Over the past eighteen months, the cryptocurrency market has weathered both extreme volatility and the revelation that cryptocurrency transactions once thought to be anonymous could be subject to forensic tracking. This possibility will not have escaped the attention of state tax auditors. Meanwhile, multistate businesses striving in good faith to comply with income and business activity tax obligations around cryptocurrency and other cryptoassets—including non-fungible tokens (NFTs) and other digital assets that rely on a cryptographically secured distributed ledger or a similar technology to validate and secure transactions—are likely to confront a series of question marks, particularly where nexus, sourcing, and the sales factor are concerned. Considerations include whether income from a cryptoasset sale constitutes apportionable or nonapportionable income, how cryptoassets are classified for apportionment purposes, whether a cryptoasset is valued at gross or net for purposes of the sales factor, and whether gain is included in the sales factor and if so how the gain is sourced. To some extent, the nexus implications of cryptoasset transactions may depend on a state’s approach to apportionment and the sales factor, particularly in states with a bright-line receipts test for corporate income or business activity tax nexus.
A handful of state tax agencies, the New Jersey Division of Taxation among them, have issued significant guidance on cryptoassets. Notably, the Division’s guidance advises taxpayers that cryptoassets are intangible property, and that sales of cryptoassets equate to sales of financial products or financial instruments.1The Division also takes the position that companies selling cryptocurrency are not eligible for the protections of Public Law 86-272.2 Although taxpayers may disagree, particularly concerning the potential applicability of P.L. 86-272 to sales of cryptoassets that are functionally similar to tangible personal property (such as an NFT that represents a collectible or piece or artwork), New Jersey has at least attempted to definitively categorize and advise upon cryptoasset transactions.
Conversely, recent events in New York underscore the uncertainty that tends to surround cryptoasset transactions. The final corporate franchise tax regulations officially adopted by the New York Department of Taxation and Finance in December 2023 eliminate language from a prior tentative draft, which in 2022 had defined digital products to include “cryptocurrency or other similar assets digitally delivered” and had taken the position that only net gain on sales of cryptocurrency should be included in the apportionment factor.3 With the removal of this language from the final rule, the proper treatment of cryptocurrency, NFTs, and similar digital assets for apportionment purposes remains alarmingly murky in New York, just as it is more broadly. Like New York, the majority of states are silent on the income and business activity tax implications of cryptoasset transactions, despite the increasingly commonplace nature of these transactions.
At the same time, the international tax community has issued a flurry of guidance in recent months addressing the tax and reporting obligations of cryptocurrency companies. For example, in August 2022, the OECD approved the Crypto-Asset Reporting Framework (CARF), which provides for the reporting of tax information on cryptoasset transactions in a standardized manner.4 In June 2023, the European Commission adopted the Regulation on the Markets in Crypto-Assets (MiCA), which establishes a comprehensive set of financial regulations governing cryptoasset trading within the EU. These international efforts followed earlier efforts by the IRS to provide guidance on the proper tax treatment of certain cryptoassets. Although state revenue departments rarely (if ever) consider themselves bound by the interpretations of international agencies such as the OECD (and also vary on the extent to which they follow IRS guidance), businesses dealing in cross-border cryptoasset sales will need to ensure that any state tax positions they take also comport with any federal and international tax and reporting requirements.
Notwithstanding the dearth of concrete guidance in most states, businesses engaged in cryptoasset transactions will need to consider how to report their income from these transactions on a multistate basis. High up on the list of concerns facing taxpayers is whether income from a sale of a cryptoasset would potentially constitute apportionable (business) income or nonapportionable (nonbusiness) income for purposes of the sales factor. In states that do not distinguish between apportionable and nonapportionable income, protections of the U.S. Constitution will operate to limit the income that can be attributed to the state. For example, income derived from a discrete non-unitary business transaction is not apportionable. Businesses that do not regularly and systematically engage in sales of cryptocurrency, or that buy and sell cryptocurrency as an investment or treasury function, should carefully consider whether their particular cryptocurrency sales are apportionable.
