State Tax Considerations for Virtual Currency Transactions and Initial Coin Offerings

October 30, 2018

Virtual currency transactions and initial coin offerings are growing rapidly, and guidance is needed to address the many state tax issues that arise from these transactions.

By Jeff Glickman, SALT Partner

It’s been about four and a half years since the Internal Revenue Service (“IRS”) issued guidance that virtual currency would be treated as property and not as currency.[1]  However, in that time frame, less than 10 states have issued formal guidance regarding the treatment of virtual currency for state tax purposes.  What makes the state tax analysis complex is the need to address “where” the transaction should be taxed, based on state sourcing rules that were written well before the use of virtual currency.  This article addresses some of the state income tax and sales tax considerations for transactions involving virtual currency, including initial coin offerings (“ICO”).[2]

Virtual Currency Transactions

So, what are the state tax implications when a person purchases a taxable good or service, and pays with virtual currency?

Sales Tax

The states that have issued guidance generally treat virtual currency as intangible property used in a barter exchange or as a cash equivalent.[3]  Either way, when a business sells a taxable good or service, it must collect sales tax from the purchaser when payment is made with virtual currency.

What is the measure of the tax?  This is an issue that the available guidance does not appear to resolve in a consistent manner.  For example, California’s guidance treats the retailer’s advertised price as the measure of the tax.[4]  The notice provides the following example (actual Bitcoin exchange rates are not considered):

A restaurant sells a taxable meal to a customer with an advertised menu price of $50. Customer pays the restaurant 0.065 bitcoin for the meal. The measure of tax from the sale of the meal is $50, which is the amount allowed by the retailer for the 0.065 bitcoin at the time of the sale. Similarly, the restaurant sells a taxable meal to a customer with the menu price of $50. Customer pays the restaurant 1 bitcoin for the meal. The measure of tax from the sale of the meal is still $50. The restaurant should retain a copy of the menu in its records to document the measure of tax from its Bitcoin transactions.

On the other hand, New York’s guidance views the measure of the tax as the value of the virtual currency received by the taxable in U.S. dollars, and provides this example:[5]

An online retailer registered for New York State sales tax purposes accepts convertible virtual currency from a customer as payment for home décor items that will be delivered to the customer’s location in New York State. . . Because home décor items are taxable, the customer owes sales tax based on the taxable receipt for the purchase of the items. The taxable receipt is the fair market value of the convertible virtual currency in U.S. dollars at the time of the transaction.

While the value of the virtual currency received by the taxpayer in the above example should theoretically be equal to the agreed upon selling price, due to fluctuations in the value of virtual currency, that may not be the case.

One of the more difficult sales tax issues raised by virtual currency transactions is sourcing; in other words, determining the location where the sale takes place in order to charge the appropriate state’s sales tax.  Some states have a sales tax sourcing rule hierarchy as follows:[6]

  • If a product received by the purchaser at seller’s location, the sale is sourced to that location;
  • If (1) does not apply, the sale is sourced to the location where received by the purchaser, if known to the seller;
  • If (1) and (2) do not apply, the sale is sourced based on the purchaser address that the seller maintains in its records in the ordinary course of business;
  • If (1)-(3) do not apply, the sale is sourced to the address obtained by the seller upon consummation of the sale, including the address of a purchaser’s payment instrument;
  • If (1)-(4) do not apply or the seller is without sufficient information to apply those rules, then the sale is sourced to the address from which (a) tangible personal property was shipped, (b) the product transferred electronically was first available for transmission by the seller, or (c) the service was provided.

In traditional sales of tangible personal property involving credit card payments, the shipping address will allow the seller to source the sale using rule (2), or perhaps if the taxable product or service is transmitted electronically, then at the very least, the use of a credit card will enable the seller to source the sale using rule (4).

However, what information will a seller obtain (or be required to obtain) with regard to a virtual currency transaction in cases where the purchaser is obtaining the taxable product or service electronically, such as downloadable software?  Perhaps those transactions should be sourced under rule (5)?

