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By Jonathan A. Feldman and Christopher Beaudro
Bitcoin and other virtual currencies may be the most controversial financial assets on the market right now and are certainly the most discussed. Over the past year, Bitcoin has gone from a value of approximately a few hundred dollars per unit to a high of approximately $16,000 and now to a value of approximately $7,600 as of the publication of this article. To put this into perspective, Bitcoins have risen from a total market capitalization of around $1 billion to a high of approximately $320 billion. This level of volatility has led to some strange behavior among Bitcoin speculators and investors. For example, in 2013, a man mistakenly discarded a hard drive containing approximately 7,500 bitcoins worth approximately $4 million at the time. [Anthony Cutherbertson, Man Accidently Threw Bitcoin Worth $108 Million in the Trash, Says There’s ‘No Point Crying About It ,’ Newsweek (Nov. 30, 2017, at 12:25 PM).]. It is estimated that the bitcoins on this discarded hard drive are now worth in excess of $100 million. [ Id.] . The hard drive is apparently currently sitting in a local landfill with over 4 years of trash sitting on top of it. [ Id.]. The man who discarded it is currently attempting to get the local jurisdiction to give him authorization to go in and search for it. [ Id.].
Although the cause of these extreme swings in the value of Bitcoin is difficult to pinpoint, the true utility of Bitcoin and other virtual currency is that they allow monetary transactions to be carried out over the internet without the use of an intermediary bank or financial institution and with zero or minimal transaction costs. The majority of virtual currencies are completely decentralized and not issued by any government or central bank.
In this article, we will examine the state sales tax implications of selling virtual currency.
Future articles will discuss the sales tax implications of (i) accepting virtual currency as payment, (ii) mining virtual currency, and (iii) the policy considerations of applying sales tax to virtual currency.
Before one can understand the state of sales tax law as applied to virtual currency, it is helpful to appreciate how virtual currencies arose and operate. There are many types of virtual currencies including Litecoin, Peercoin, and Zcash. But, for the purposes of this article, we will focus on Bitcoin, the most widely traded and valuable virtual currency.
In January 2009, a programmer named Satoshi Nakamoto (this name is most likely a pseudonym and Mr. Nakamoto’s true identity is not known publicly) released a whitepaper online detailing how Bitcoin works. [Bitcoin: A Peer-to-Peer Electronic Cash System, Satoshi Nakamoto, January 2009.]. According to this whitepaper, Bitcoin is a “peer-to-peer version of electronic cash [that] would allow online payments to be sent directly from one party to another without going through a financial institution.” [ Id. at 1.]. Bitcoin is not redeemable for any commodity or precious metal. [Reuben Grinberg, Bitcoin: An Innovative Alternative Digital Currency, 4 Hastings Sci. & Tech. L.J. 159, 162 (2012).]. Thus, like most other fiat currencies, Bitcoin has no intrinsic value. Bitcoin exists only in the digital world and has no tangible representation.
Bitcoin, like most virtual currencies, is a completely decentralized and anonymous medium of exchange used over the internet. [T.S., How Does Bitcoin Work?, The Economist explains blog (Apr. 11, 2013, 11:50 PM).]. No government or central bank supports or controls it. [ Id.]. Users transfer Bitcoins via the internet through an open source network known as the Bitcoin Network. [ Id.]. This network is an online peer-to-peer network that hosts the Bitcoin transaction record, known as the Blockchain [Investopedia Staff, How Bitcoin Works, Forbes, (Aug. 1, 2013, 12:25 PM).]. The Blockchain is a publicly accessible ledger of all Bitcoin transactions that have ever taken place. [Handbook of Digital Currency: Bitcoin, Innovation, Financial Instruments, and Big Data, David Lee Kuo Chuen Publisher Elsevier Science Date 2015-01-01, Pg.-15.]. Sales and purchases of Bitcoin are posted to the Blockchain after verification. [ Id. at 16.]. The Blockchain “uses public-key cryptography to solve the double-spending problem. In Public-key cryptography, each transaction has a digital signature.” [ Id.] . This system allows for easy tamper detection; thus, it is impossible for one person to spend the same Bitcoin twice.