Another critical consideration for companies selling cryptoassets is determining how a particular asset should be categorized under the state’s sourcing rules. Noted scholar Walter Hellerstein explains in a new chapter devoted to cryptoassets in his foundational State Taxation treatise that “[c]lassification of crypto-assets is critical to the application of existing legal frameworks—and to the modification of such frameworks to address the challenges associated with such assets—in the areas of property law, intellectual property law, commercial law, securities law, and, needless to say, tax law.”5 Various classification approaches could include classifying a cryptoasset as a general intangible, a digital product, a financial instrument, or even an uncategorized business receipt. In states that have different apportionment rules for different categories of property, the classification of the cryptoasset in effect drives the apportionment result.
Some states have attempted to affirmatively answer the classification question. For example, New Jersey guidance effective for tax years ending on or after July 31, 2023, explains that offering, soliciting, selling, accepting, or buying digital assets such as virtual currency or NFTs, or offering services pertaining to them, constitutes offering and selling of financial products, financial instruments, and financial services.6 The guidance also explains that these activities are unprotected for purposes of the P.L. 86-272 safe harbor. Prior guidance also established the Division’s position that virtual currency is intangible property rather than tangible personal property, and that consequently the safe harbor protections afforded by P.L. 86-272 do not apply to a company that sells cryptocurrency to customers in New Jersey.7 Other states, such as New York, have avoided definitively categorizing cryptoassets for apportionment purposes. As discussed above, an earlier version of New York’s draft corporate franchise tax regulations would have classified cryptocurrency and NFTs as digital products. In deleting this provision from the final regulations, the Department has arguably sown more confusion than if it had never tentatively addressed the issue at all. New York is a state that provides different apportionment rules for digital products, financial instruments, and uncategorized business receipts;8 therefore, correctly categorizing cryptoassets is critical for any taxpayer trying to properly apportion its income and file its corporate franchise tax returns. At this point, however, businesses and practitioners are left to speculate which way the Department might be leaning, and whether perhaps the Department may be intending to categorize cryptoasset transactions on an ad hoc basis on audit.
Another particularly tricky question in some states is whether the cryptoasset should be valued at gross or net for purposes of the apportionment sales factor—or, critically, whether it should be included in the sales factor at all. Again, how the cryptoasset is classified is highly relevant to this issue, because many states provide different inclusion rules for sales of tangible personal property and sales of other types of assets. In some states—particularly states that base their sales factor on gross receipts—the plain language of the sales factor statute creates a risk that one cryptocurrency transaction could effectively be included in the sales factor twice. For example, in California, gross receipts includible in the sales factor include cash and the fair market value of other property received in a transaction that produces business income, without reduction for the basis of the property sold for which income, gain, or loss is recognized for federal income tax purposes.9 Similarly, in Florida, a taxpayer’s gross receipts, without reduction for basis, are included in the sales factor. In a “gross receipts-based” state, a taxpayer receiving cryptocurrency as payment for the sale of tangible personal property would presumably include the value of the cryptocurrency in its sales factor (as gross receipts from the sale of tangible personal property).10 If that same taxpayer then exchanges the cryptocurrency for cash, the plain language of the sales factor statute appears to require the taxpayer to also include the full value of the cash received, without reduction for basis. A similar taxpayer that simply received cash for the tangible personal property, however, would only include the value of the cash in its sales factor once. Thus, at the end of the day, although the two taxpayers are economically equivalent—both have ultimately received cash after selling tangible personal property—the taxpayer that accepts cryptocurrency as payment and then exchanges that cryptocurrency for cash potentially doubles its sales factor as compared to the taxpayer that directly accepts cash as payment. Of course, apportionability considerations, requests for alternative apportionment, and classifying the cryptoasset as a treasury function receipt (discussed below) may provide relief from this double inclusion, in states where these options are available; nevertheless, the gain must be considered and properly accounted for by the taxpayer when filing returns.
