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September 8, 2014
How Will States Tax Sales Transactions Involving Bitcoin? (If You Don't Know The Answer, Then You Should Probably Read This Even If I Don't Have The Answer.)
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In State Tax Notes, on February 17, 2014, Tax Analysts published the Billy Hamilton article, “Is Bitcoin a Problem for State Taxes?”  I had heard media references to Bitcoin[1] but I had not given it much thought before scanning the article’s title.  His reference to “state taxes” snatched my attention.  What could be so different about a bitcoin for state tax purposes?  It is just money, right?  Hamilton had time only to touch on the topic’s surface.  But his article prompted me to think about how bitcoins would interact with the sales and use tax laws.  I came up with the following thoughts.

Is bitcoin the same as currency?  Maybe, maybe not.

Well, the thought that it is “just money” may be correct, depending upon how far you peel back the onion.  Let’s begin with the question:  What is a bitcoin?  Actually, it might be better to begin with what a bitcoin is not.  It is not tangible.  It cannot be kept it in a purse or wallet.  It is not part of any centralized bank that regulates it as currency.  It is not processed through the federal banking system for payments like personal checks.  It is not recognized by VISA, MasterCard, AMEX or Discover’s electronic payment systems.  It is not any of these things, yet many describe bitcoin as currency -- virtual currency -- and it is easy to see why.  You keep it in a virtual wallet, and you electronically transfer it from one person to the next through the Bitcoin network as consideration for the purchase of a good or service.  Unlike tangible currency, a bitcoin is an intangible right that has the same function as U.S. currency in that the parties can use it in lieu of legal tender. 

That brings us to the question: What is a bitcoin?  At a very high level, a lay description of a bitcoin is that it represents an intangible right created by cryptography[2] technology (very serious encryption of digital files).  The Bitcoin architecture uses the worldwide network of privately owned computers to process and validate a bitcoin through a series of timestamps that make it extremely difficult to “hack”.[3]   The process is referred to as “mining.”  The bitcoin is kept in the owner’s virtual wallet.  These wallets are anonymous in that they are digitally created and are not tied to a person’s name, proxy identification (e.g., a Social Security number) or bank account.  The system of distribution is “peer to peer” which means that the sender transfers the bitcoin directly to the receiver via the Internet (though, ATM bitcoin machines are beginning to appear now and they will convert the intangible property right to currency).  There is no need to clear the payment through banks or other payment facilitators like PayPal, Visa or Mastercard.[4]

Does a bitcoin share currency’s key general characteristic of stable value?  No, it is not stable, at least not in the recent past.

One important bitcoin characteristic differs from currency.  That characteristic is instability.  U.S. currency in the hands of most people (ignoring commodity traders that might use currency as an investment on a global scale), is a stable and static value in that comparing one U.S. dollar today will be essentially worth one U.S. dollar tomorrow.  Bitcoins are used globally, so comparing the U.S. dollar’s stability to other global currencies is a better comparison to understand a bitcoin’s instability.  That comparison shows a small amount of volatility.  Using daily values, from December 2013 to June 2014, a U.S. dollar compared to the Euro ranged from .7182 to .7476 for a value swing of a little less than four percent.[5]  A U.S. dollar compared to the Canadian dollar ranged from 1.0414 to 1.1249, a swing of less than seven and a half percent.  A U.S. dollar compared to the Japanese Yen ranged from 98.34 to 105.25, a swing of a little more than six and a half percent.  A U.S. dollar compared the Chinese Yuan ranged 6.06860 to 6.1775, a swing of a little less than two percent.

Historically, however, bitcoins have been anything but stable and static.  Over the same time period, a U.S. dollar compared to a bitcoin ranged daily from .0009 to .0049, a swing of nearly 444%.  A bitcoin value can have wild value swings in a very short period of time.  For example, in December 2013 a bitcoin was worth $1,128.80.  From that high, Bitcoins began to decline in value.  On February 22, 2014, a bitcoin fell to a low of $298.73.  By June 30, 2014, it closed at $592.19.  The value swings are significant.  Perhaps bitcoins will become more stable and less volatile in the future, but that remains to be seen. 

The Bitcoin system also lacks a high degree of integrity, at least at this phase of the Bitcoin evolution.  Government regulation is absent, which is, ironically, what proponents tout as one of its strengths.  The Financial Industry Regulatory Authority (“FINRA”) has issued an investor alert, warning investors that bitcoins are “More Than a Bit Risky”.  The article has a distinct “wild west” tone to it as it describes the Bitcoin world.  For more information, see FINRA’s explanation about the risks, see

So, what tax classification does a bitcoin possess?  We really don’t know for sure.