On the other hand, perhaps other sourcing information will be acceptable.  Our January 2018 SALT Newsletter contains an article addressed a Texas Private Letter Ruling that permitted a taxpayer to use the physical address associated with the purchaser’s “registration IP address” for purposes of sourcing sales for sales tax purposes.[7]  In that private letter ruling, the taxpayer provided VOIP and related services on a subscription or pay-as-you-go basis.  Purchasers created accounts, but were not required to supply addresses, so the taxpayer had only an IP address from which the account was created.  The state concluded that the “registration IP address” was acceptable, and that the sale would be sourced to Texas if the registration IP address was associated with a physical address in Texas.

Income Tax

Similar to sales tax, the issue of sourcing for income tax purposes may present compliance challenges for taxpayers involved in virtual currency transactions.  Specifically, taxpayers will need to analyze the sourcing rules under the sales or receipts factor of the income tax apportionment formula.

Generally, states source sales of tangible personal property to the location to which the property is shipped, so whether or not the purchaser uses virtual currency to pay for the property, the seller is likely to have the shipping address, and will use that for sourcing purposes.

However, what if the property being sold is downloadable software that a state treats as tangible personal property?[8]  When a purchaser uses a credit card for payment and provides a billing address, taxpayers may feel comfortable using that address for sourcing purposes, although that may not be the same as the shipping address.  For example, a father may use a credit card to pay for downloadable software used by his son while at college, and the address to which the son downloads the software is in a different state than the father’s credit card billing address.  Should a seller be required to obtain a shipping address (i.e., the address of the location of the computer that downloaded the software), or is a billing address a reasonable substitute?

Now assume the purchaser uses virtual currency for the transaction, and the seller has neither a shipping address or a billing address.  Where should the revenue be sourced for sales factor purposes?  What if the state has a throwback rule that requires treating the revenue as sourced to the state from which the good was shipped if the taxpayer is not subject to tax in the destination state, but the taxpayer does not know the destination state?

A similar issue may arise where services are provided, and the purchaser pays for those services with virtual currency.  States generally use one of two methods to source sales of other than tangible personal property: (1) the state where the services are provided (i.e., the income-producing activity or cost-of-performance rule) or (2) the state where the purchaser receives the benefit of those services (i.e., the market-based sourcing rule).

In states that use the income-producing activity rule, sourcing sales involving payment with virtual currency should not create any complexity since those sales will typically be sourced at the seller’s location where the services are performed.  However, in market-based sourcing states, the lack of any destination-based address may cause difficulties for sellers when calculating their sales factor.  Sellers looking to understand what type of information may be used to determine the source of revenues earned from services should review each state’s rules.

For example, in California, the market-based sourcing rules follow a hierarchy to determine where the benefit of the service is received based on specific information as follows:[9]

  • The location where the benefit is received is presumed to be the customer’s billing address (determined at the end of the taxable year);
  • This presumption may be overcome by showing, based on a preponderance of the evidence, that either the contract between the taxpayer and customer, or other books and records kept in the ordinary course of business provide the extent to which the location of the benefit of the service is received at location(s) inside or outside the state;
  • If the presumption in (2) is overcome but an alternative method cannot be determined based on the contract or the taxpayer’s books and records, then the location where the benefit is received shall be reasonably approximated.

Notwithstanding the general complexity of the rules themselves, this hierarchy assumes some level of information that the seller may not obtain in a virtual currency transaction in the regular course of business.  Even if a seller tries to reasonably approximate the location under (3), the term “reasonably approximated” means determining the location where the benefit of the service is received “in a manner that is consistent with activities of the customer to the extent such information is available to the taxpayer.”[10]

With limited guidance, sellers should look towards creating internal “know your customer” (“KYC”) policies so that they can obtain potential sourcing information in the ordinary course of business that can later be used for income tax compliance purposes.  For example, a seller could require a customer to provide an address when her or she registers for an account, or there could be an electronic contract or terms and conditions that a customer e-signs that requires KYC information.

