Because of the transparency issues around who owns and trades digital assets, taxing them is so difficult. It is especially true for NFTs (non-fungible tokens), which are exclusive digital assets that cannot be mutually exchanged like traditional cryptocurrencies.
In an effort to remedy this, two states recently became the first in the US to officially classify NFTs as digital assets that are subject to sales and use taxes. The acts of Pennsylvania and Washington show a growing knowledge of the tax ramifications of NFTs and a readiness to modify current tax rules to account for this new asset class.
The first agency to take action was Pennsylvania’s Department of Revenue, which added NFTs to its “taxability matrix” in June without offering any more instructions. Washington adopted a similar strategy in July, releasing an interim report that recommended a framework for identifying the “source” of NFTs (or where, for tax purposes, related transactions physically take place).
The current ecosystem around NFTs is unclear, down to where the buyers and sellers are. Also, the way NFTs are currently used as unique digital collectibles rather than for utility purposes means there is no easy way to value NFTs for tax purposes.
The actions in Pennsylvania and Washington indicate that they recognize the need to clarify NFT taxation, even as the asset class itself continues to evolve. As NFTs gain popularity and use cases grow, other states may follow suit to clarify their tax positions.
NFT regulation is still in its infancy. Therefore, there may be changes in the future. The International Revenue Service (IRS) has considered cryptocurrencies an asset since 2014. All benefits of its use are subject to certain rights. President Biden called for new disclosure requirements for cryptocurrency exchanges as part of the Infrastructure Investment and Jobs Act signed in November 2021, which requires organizations to collect additional data. The IRS should issue additional regulations for the Government Review of Automated Tools to determine how to update these new rules.
For the time being, anybody involved in buying, selling, or trading NFTs should be aware of the possible assessment repercussions in Washington and Pennsylvania. Keeping up with any governmental changes that can have an impact on how NFTs are taxed is also crucial.