The key characterization that draws my attention as a state tax lawyer is whether bitcoins are “property.”  For federal income tax purposes, the Internal Revenue Service (“IRS”) thinks so, according to a statement on March 25, 2014.  In IRS Notice 2014-21, addressing bitcoins (, the IRS asks and answers:

Q-1: How is virtual currency treated for federal tax purposes?

A-1: For federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency.

The IRS classifies virtual currencies, like bitcoins, for purposes of federal income tax treatment, as property and applies the existing rules for property.  That means that they are subject to holding periods and trading gains and losses, not the ordinary income rules.

Washington’s Department of Revenue has not yet announced any guidance, but it unofficially hints that it will depart from the IRS and treat bitcoins as currency.   Unlike Washington’s potential direction, Texas seems to go the way of the IRS, calling bitcoin as an investment and not currency.  See  States are still trying to figure this out, and yet, the tax classification of a bitcoin is so critical in the analysis of how sales and use tax states might treat the use of bitcoins.  Taxpayers need states to address this sooner than later.  The financial risks of which way a state picks could be significant.

What are the state sales and use tax issues lurking with Bitcoin?  There is no clear statement as to whether any exist, but if they do, then they could be substantial.

Let’s look at some options that a state could use.  If states treat bitcoins as currency, then nothing really changes as to tax computations.  Transactions involving bitcoins would be no different from receiving cash or a credit card payment. 

However, if they follow the lead of the IRS, then states might create substantial financial mischief for parties using bitcoins, resulting in a greater tax cost for the recipient of bitcoin than just the B&O or income tax from receiving currency or its commonly accepted equivalent.  More curiously, what could this mean for sales and use taxes?  It would be beyond the scope of this article to explain how the laws would work in each state, but for purposes of illustration, we’ll use Washington laws even though Washington hints that it will treat bitcoins as currency and not property. 

In Washington, if bitcoins are treated as property, then when a buyer pays the seller for goods or services, then the transaction would be a barter --- property in exchange for property or a form of payment (trading a service for the property) other than currency.  Each party is treated as making a sale to the other.  Let’s look at some examples.

In example 1, assume that Ricky and Taylor both own Van Gogh paintings.  Taylor wants to sell hers.  Ricky gives Taylor $20,000 for her Van Gogh.  Ricky owes use tax on his new purchase, so he ends up paying $20,000 to Taylor and $1,900 of use tax to the state, assuming a tax rate of 9.5%.  Taylor has $20,000 in her bank account.  Taylor couldn’t be happier.

Let’s change the example a bit.  In example 2, Ricky sees Taylor’s painting and rather than offering cash, he offers his Van Gogh painting in exchange for Taylor’s painting.  Because they bartered, Ricky would owe use tax on the Van Gogh he got from Taylor, and Taylor would owe use tax on the Van Gogh that she got from Ricky.  The state will receive $1,900 from each for a total of $3,800.

In example 3, let’s assume that Ricky gives Taylor $20,000 in bitcoins instead of paying cash or exchanging paintings.  Many in Taylor’s shoes would think she has $20,000 in a virtual bank account and should be treated like example 1 for tax purposes.  Instead, Bryce, a state tax auditor, does an audit and concludes that she owes use tax of $1,900, treating her like example 2 on the bitcoin that she holds in her virtual bank account.  It is true that these types of transactions might be difficult for Bryce to find, because these are of the “one-off” variety.  But the risk is clearly there.

In example 4, imagine Blayne is an engineer who accepts bitcoin and has received $500,000 in bitcoin payments over the last four years.  This is a barter, because Blayne exchanged services for bitcoins.  When Bryce visits Blayne for a routine audit and finds that Blayne has received $500,000 of property in exchange for services.  Bryce will ask Blayne to pay $47,500 in use tax plus interest and maybe penalties.  Blayne’s gross receipts effectively decreased by at least $47,500.  Bryce likely will find this transaction, because revenue departments routinely audit businesses.

But, Blayne and Taylor don’t care about the audit results because their bitcoins have appreciated by 20%.  Taylor’s bitcoins are now worth $24,000 and Blayne’s bitcoins are worth $600,000.  There’s plenty of gain to pay the use tax.  However, because the IRS treats bitcoins as property, they will pay income tax on their gains.  And, if they are exposed to the jurisdiction of an income tax state, that state also may be able to tax the gain.  A short term gain will be taxed at ordinary income tax rates and a long-term gain at capital gains rates. 