Again, each state’s specific rules should be analyzed to understand what type of KYC information should be obtained, if possible.  There is no doubt that states need to be more active in providing guidance on these issues, as the volume of these types of transaction are only going to grow in the future.

Initial Coin Offerings (ICOs)

ICOs have certainly gained in popularity in recent years, and they present some unique state tax issues in addition to the typical issues identified above in connection with virtual currency transactions.  For purposes of this article, an ICO is a way for a business to generate cash flow in the absence of raising capital in the form of debt or equity by issuing tokens in exchange for dollars or a virtual currency.  The holder of such tokens (referred to as utility tokens) may use those tokens in the future to access the issuer’s goods or services but may also trade them.

Sales Tax

From a sales tax perspective, to the extent the token represents some value, the issuance of tokens should not be subject to sales tax.  Much like gift cards, the purchaser of the token has only obtained the right to use that token to acquire the issuer’s goods or services at some later date.  Therefore, sales tax should be applied at the time the token is redeemed, as long as what the issuer provides in exchange for the token is subject to sales tax.

Similar sourcing issues as described above are likely to be present in these transactions as well, with one added complexity.  At the time of the ICO, the issuer may obtain the address (or some other relevant sourcing information) of the purchaser.  However, the initial purchaser may trade the token, so that at the time the token is redeemed by the issuer in exchange for taxable goods/services, the actual purchaser may be located in a different state (or country).  Thus, token issuers should require every buyer – whether direct or indirect through one or more exchanges – to provide KYC information in order to be able to comply with sales tax obligations.

Income Tax

For income tax purposes, when a company issues utility tokens in exchange for capital, the holders of the tokens do not receive equity in the company.  Therefore, the ICO transaction generates revenue and income to the issuer; the subsequent redemption of the token by the holder in exchange for the issuer’s product/service does not create any income tax consequences.  From a state income tax perspective, there are several issues that need to be addressed with regard to the apportionment of such income.[11]

First, does the income received from the issuance of tokens constitute apportionable business income or allocable nonbusiness income?  States generally define business income to be income arising from transactions in the regular course of business or income from tangible or intangible property if the acquisition, management or disposition of the property constitute integral parts of the taxpayer’s regular trade or business.

Under either of these tests, it is likely that the income will be treated as apportionable business income because the income essentially represents an intangible value that the holder can use at a later date to redeem for the issuer’s goods/services (i.e., no different than a retail store that has revenue from the sale of gift cards).

Second, assuming business income, the next issue is whether or not the revenues from the ICO are excluded entirely from the receipts factor (i.e., excluded from both the numerator and denominator).  Some states exclude gross receipts from the receipts factor if the receipts are not generated in the regular course of business.

For example, California regulations provide that “where substantial amounts of gross receipts arise from an occasional sale of a fixed asset or other property held or used in the regular course of the taxpayer’s trade or business, such gross receipts shall be excluded from the sales factor.”[12]  “Substantial” means a decrease in the denominator of at least 5 percent if the receipts are excluded, and “occasional” means that “the transaction is outside the normal course of business and occurs infrequently.”

Ignoring the issue of whether the receipts are substantial, the real issue is whether the ICO transaction meets the definition of “occasional.”  Again, similar to the business income analysis, while the ICO transaction itself as a whole may be occasional and not in the regular course of the taxpayer’s business, the transaction really represents numerous sales of an intangible right to purchase the taxpayer’s goods/services at a later date.  Therefore, it is likely that the receipts would not be excluded from the receipts factor.

