein: Well, again, in my judgment, I think the best of, at least from the standpoint of a taxpayer, and I think people who give tax advice, is that there be consistency. And as far as it makes sense, conformity to the guidance that’s already out there. Now, there are reasons why states might not want to adopt the notion now embodied in at least some federal guidance that we’re going to treat a fungible, we’re going to look through, we’re going to take a look-through analysis. Not without problems, but it seems to me that states should try as best as possible to conform to reasonable federal guidelines because then the discomfort that we already have with these emerging guidelines is going to be even worse. And that would be kind of No. 1, to make sure that we try to be conformed as much as possible.

In addition, I would say, and here’s where the, at the subnational level, states have a number of organizations where they get together and they try to come up with similar approaches. This is a perfect example for the Multistate Tax Commission and for other organizations that try to have conformity among the states. Given the emerging issues associated with this area, there is nothing more important, I think, than trying to be consistent with this because you don’t want either double tax or double nontax, particularly at the sales and use tax level, with regard to these issues. And again, I’m not saying they’re not difficult, but we should really aim for consistency.

Audrey Pollitt: Absolutely. The case for MTC seems strong with an upcoming digital products work group meeting scheduled for this December 7. I know that they are front-runners on putting together a white paper on sales taxation of digital products and services.

Wally Hellerstein: But one point here, again, it’s a vocabulary point. We need to have a good understanding of what “digital” means. Again, the definitions of digital, crypto, I mean, does digital mean crypto? Does crypto mean digital? And I think that most of us sitting around a table, if you say it’s something that digital isn’t necessarily on a decentralized ledger chain, I think the answer would be no.

But guess what? The states often, or at least they have for many purposes, and so has the federal government, said that for our purposes we’re talking about digital assets, but they’re really only those that are cryptoassets. So I think we need to be, again, our guidance should be consistent insofar as possible, consistent with normal understandings. But I think that’s part of the challenge there and part of the reason why states should get together and [as] best as possible, make clear what they mean by digital and crypto because it’s not — everybody doesn’t understand it, and indeed some people understand it differently.

Audrey Pollitt: That’s great. So other than taxnotes.com, which spaces would you suggest our listeners watch for the latest on next steps and future developments?

Wally Hellerstein: Well, again, I think that we all can talk about what crosses our screen on a daily basis. And I think in addition we need to pay attention because we’re getting a lot of information, not just from the excellent daily reports we get from Tax Notes, but the information coming out of governmental organizations. And I would also include the OECD. I think anybody who’s interested in this problem should read that, it’s all publicly available, doesn’t cost any money, but there’s a lot of very interesting guidance on a country-by-country, and I’m happy to also say state-by-state, basis.

So there’s a lot out there, and I think anybody who’s interested in this, just go on to Google and you’ll find a lot. But again, I think global organizations, European Union, has its own guidance. There’s a lot of guidance out there. I think everybody would be well advised to look at that. They don’t have to incorporate it obviously, but it may be useful, and try not to be an outlier, try not to be a New Jersey.

Audrey Pollitt: In conclusion, the pace and volume of new information demands discernment, disciplined reading, and consistent consumption, which to my mind benefits from constant curiosity, a spirit in which I think you and I share, Wally. In a space that seeks to answer questions with guidance that begs still more questions, it sounds like we may need to have you back for a part 2 in the future.

Wally Hellerstein: I’d love to come either digitally or otherwise.

Audrey Pollitt: Thank you so much for joining us today.

Wally Hellerstein: Thank you. It’s been a pleasure.