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Crypto Crash Weighs on States’ Plans for Tax Payment by Bitcoin

July 5, 2022, 8:45 AM

Two US states are steaming ahead with programs that will permit taxes to be paid in cryptocurrency, but the idea has been shelved almost everywhere else in the wake of the crash that has erased hundreds of billions of dollars worth of digital assets.

Revenue departments in Colorado and Utah are implementing programs to enable businesses and individuals to pay their tax bills with virtual currencies such as Bitcoin, Ethereum, and Dogecoin, targeting implementation within a few months. The two Western states look to be outliers, however, and still face some logistical hurdles before their programs launch.

The sector’s selloff has taken the value of the global cryptocurrency market below $1 trillion from a $3 trillion peak last November. Bitcoin alone has plummeted more than 70% since Nov. 9.

While a half-dozen states have considered following the lead of Colorado and Utah, a chorus of fiscal watchdogs, academics and crypto skeptics is now warning lawmakers against initiatives that might put state treasuries and taxpayers at risk.

“Anything involving crypto is less appealing in the wake of the massive volatility we’ve seen over the last month, and frankly the last six months,” said Lee Reiners, executive director of Duke University’s Global Financial Markets Center. “I don’t know if that slows momentum at the state level for payment of taxes, but it doesn’t help. And there is no financial benefit to the states to permit it.”

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Betty Yee, California’s state controller, calleda crypto-payment bill (S.B. 1275) currently before the California Legislature “fiscally irresponsible,” pointing to price volatility for cryptocurrencies and lack of a robust federal regulatory framework for digital assets.

“It’s still too new for government agencies to wade into cryptocurrency,” she told Bloomberg Tax.

New and Mysterious

The rationale for tax payments in cryptocurrency has always been thin.

Digital currencies are relatively new, highly volatile, and remain a mystery to most consumers, Reiners said. It’s unclear if Bitcoin or Ether will ever be viewed as viable mediums of exchange, whether for buying pizza or paying property taxes. Moreover, Reiners said, states don’t accept shares of stock, futures contracts, or foreign currencies for the payment of taxes, so why should they accept Bitcoin or Ether?

Still, parades of cryptocurrency investors and lobbyists have descended on state capitols with a mission. Their campaigns have led lawmakers to debate—and, in many cases, to enact—bills to bring cryptocurrencies into their states’ commercial codes and supercharge investments in blockchain businesses. Advocates are also pushing states to permit payments of taxes and services in digital currency, hoping such programs would accelerate crypto’s profile as a medium of exchange.

“A lot of states want to signal they’re friendly to the industry,” said Samuel Armes, president of the Florida Blockchain Business Association. “They want the business, and they want the innovation. So, they will push policies to attract this new wave of tech and talent.”

Thirty-seven states considered bills affecting some aspect of cryptocurrency during the 2022 legislative session, according to Heather Morton, a policy analyst at the National Conference of State Legislatures. Within that group, she said Arizona, California, Hawaii, Illinois, Louisiana, New York and Oklahoma all considered bills that would authorize the authorities to accept crypto.

Utah and Colorado

Utah was the only state to take final action, enacting H.B. 456, which directs the state and local units of government to accept crypto for the payment of taxes beginning Jan. 1, 2023. The law directs the Division of Finance to contract with a third party—a cryptocurrency payment gateway—to quickly convert cryptocurrency into US dollars before remitting the funds to the state.

Payment gateways serve as an interface between the crypto world and the traditional financial sector. They provide a critical service by locking in a precise dollar value for a coin at the moment of transaction; otherwise, the revenue authority could be out of pocket in the blink of an eye.

Colorado chose a slightly different path than Utah’s, though it aimed at the same goal. In February, Gov. Jared Polis (D), a strong advocate for the cryptocurrency industry, directed the Department of Revenue to develop a program for tax remittances in crypto.

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Meghan Tanis, a spokesperson for the department, said the state is still working through some details, but taxpayers will be able to use a special crypto payment portal beginning in September. Like Utah, Colorado plans to use a third party to immediately convert cryptocurrency payments into US dollars.

“We are working to make it similar to how we accept credit cards and other forms of payment,” Tanis said. “The state does not intend to hold a balance of cryptocurrency.”

The industry has a like-minded friend in Florida Gov. Ron DeSantis (R), who slipped several crypto-friendly features into his “Freedom First Budget proposal.” The budget included a plan allowing corporations to pay state fees via cryptocurrency directly to the Department of State.

“The Legislature did not act on this idea during the legislative session that concluded in March, but it could happen next session,” the governor’s press secretary, Christina Pushaw, said.

Diminishing Enthusiasm

With “Crypto Winter” setting in, however, momentum has been ebbing. The market crash also raises some practical questions about the feasibility of the Colorado and Utah approaches.

Utah’s program prohibits it from risking state money during the conversion of cryptocurrency into US dollars. Finding a vendor to absorb the risk could prove challenging, said John Valentine, chairman of the Utah State Tax Commission.

“I don’t know what they’re going to find when they go out to the marketplace,” Valentine said. “Markets have to be very effective at scoring their risk. With the uncertainty in the cryptocurrency markets right now, I think it’s going to be harder to find a third-party vendor than when it was more stable a year ago.”

Payment service providers that specialize in cryptocurrencies insist they can fulfill these duties at minimal risk to the states.

“At the end of the day, you want to provide your residents with as many payment options as possible,” said Merrick Theobald, vice president of marketing for Atlanta-based BitPay. “And there is no better way to transact online than with cryptocurrency. It’s a great digital payment method.”

Solves No Problems

Tax law scholars predicted that few states would follow Colorado and Utah. Offering cryptocurrency tax payment programs doesn’t solve any inherent problems for taxpayers or state revenue departments, and likely creates new ones, said Omri Marian, a professor of tax law at the University of California-Irvine School of Law.

Marian said the payment of taxes from a digital currency wallet would qualify as a tax realization event triggering either a capital gain or loss at both the state and federal levels. Accounting for these events “creates a new compliance burden for taxpayers and a new administration and enforcement headache for tax authorities,” he said.

He also dismissed programs that require third-party conversion and clearing, arguing that those processes would leave revenue agencies with new layers of complexity and expense to do something that is simple, efficient, and inexpensive when transacted in US dollars.

Given the tax policy issues at play, Marian said, Colorado- and Utah-style programs would only be enacted in jurisdictions governed by lawmakers living under the spell of crypto evangelists.

“States have absolutely nothing to gain from this,” he said. “It is a rather pathetic attempt to look cool with crypto bros. As far as tax policy is concerned, it is just stupid.”

To contact the reporter on this story: Michael J. Bologna in Chicago at mbologna@bloomberglaw.com

To contact the editors responsible for this story: Jeff Harrington at jharrington@bloombergindustry.com; David Jolly at djolly@bloombergindustry.com