On the other hand, some states’ statutes may avoid double inclusion in application. One way states may alleviate the double inclusion issue is by statutorily limiting the sales factor inclusion to the net gain—rather than the gross receipts—from the sale of the cryptoasset. As noted above, in some states, such as Alabama, “treasury function” receipts (i.e., receipts from financial assets meant to provide liquidity to the taxpayer) are included in the sales factor net of expenses.11 In California, treasury function receipts are excluded from the sales factor.12 States may also choose to adopt targeted sales factor rules that specifically exclude cryptoasset receipts from the sales factor. In New York’s prior version of the corporate franchise tax draft regulations, the Department expressly stated that only net gains from cryptocurrency transactions would be included in the sales factor; however, as noted above, this provision was deleted from the final adopted version of the regulations. Meanwhile, Arizona has enacted a personal income tax exclusion from gross income for the value of certain cryptoassets that a taxpayer receives through a distributed ledger distribution.13 No counterpart exclusion of this kind has been provided for corporate income tax purposes, however, raising the likelihood of different treatment for a corporation subject to Arizona corporate income tax.
Still other states’ statutory schemes may altogether prevent sales factor inclusion of gains from cryptoasset sales. Notably, the increasing number of states conforming to the MTC’s model regulations on market-based sourcing may offer this relief, if the cryptoasset is classified as a general intangible. For example, Colorado’s conforming regulations provide that receipts from sales of intangible property are excluded from both the numerator and the denominator of the Colorado receipts factor unless the receipts: (1) constitute a contract right, government license, or similar intangible property authorizing the holder to conduct business activity in a specific geographic area; or (2) are contingent on the productivity, use, or disposition, of the intangible property.14 For sales of intangible property that are includable, Colorado includes only the gain; for receipts from other sales, the state includes gross receipts.15 If the cryptoasset at issue does not meet the definition of an includable intangible, the receipts from the sale of that cryptoasset will be excluded from the sales factor entirely in states that conform to the MTC’s model regulations. Regulations of the Missouri Department of Revenue explicitly exclude gain on a sale or exchange of cryptocurrency from the definition of “receipts” for purposes of the state’s receipts factor.16 In an interview, Professor Hellerstein remarked that excluding cryptocurrency from the sales factor altogether may in many cases be the correct result, particularly given the many challenges that can arise around sourcing, discussed below.17
As a final apportionment consideration, the business will need to determine how the gain is sourced geographically, and as a result whether the gain is included in the numerator of a given state’s sales factor. As with the issue of including the value of the cryptoasset in the sales factor, the sourcing issue depends heavily on how the asset is classified for apportionment purposes. Again, the sourcing rules applicable to a transaction may vary depending on whether the transaction involves a sale of tangible personal property, intangible property, services, financial instruments, or digital products—thus, determining how the cryptoasset is classified is a prerequisite to determining which set of sourcing rules the taxpayer should follow. Adding to the complexity, the practical difficulties of determining how and where to source gain from cryptocurrency can be significant given the presumed anonymity of trading on a blockchain, particularly in states that use market-based sourcing. In market-based sourcing states, taxpayers are to some extent required to locate their customers to determine where the cryptoasset is being used or where the benefit of the cryptoasset is received. Even in states, such as Florida, that use cost of performance sourcing, uncertainties can arise. The Florida Department of Revenue has in practice sometimes attempted an approach more akin to market-based sourcing, with state courts intervening to rein in the agency.18 In a very real sense, sellers in a cryptocurrency transaction generally lack access to the type of information about the purchaser that a seller would have in a more “traditional” transaction, and this anonymity creates challenges around cryptocurrency beyond those surrounding many other electronically delivered goods and services. While increased federal and cross-border reporting requirements may ultimately alleviate these practical difficulties, gathering the information necessary to satisfy a state taxing authority may be a long and arduous road for taxpayers, particularly those that are newly entering the cryptoasset marketplace.