Finally, the remaining issue is whether or not the receipts from the ICO transaction are included or excluded from the numerator of the receipts factor.  This determination will depend on the rules used by states to source these revenues, similar to the issues discussed above involving virtual currency transactions: (1) income-producing activity or cost-of-performance rules; (2) market-based sourcing rules; or (3) some other rule for receipts from intangible property.  Ultimately, depending on the particular rule, taxpayers may find themselves with a lack of KYC information and should consider changes in their KYC process to ensure that information is available in order to properly comply with income tax apportionment requirements.


Remember when software vendors first began offering downloadable software as opposed to software on an actual disk, and then began offering remote access software (i.e., SaaS)?  It took years for states to develop guidance addressing how downloaded software, and then SaaS, would be treated for sales tax purposes.  During that time, there was a period of uncertainty, and taxpayer and their advisors were left to their professional judgments (and in some states that is still the case).

We are in a similar period for virtual currency and ICO transactions.  These transactions are occurring with increasing frequency, yet states have generally been silent with respect to the their sales and income tax consequences.  During this time of uncertainty, taxpayer and their advisors must analyze the varying state tax rules that currently exist and use professional judgement to make reasonable determinations.  In particular, taxpayers must address whether there is particular KYC information that should be obtained in order to be able to comply with state tax requirements.

Contact Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at [email protected] for more information.

This article was featured in the October 2018 SALT Newsletter.

[1] IRS Notice 2014-21 (March 25, 2014).

[2] Please note that for purposes of this article, I am ignoring any potential nexus issues.

[3] Minnesota Fact Sheet 167 (June 2015) (treating Bitcoin as cash); New Jersey Technical Advice Memorandum TAM-2015-1(R) (July 28, 2015) (treating virtual currency as intangible property).

[4] California State Board of Equalization Special Notice L-382 (June 2014).

[5] New York TSB-M-14(17)S (December 5, 2014).

[6] These rules (with minor modifications) appear in S.D. Admin R. 64:06:01:63; O.C.G.A. § 48-8-77; N.J. Rev. Stat. § 54:32B-3.1(a); Mich. Comp. Laws Ann. § 205.69, and other states.

[7] Texas Private Letter Ruling No. 201711002L, Nov. 9, 2017.

[8] The treatment of downloadable software as tangible personal property for income tax apportionment purposes may differ among the states, but a detailed analysis is outside the scope of this article.

[9] Cal. Code Regs. 25136-2(c)(1).  These rules apply to individual customers; the state applies a different set of rules when the customer is business entity.  This is the case on other states as well, such as Georgia and Illinois.

[10] Cal. Code Regs. 25136-2(b)(7).

[11] For purposes of this article, it is assumed that the taxpayer (i.e., issuer) has nexus in more than one state, and thus, has the right to apportion income.  If the taxpayer has nexus in only one state, then all of the income will be reported to and taxed by that state.

[12] Cal. Code Regs. 25137(c)(1).

Disclaimer: Any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Aprio does not provide investment or securities advice. Please do not hesitate to contact us if you have any questions regarding this matter. Aprio, LLP is affiliated with Aprio Wealth Management, LLC a registered investment advisor. Aprio Wealth Management, LLC does not offer investment advice related to token or coin offerings or virtual currencies. No tax advice contained in this circular constitutes a recommendation to buy, sell or hold a particular investment. Neither Aprio, LLP nor Aprio Wealth Management, LLC accepts any fees associated with the sale of securities in connection with token sales.

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About the Author

Jeff Glickman

Jeff Glickman is the partner-in-charge of Aprio, LLP’s State and Local Tax (SALT) practice. He has over 18 years of SALT consulting experience, advising domestic and international companies in all industries on minimizing their multistate liabilities and risks. He puts cash back into his clients’ businesses by identifying their eligibility for and assisting them in claiming various tax credits, including jobs/investment, retraining, and film/entertainment tax credits. Jeff also maintains a multistate administrative tax dispute and negotiations practice, including obtaining private letter rulings, preparing and negotiating voluntary disclosure agreements, pursuing refund claims, and assisting clients during audits.

(770) 353-4791