To date, only a handful of states have provided guidance specific to the sales and use tax treatment of non-fungible tokens (NFTs), a widespread type of cryptoasset that can provide the NFT holder either with a right to a digital file or a right connected to an asset that is not a digital file. Guidance from state tax agencies in Washington, Pennsylvania, Wisconsin, and Minnesota, establishes that sales of NFTs may be subject to sales tax. The Michigan Department of Treasury defines NFTs and categorizes them as digital goods, which are not subject to sales and use tax in Michigan. Illinois classifies NFTs as “digital assets,” but declines to offer guidance on these transactions. Other states that are frequently of heightened importance to taxpayers, including California, New York, and Texas, have not issued any guidance discussing the taxability of NFTs from a sales and use tax perspective. Taxpayers selling, facilitating sales of, or buying NFTs should be alert to the potential for taxability and be mindful of economic nexus thresholds that could be tripped by these transactions. As noted scholar Walter Hellerstein and his co-authors observe in the State Taxation treatise, ideally laws would quickly be enacted to address the many issues posed by these transactions, but given the complications and realities of the sluggish state legislative process, states’ tax agencies will more likely issue guidance under existing law and regulations, as they did for transactions involving remote access to software before legislatures acted, and electronically downloaded software before that.1 In this article, Checkpoint Catalyst surveys guidance to date and pinpoints areas of particular concern and uncertainty.
Proposed federal approach. A proposed IRS notice issued in 2023 designating NFTs as “collectibles” describes an NFT as a unique digital identifier that is recorded using distributed ledger technology and that can be used to certify authenticity and ownership of an associated right or asset.2 Ownership of an NFT may provide the holder a right with respect to a digital file (such as a digital image, digital music, a digital trading card, or a digital sports moment) that typically is separate from the NFT. Alternatively, NFT ownership may provide the holder a right connected to an asset that is not a digital file, such as a right to attend a ticketed event, or certify ownership of a physical item. The notice characterizes the right provided by an NFT, or the ownership of an asset that an NFT certifies, as the NFT’s “associated right or asset.” Under this guidance, the IRS employs a “look-through analysis” for determining whether an NFT constituted a collectible. For example, according to the guidance, a gem is a collectible and an NFT certifying ownership of the gem is therefore also a collectible, whereas an NFT certifying ownership of land would not constitute a collectible. As Hellerstein observes, however, although this look-through approach is “an intuitive way for taxing authorities to reach the substance of the transaction,… it may raise problems in application.”3Importantly, while not referenced in the IRS notice, some NFTs entitle the holder to both a digital file and a separate intangible right; for example, several luxury fashion houses have issued NFTs that serve as both digital versions of their luxury goods and entitle their owners to various perks such as guaranteed access to fashion shows and other events. These multi-use NFTs raise particularly thorny issues in the state tax context.
State look-through approaches. A number of state tax agencies have announced some form of look-through approach for sales and use tax purposes, by tying taxability to the underlying good or service to which the NFT is connected.
Washington’s approach: Interim guidance from the Washington Department of Revenue explicitly takes a look-through approach and notes that the sales and use tax treatment of an NFT will vary depending on a number of factors, including: (1) whether the transaction consists of multiple components or merely a digital code which grants the owner access to a digital good, (2) the taxability of each underlying component, and (3) the identity of the parties to the transaction, such as whether the purchaser is a consumer or reseller.4 If the object of the purchase is a stand-alone digital product, such as if an NFT itself is valuable—for example, as a digital piece of artwork, video clip, autograph, or similar item— the sale would generally be subject to retail sales tax as a digital product. However, if the object of the purchase is a stand-alone good or service other than a digital product—such as when the NFT represents the right to receive a good or service other than the NFT itself—the taxability of the transaction depends on whether the underlying good or service is taxable. Generally, the selling price of an NFT is the consideration received by the seller, whether from the purchaser or a third party. Other issues addressed by the Department’s guidance include bundled transactions, potential economic nexus liability for remote marketplaces facilitating retail sales of NFTs, and sourcing, which depends on the sourcing rules for digital products more broadly.
