Very few states have issued guidance explaining whether the sale of an NFT is subject to sales and use tax. Whatever description a state gives about what is taxable, the real question is whether that description is consistent with the statute and regulations, say Cozen O’Connor tax attorneys Joseph C. Bright, Cheryl A. Upham, and Heidi R. Schwartz.
Few people have considered the state tax consequences of buying or selling non-fungible tokens. Pennsylvania recently became the first state to issue direct guidance on the taxability of NFTs, and other states are likely to follow.
Fungible means replaceable, or mutually interchangeable; an NFT is non-fungible because each one is unique. An NFT purchaser receives a unique piece of data that functions as a reference to another file and as a certificate of ownership of the referring file. The file referred to by an NFT may be practically any digital item and may grant the owner access to a website or a real-world event.
The word NFT is used popularly to refer to the digital item referred to by the NFT. But the NFT itself is only the data that contains the reference to the digital item, and a right to have one’s ownership of the reference reflected on a blockchain. This distinction is important for sales and use tax analysis purposes.
It is unclear whether an NFT is taxable at all for sales and use tax purposes. At its core, an NFT is a piece of data that is a key to another piece of data that comes with a range of rights. Buying an NFT doesn’t necessarily grant a license to use an original work or a copy of an original work other than to view it. If the pieces of data and corresponding rights fall within the scope of a state’s statutes and regulations, they will likely be viewed as taxable.
A state may take the position that the sale of an NFT is taxable and that the seller or purchaser may have sales or use tax obligations. If NFTs are taxable for sales or use tax purposes, a seller may have a duty to collect and remit tax on the sale of an NFT, provided the seller has nexus with the state in which the sale is completed. Websites through which sales of NFTs are made could also be responsible for collecting and remitting sales tax on each sale made through their platforms due to states’ marketplace facilitator rules if the site has nexus with the state where the sale is completed.
Sellers or website platforms don’t need to have a physical presence in a state to have nexus with a state. Depending on the state law, a seller that completes a certain number of transactions with buyers located in the state or that derives a certain amount of revenue from sales to buyers in the state could have nexus. If the transaction is taxable and the seller doesn’t collect sales tax, the seller will be liable for the sales tax it failed to collect—and at the same time, the buyer will be required to remit use tax to the state.
Very few states have issued guidance explaining whether the sale of an NFT is subject to sales and use tax. But in most states, the foundation is laid to tax NFTs, even if specific guidance hasn’t been issued. Many states tax digital goods or digital products, even if they don’t treat them as a type of tangible personal property. For example, Indiana taxes electronic transfers of specified digital products, which include digital audiovisual works. Digital audiovisual works could encompass many types of animated digital items, even those that don’t have audio elements.
Some other states tax digital goods as a type of tangible personal property. In states that broadly define the term “digital product” or “digital goods,” an NFT could fall within the scope of the term. For example, Pennsylvania taxes “any otherwise taxable tangible personal property electronically or digitally delivered, streamed or accessed.” Pennsylvania recently issued direct guidance stating that retail sales of NFTs are subject to state sales and use tax as a digital good. The Pennsylvania Department of Revenue can, and likely would, posit that retail sales of NFTs have been taxable under this statute since its inception.
The state of Washington recently released interim guidance explaining how and under what circumstances NFTs would be viewed as taxable.
If a resident individual sells an NFT, the resident may owe personal income tax on the income or gain from the sale. Many states use federal taxable income as a starting point to calculate state taxable income for personal income tax. In these states, if income or gain from the sale of NFTs is taxable for federal income tax purposes, it would likely be included in a state income tax base unless an applicable exclusion applied.
In states that don’t use federal taxable income as a starting point in calculating state taxable income for personal income tax, what the state does tax may include income or gain from the sale of an NFT. For example, Pennsylvania is unique in that a resident’s personal income tax base doesn’t start with federal taxable income; however, it taxes income from sales of all types of property, including intangible property by residents. Thus, a Pennsylvania resident should be subject to Pennsylvania personal income tax on income or gain obtained from the sale of NFTs. Non-residents of Pennsylvania could be subject to tax on income from sales of NFTs attributable to Pennsylvania under its sourcing and allocation.
Corporations should be as wary as individuals. In states that follow the federal treatment of cryptocurrencies by classifying them as intangible property, it wouldn’t be a stretch to apply the same reasoning to NFTs. For example, the Illinois Department of Revenue stated in informal guidance that income from selling bitcoin is income from a sale of intangible property for the purpose of apportioning a corporation’s income to the state. If this same rationale were applied to NFTs, sale gains could be taxable for corporate income tax purposes.
New York recently published draft apportionment regulations that would subject to the state income tax the granting of access to certain types of digital property, which would include cryptocurrency and similar digital assets. If these regulations become final, NFTs could be viewed as a digital asset within their scope.
New Jersey has issued guidance to taxpayers on how to track transactions completed with cryptocurrency for various state taxes.
If a state asserts the taxability of NFTs, a taxpayer needs to know whether it’s required to collect sales tax on a sale, or whether it should pay sales tax or accrue use tax on a purchase. An NFT by itself may not be taxable at all; it is essentially a digital address with a certificate evidencing ownership of that address. If the NFT in question is accompanied by certain rights, the question then becomes whether those amount to the transfer of ownership, custody, or possession—the usual definition of the sale of a taxable item.
Whatever description the taxing authority gives of what is taxable, the question raised is whether that description is consistent with the statute and regulations. It may be that many, but not all, NFTs are taxable items. The devil is in the details.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Joseph C. Bright is a member of Cozen O’Connor’s tax practice, concentrating in state and local taxation and assisting business and individual taxpayers regarding corporate, financial institution, sales and use, income, real estate, transfer, and all other state and local taxes.
Cheryl A. Upham is vice chair of Cozen O’Connor’s tax practice, focusing on state and local tax law, including corporate and personal income, net worth/franchise, sales/use, property, payroll, and realty transfer taxes issues.
Heidi R. Schwartz is an associate in Cozen O’Connor’s tax practice, advising clients on state and local tax issues for individual and business taxpayers regarding sales and use, income, real estate, transfer, and other state and local taxes.
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