To begin using Bitcoin, the user must either run the software that implements the Bitcoin protocol on their own computer or create an account on a website that will run the Bitcoin software for its clients. Downloading the Bitcoin software or creating an account on a website that runs the software allows a person to create a Bitcoin wallet. [ Id at 15.]. A Bitcoin wallet provides the use of a numerical address that is similar to a bank account number. [ Id.]. This address is specific to a given Bitcoin wallet and is used to send and receive payments. [ Id.]. By using the Bitcoin Network, Bitcoin users connect to one another to form peer-to-peer networks, which carry out the Bitcoin transactions. [Investopedia Staff, How Bitcoin Works, Forbes, (Aug. 1, 2013, 12:25 PM).]. Thus, in order to engage in Bitcoin transactions, users must access the internet to connect to the Bitcoin Network through their individual Bitcoin wallet.
As mentioned above, Bitcoin transactions must be verified to the Blockchain. This verification process is called Bitcoin “mining.” This mining process is how new Bitcoins enter circulation. [Investopedia Staff, How Bitcoin Works, Forbes, (Aug. 1, 2013, 12:25 PM)]. A Bitcoin miner is a person or organization that is running specific software on specialized computer hardware for the purpose of validating Bitcoin transactions to the Blockchain. [ Handbook of Digital Currency: Bitcoin, Innovation, Financial Instruments, and Big Data, David LEE Kuo Chuen Publisher Elsevier Science Date 2015-01-01, Pg.-19.]. When a person attempts to send Bitcoins through their wallet to another wallet, the transaction is verified or “mined” to prevent fraud or double-spending. [ Id.] This verification process is computationally intensive and requires an incredible amount of computing power to perform. [ Id.]. Once a miner verifies a Bitcoin transaction, the transaction posts to the Blockchain and the miner receives a set number of new Bitcoins (or fraction thereof) for their effort. Thus, each time a miner verifies a transaction, the total number of Bitcoins in circulation increases. The Bitcoin software sets the total number of Bitcoins available at 21 million. [ Id. at 20.]. As of the publication of this article, there are approximately $17 million Bitcoins in circulation. The mining process is somewhat analogous to the U.S. Treasury printing new U.S. currency.
Consider the following simplified example: if Chris wants to send Bitcoins to Jonathan, Chris must transmit that message to the Bitcoin network. Miners then use their computing power and specialized software to verify the transaction and ensure that Chris actually owns the Bitcoins he is attempting to send to Jonathan. Once a miner verifies the transaction, it posts to the Blockchain. The transaction is now complete. Thus, as a part of this transaction, Chris sent some Bitcoins to Jonathan, and the miner that mined the transaction received some new Bitcoins for their efforts. Rather than a transaction fee paid by either Chris or Jonathan, the Bitcoins that the miner receives are entering circulation for the first time when they are mined.
Users can currently exchange Bitcoins for numerous goods and services, and the number of businesses that accept them continues to increase. Seminole County in Florida recently announced that it will become the first U.S. government agency to accept Bitcoins as payment for taxes and services. [ Joel Greenberg Accepts Bitcoin and Bitcoin Cash for Payments through BitPay (last visited May 25, 2018)]. Major retailers and vendors that now accept Bitcoins include Expedia, Overstock.com, and Microsoft. [ Add money to your Microsoft account with Bitcoin; Bitcoin on Overstock.com; Bitcoin Terms & Conditions.]. In addition, there are a number of Bitcoin exchanges that allow people to buy and sell Bitcoins. Given this structure, users can engage in three basic transactions involving Bitcoins. First, a miner validates a Bitcoin transaction and receives new Bitcoins. Second, a person can purchase Bitcoins by exchanging traditional fiat currencies, like Dollars or Yen, for Bitcoins. Third, a person can exchange Bitcoins for goods or services.