Wisconsin’s approach: The Wisconsin Department of Revenue addresses the tax treatment of NFTs in an October 2022 Tax Bulletin.5 The Department describes an NFT as a unique digital identifier that is recorded on a blockchain, is used to certify authenticity and ownership of a particular product, and cannot be copied or substituted. The Department takes the position that a sale or purchase of an NFT may be taxable if the underlying product, good, or service is taxable in Wisconsin. For example, if an NFT entitles the purchaser to download music or movies, the sale of the NFT is a taxable specified digital good; if an NFT entitles the purchaser an admission to a sporting event, the sale of the NFT is a taxable admission; and if an NFT entitles the purchaser to a tangible piece of artwork, the sale of the NFT is a sale of taxable tangible personal property.
Minnesota’s approach: In Minnesota, the Department of Revenue notes that NFTs may entitle purchasers to receive products or services including but not limited to: (1) digital products such as music, audio visual works, or video games; (2) admissions to sporting events or concerts; (3) prepared food and beverages; or (4) tangible personal property such as collectibles or memorabilia.6 According to the Minnesota Department of Revenue’s guidance, NFTs are subject to sales and use tax when the underlying product or service to which the purchaser is entitled is taxable in Minnesota.
Pennsylvania’s approach: Pennsylvania has not issued detailed guidance on the sales and use tax tax treatment of NFTs or similar items, but the Pennsylvania Department of Revenue lists NFTs as “taxable” on a 2022 bulletin identifying taxable and non-taxable items.7
Other state guidance. The Michigan Department of Treasury defines NFTs and categorizes them as digital goods, which are not subject to sales and use tax in Michigan.8 Illinois classifies NFTs as “digital assets,” but declines to offer taxability guidance on these transactions, with the classification arguably raising more issues than it resolves.
9 Other states that are frequently of heightened importance to taxpayers, including California, New York, and Texas, have not issued any guidance discussing the taxability of NFTs from a sales and use tax perspective.
The larger takeaway. As Hellerstein observes, the look-through approach, though simple in conception, may not account for questions that arise around complex multi-layered transactions. For example, while it may be possible to clearly identify the underlying asset in some NFT transactions, other NFTs entitle the purchaser to multiple items, potentially requiring the use of a bundled transaction or true object analysis to determine taxability. NFT transactions may also present intricate sourcing issues, particularly where the NFT’s digital ledger, the underlying asset or assets, and the consumer are not all located in the same state. In the absence of laws or guidance from specific states around potential sales and use taxation NFTs, businesses and tax advisors should consider the taxability of the underlying transaction, the composition of applicable economic nexus thresholds for remote sellers and marketplaces and whether sales of NFTs may potentially count toward those thresholds, and questions that may arise around bundled transactions and sourcing.
Checkpoint resources. For an in-depth, state-by-state consideration of guidance to date on NFTs and other cryptoassets, and the sales and use taxability of electronically delivered goods and services more broadly, see Checkpoint Catalyst Topic # 1051: Sales and Use Tax: Electronically Delivered Goods and Services. Walter Hellerstein’s State Taxation provides an indispensable overview of state taxation and cryptoassets. A recent Checkpoint Catalyst article delves into corporate income and business activity tax nexus and apportionment issues raised by cryptoassets across the states: Ford and Newton-Clarke, “Income and Business Activity Taxation of Cryptoassets: Multistate Nexus and Apportionment Concerns,” Checkpoint State Tax Updates, 01/09/2024.
Other Checkpoint Catalyst Topics that may be of interest to tax advisors and businesses with potential NFT tax obligations include:
- Checkpoint Catalyst Topic # 1050: Sales and Use Tax: Nexus;
- Catalyst Topic # 1010: Electronically Delivered Goods and Services (Corporate Income and Business Activity Taxes);
- Checkpoint Catalyst Topic # 1002: Nexus (Corporate Income and Business Activity Taxes); and
- Checkpoint Catalyst Topic # 1007: Sales Factor.
4 Interim statement regarding the taxability of non-fungible tokens (NFTs), Washington Department of Revenue, 07/01/2022.
5 Wisconsin Dept. Rev. Tax Bulletin 219, 10/01/2022.
7 Notice of Taxable and Exempt Property, P.A. Bull. Doc. 22-871, Pa. Bull. Vol. 52, No. 24, 06/11/2022.
9 General Information Letter ST 23-0017-GIL, Illinois Department of Revenue, 05/31/2023.
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