Conceptually, nexus determinations take precedence over all other considerations, given that a business lacking a sufficient connection to a state cannot be subjected to the state’s income or business activity tax. With receipts-based economic presence tests now increasingly commonplace, though, income and business activity tax nexus for an out-of-state business engaged in cryptoasset transactions may depend on the answers to many of the apportionment considerations outlined above. In states with receipts-based nexus tests, taxpayers should track their cryptoasset sales carefully, being mindful of any sourcing rules specific to nexus as well as how the sales may be classified for apportionment purposes and whether and how the cryptoasset sales need to be included in the sales factor. In states where nexus can be established by an economic presence in the state but no exact receipts test is provided, significant sales of cryptoassets into the state could potentially raise nexus issues, depending on the facts and circumstances. An increasing number of states run the risk of blurring the line between the protections of P.L. 86-272, which cover only solicitation for sales of tangible personal property, and the protections inherent in the substantial nexus requirement of the U.S. Constitution. As a recent New Jersey Tax Court ruling illustrates, nexus is a distinct inquiry and the preliminary and paramount one.19 Nonetheless, the interplay between nexus and P.L. 86-272 protections is likely to be a subject of increased litigation in the near term. More conventional nexus considerations may also come into play around cryptoassets. For example, contracts between a remote cryptoasset business and third-party brokers, mining agents, or other agents in the state could raise the possibility of nexus based on physical presence. And of course, nexus exposure is not limited to the income and business activity tax sphere. Sales and use tax nexus thresholds, in particular, warrant careful consideration.
Like electronically delivered goods and services before them, cryptoassets map uneasily onto existing corporate income tax laws and have outpaced states’ and taxing agencies’ efforts to respond. Very few states have issued concrete guidance addressing how cryptocurrency transactions will be treated for corporate income tax apportionment purposes. Of the states that have issued guidance, there has been a marked lack of uniformity in approach. Yet taxpayers are increasingly dealing in cryptoasset transactions, whether as a regular part of their business or as part of their investment, treasury, or cash management functions, and should carefully consider the nexus, apportionment, and sourcing implications raised by these transactions. If potential exposure is particularly significant in a given state, seeking a private ruling from the state tax agency now could prevent unpleasant surprises on audit.
Subscribers to Checkpoint Catalyst can access a nuanced, state-by-state analysis of these considerations in Catalyst Topic # 1010: Electronically Delivered Goods and Services (Corporate Income and Business Activity Taxes). Additional germane topics include Catalyst Topic # 1002: Nexus (Corporate Income and Business Activity Taxes); Catalyst Topic # 1005: Allocation and Apportionment; Catalyst Topic # 1007: Sales Factor; and Catalyst Topic # 1051: Sales Tax: Electronically Delivered Goods and Services. A new chapter of Walter Hellerstein’s State Taxation treatise provides in-depth context around cryptoassets and their potential state tax implications.
11 Ala. Admin. Code 810-27-1.18(5)(b)
12 Cal. Rev. & Tax. Cd. § 25120(f)(2); see also Microsoft Corp. v. Franchise Tax Bd., 39 Cal. 4th 750 (2006, Cal) and General Mills, Inc. v. Franchise Tax Bd. 146 Cal. Rptr. 3d 475 (2012, Cal. Ct. App. 1st Dist., Div. 5).
16 Mo. Code Regs. Title 10 § 2076(2)(H)(3).
17 Interview with Walter Hellerstein, Transcript on File With Checkpoint Catalyst, 12/13/2023.
18 Fla. Admin. Code Ann. 12C-1.0155(2)(l); Billmatrix Corporation; Checkfree Services Corporation; Fiserv Automotive Solutions, Inc., Iti of Nebraska, Inc., Xp Systems Corporation, and Carreker Corporation, Plaintiffs, v. State of Florida, Department of Revenue, Defendant, (03/01/2023, Fla. 2nd Cir. Ct.) Dkt. No. 2020 CA 000435; Target Enterprise, Inc., a foreign corporation. Plaintiff, v. State of Florida Department of Revenue, an agency of the State of Florida, Defendant, (11/28/2022, Fla. 2nd Cir. Ct.) Dkt. No. 2021-CA-002158.
19 Re: H&M Bay Inc. v. Dir., Div. of Taxation, (12/18/2023, N.J. Tax Ct.) Dkt. No. 012545-2021
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