In recent months, the value of a single Bitcoin has fluctuated with great regularity. For example, in July 2017, the price of a Bitcoin was approximately $2,400. [ Bitcoin Value Tracker (last visited May 20, 2018)]. By December 1, 2017, the price of Bitcoin had reached approximately $9,800. [ Id.]. In Mid-December 2017, Bitcoin reached its high of approximately $19,000. [ Id.]. By comparison, from the beginning of 2014 to the beginning of 2017, Bitcoin’s value fluctuated between $700 and $1,000. [ Id.]. A number of factors have been proposed to explain what is causing this sudden surge in Bitcoin’s value, including political regulation, economic uncertainty, and irrational investor excitement. [Alicia (Lucy) Cameron and Kelly Trinh , Bitcoin: Four reasons driving the cryptocurrency’s price, ABC News, (January 15, 2018, 3:38 PM).]. Likely, one of the largest factors involved in the rise in Bitcoin’s value is increased attention from Wall Street. According to a recent New York Times article, there are now approximately 130 hedge funds dedicated to investing exclusively in Bitcoins. [ Nathaniel Popper, Hedge Funds Push the Price of Bitcoin to New Highs, New York Times, (November 6, 2017). In addition, the Chicago Mercantile Exchange announced in October 2017 that it would begin offering Bitcoin futures. [ CME Group Announces Launch of Bitcoin Futures (last visited, January 15, 2018, 3:46 PM).]. The courts and Congress are also beginning to get involved with virtual currency. For example, the U.S. District Court for the Eastern District of New York recently held that Bitcoins and other virtual currencies are commodities and can be regulated by the U.S. Commodity Futures Trading Commission. [ Commodity Futures Trading Comm’n v. McDonnell, No. 18-CV-361, 2018, WL 1175156 (E.D.N.Y. Mar. 6, 2018).]. In addition, the New York State Public Service Commission recently approved a measure that allows the New York Municipal Power Agency, an association of 36 municipal utility authorities, to impose higher electricity rates by imposing a tariff on cryptocurrency mining companies. [James Denn, PSC Allows Upstate Municipal Power Authorities to Charge Higher Electricity Rates for Heavy Electricity-Using Cryptocurrency Companies , (March 15, 2018).]. While a full discussion of the economic factors fueling Bitcoin’s current rally is outside the scope of this article, it is clear that Bitcoin is one of the hottest financial assets in the marketplace right now and the mainstream financial community, the courts, and government regulators are beginning to take notice.
In general, users purchase Bitcoins because they have the following practical advantages for individuals and businesses: anonymity and zero or very low transaction costs. When a financial intermediary is used to facilitate a transaction, there is a transaction cost associated with the transfer. However, Bitcoin has no such transaction costs. Further, many individuals and businesses prefer greater anonymity and don’t want a bank or government to be able to view and analyze their financial transactions. For these businesses and individuals, Bitcoin offers the anonymity that traditional fiat currencies cannot.
Initially, it is important to consider whether the sale of Bitcoin or other virtual currency could properly be subject to sales tax in the various states. In some states, it appears unlikely that the sale of Bitcoins would be subject to sales tax. For example, California generally does not impose sales tax on transfers of products that are electronically transmitted to customers. [California SBE Information Publication No. 109, 10/01/2016.]. It appears then that California would not impose sales tax on the sale of Bitcoins in the state as long as no tangible item was transferred with the Bitcoins.
At least three states have provided specific guidance stating that the purchase of Bitcoin and other virtual currency is not subject to sales tax. [Michigan Treasury Update Volume 1, Issue 1, 11/01/2015; Missouri Private Letter Ruling No. LR 7411, 09/12/2014; Wisconsin Sales and Use Tax Report, No. 1-14, 03/01/2014.]. Specifically, Michigan has published guidance that states “virtual currency itself is not tangible personal property for purposes of the General Sales Tax Act or the Use Tax Act. Therefore, sales of virtual currency—as contrasted with purchases made with virtual currency—are not subject to sales or use tax.” [Michigan Treasury Update Volume 1, Issue 1, 11/01/2015.]. The Missouri guidance on this issue discusses a Bitcoin Automatic Teller Machine in which customers can purchase Bitcoins. [Missouri Private Letter Ruling No. LR 7411, 09/12/2014.]. In response to these facts, the Missouri Department of Revenue held that:
Bitcoins are intangible property. Absent an enumeration as a taxable service, the Missouri Sales and Use Tax Law does not impose a tax upon intangible property. As there is no enumeration that may apply to intangible property such as a Bitcoin, Applicant is not required to collect and remit sales or use tax upon its transfers. [ Id.].
Finally, the guidance issued by the Wisconsin Department of Revenue states that “[t]he sales price from the sale of the virtual currency is not taxable because the virtual currency represents an intangible right.” [Wisconsin Sales and Use Tax Report, No. 1-14, 03/01/2014; See also TAM-2015-1(R): New Jersey Tax Treatment of Virtual Currency, 07/28/2015].