Remember though, that bitcoins can lose value as well as increase in value.  Let’s assume that when Bryce audits Taylor and Blayne, the bitcoins have fallen by 20% to $16,000 and $400,000 respectively.  Now, they have to sell their bitcoins to pay the tax when they are worth less than when they received them.  They just went backwards by the additional 9.5% in addition to the 20% loss in the value of the bitcoins.  The only small salvo is that for income tax purposes, selling the bitcoins at a loss will have some income tax benefit as an offset to other gains, or perhaps a deduction from ordinary income.  For Washington tax purposes, there is no small salvo.  For Taylor and Blayne, there is no way to use this loss to offset other Washington taxes. 

In example 5, let’s assume that Susie has a website from which she makes retail sales of office supplies to businesses like Blayne’s engineering company.  Let’s look first at what Susie’s tax reporting obligations would be.  Assume that she sold ink and paper to Blayne for $100.  She would charge Blayne $100 for the paper and ink plus 9.5% or $9.50 of sales tax.  The total bill would be $109.50.  Blayne would tender to Susie bitcoins to cover $109.50.  Susie would keep $100 and pay the state $9.50 of sales tax that she collected from Blayne and pay the retailing B&O tax on the $100.00 sale proceeds.  That is pretty straightforward, just like a regular currency transaction. 

But now, let’s look at what Blayne’s tax reporting obligations would be.  This is a barter transaction; Blayne sold bitcoins to Susie and Susie sold office supplies to Blayne.   Under Washington tax law, Blayne must collect the sales tax from Susie on her purchase of the bitcoins which was $109.50 (selling $100 of office supplies for $109.50 in bitcoin).  Because Blayne sold and Susie bought bitcoins at retail, he must collect sales tax from Susie and pay retailing B&O tax on the $109.50, the value of the bitcoins that Susie received from him.  The sales tax would be $10.40 ($109.50 times 9.5%) due from Susie.  (I know this sounds weird.  Susie sold $100 of ink and paper to Blayne but has to pay him $10.40 of sales tax for the privilege of accepting bitcoins.)  The net effect is that Susie’s gross receipt on the ink and paper has just been decreased by $10.40 taking her sales proceeds from $100 to $89.60.  This might eliminate a substantial portion of her net profit.  Maybe all of her net profit, depending upon her spread.  She went backward on the transaction unless the bitcoin that she received appreciates greatly in value.  (Note that Blayne’s collection of the sales tax means that Susie does not have to report the use tax as required in examples 2, 3 and 4.  Either the sales tax or the use tax applies but not both.) 

What to do?  Good question.

If states do what Washington is hinting that it will do, then this is a non-issue.  However, if they don’t, then bitcoins might have a significant a tax cost that should be considered before agreeing to accept bitcoins.  For example, Taylor is not fully receiving $20,000, Blayne is not fully receiving $500,000 and Susie is not fully receiving $100; these amounts are actually decreased by the additional sales or use tax cost by taking bitcoins as payment. 

The lesson here is to find out from your respective taxing jurisdictions how they will treat the receipt and possession of bitcoins.  Some states may take the position that bitcoins are intangible personal property and not subject to their sales and use tax laws.  In some states, it might be possible that the resale exception might apply if one could establish that the reason for accepting the bitcoin was to resell it in the ordinary course of business (when reselling bitcoins to vendors for goods and services.)  Yet in other states like Washington, there might be digital products laws that specifically subject intangible property to the sales and use tax rules wherein tax might apply or an exemption might exempt them from taxation.  It’s not enough to understand your home state, but it is also important to understand the rules in other states where you might be deemed to be doing business and required to report taxes with regard to transactions when bitcoins are used.


[1] The uppercase B refers to the technology and the network used to create and process the transactions; lowercase b refers to the virtual coin.

[2] Cryptology is the science of coding and decoding secret messages. (Crypto is the Greek root for secret or hidden).

[3] For a more technical description, there is a white paper at the website.  See

[4] As pointed out in Hamilton’s article, this anonymity creates a Bitcoin “dark side” in that it allows payments to occur with a much smaller risk of detection by law enforcement.  The “peer to peer” use of bitcoins does not create a money trail, making illicit operations difficult for criminal investigators to discover.  Forbes published a 2013 article about an underground, internet drug dealer, operating the website, Silk Road.  The operator took payments in bitcoins until busted by the FBI.  The FBI seized $3.5 to $4 million in bitcoin at the time.  See   When the federal government decided to liquidate nearly 30,000 of the seized bitcoins, they were worth $25,000,000 at the then value of $850.  See

[5] All historical currency rates are from  


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