Thus, the Departments of Revenue in Michigan, Missouri, New Jersey, and Wisconsin have explicitly recognized that Bitcoin is neither a taxable service nor tangible property.
However, there are states that impose sales tax on items that are transmitted electronically. For example, Washington imposes its sales tax, in relevant portion, on “digital goods.” [Wash. Rev. Code § 82.04.050(8)(a) (2017).]. The term “digital good” is defined as “sounds, images, data, facts, or information, or any combination thereof, transferred electronically” [Wash. Rev. Code § 82.04.192(6)(a) (2017); Wash. Admin. Code § 458-20-15503(202) (2017).]. When a purchaser purchases a Bitcoin, that Bitcoin contains the Blockchain information about that transaction.
Connecticut has issued a sales tax FAQ that states that purchases of “digital downloads” from the internet are subject to sales tax. [Connecticut FAQ, No. 750, 06/11/2012.]. This FAQ goes on to state that the term “digital download” includes, but is not limited to, “software, books, magazine or newspaper articles, artwork, ringtones, games, music, videos, concerts, and sporting events.” [ Id.]. This ruling leaves open the question of whether Bitcoin would be considered to be “downloaded.” For purposes of this ruling, Connecticut does not specifically define the term “download” or “downloaded.” A Bitcoin is transferred to a virtual wallet, which can be copied to a device (computer, mobile device, etc....) and viewed without access to the internet. However, internet access is necessary to transfer Bitcoins. Thus, it is not immediately clear whether states would consider Bitcoins as “downloaded.”
Finally, Hawaii imposes its excise tax broadly on the gross receipts of all service businesses operating in the state unless specifically exempt. [Haw. Rev. Stat. § 237-13(6)(a).]. Neither Washington, Connecticut, nor Hawaii has issued any guidance regarding the applicability of their taxes directly to Bitcoin or other virtual currencies.
A state could also classify Bitcoins as foreign currency and apply its sales tax laws to the sale or transfer of Bitcoin based on this classification. However, most of the largest states do not impose tax on the sale or exchange of currency or only impose sales tax on the sale of currency if the currency is sold at an amount above the exchange rate.
For example, Illinois regulation states that “[g]ross receipts from the sales of legal tender, currency, medallions, or gold or silver coinage issued by the State of Illinois, the government of the United States of America, or the government of any foreign country, and bullion are exempt from Retailers’ Occupation Tax.” [Ill. Admin. Code 130.1910(c).]. This approach of exempting all sales of currency is also followed by Colorado in that Colorado explicitly exempts sales of “coins” from sales tax. [Colo. Rev. Stat. §39-26-706(4)(a).]. The term “coins” is defined as “monetized bullion or other forms of money manufactured from gold, silver, platinum, palladium, or other such metals now, in the future, or heretofore designated as a medium of exchange under the laws of this state, the United States, or any foreign nation.” [Colo. Rev. Stat. § 39-26-102(2.6).]. Florida, however, imposes its sales tax on sales of foreign currency if the sale is made at an amount above the exchange rate of the currency. [Fla. Stat. § 212.05(1)(j).].
However, it seems unlikely that any of the above rules regarding currency would apply to Bitcoins or any variety of virtual currency given that Bitcoins are not issued or supported by a foreign nation and the IRS has already stated that its position is that virtual currency is property and not currency. Further, as of the publication of this article, it does not appear that any state has classified virtual currency as foreign currency for the purpose of its sales tax.
Based on the above discussion, the characterization of sales of virtual currency for sales tax purposes is an evolving area of the law. As such, we recommend that your business consult the relevant state law prior to dealing in any form of virtual currency.
In the next installment of this series, we will discuss the sales tax implications of accepting virtual currency as payment.
Jonathan A. Feldman is a partner in Eversheds Sutherland’s State and Local Tax practice in Atlanta and helps clients stay on top of ever-changing state and local tax issues that directly impact their businesses. With a strong background in the manufacturing, telecommunications, transportation, entertainment, and retail industries, Jonathan counsels clients in all areas of state and local taxation including income, franchise, sales and use, and property taxes.
Christopher Beaudro is an associate in Eversheds Sutherland’s State and Local Tax practice in Atlanta and serves clients in various capacities regarding their state and local tax needs, including counseling on state sales and income tax audits, refund claims and assessments, corporate restructurings, and stock and asset purchase agreements.
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