More Questions than Answers as Washington Holds NFT Listening Session

On October 20, the Washington Department of Revenue hosted a public “listening session” to garner taxpayer feedback on the Interim Statement it published regarding the tax treatment of Non Fungible Tokens (NFTs), dated July 1, 2022. As written here, Washington is one of a small handful of states that has overtly addressed the sales tax treatment of NFTs, with the other jurisdictions being Puerto Rico, Minnesota and Pennsylvania. Of those states, Washington has been the most thoughtful in attempting to understand the underlying technology surrounding the minting and transfer of NFTs, including the tax complexities related to how transactions are effectuated on the blockchain using smart contracts and cryptocurrency. Washington has also, at least initially considered the reality that most NFT transactions occur through marketplace facilitators, many of which are located outside the United States.

Washington should be applauded for investing significant time and energy in garnering taxpayer feedback, and its evident that it is serious about providing thoughtful and comprehensive guidance that should, eventually, allow NFT sellers and buyers to fully understand their compliance requirements. With that said, there were two clear takeaways from this session.

Right now, there are more questions than answers

Since July 1, 2022, Washington has been compiling taxpayer questions flowing from its interim guidance and the list of open questions is substantial, including:

1. What are the precise responsibilities of NFT marketplaces?
2. How should NFT bundles be taxed (e.g., the NFT that offers a digital image and an event ticket)?
3. How do you determine the timing and place of sale?
4. How should sellers and marketplaces comply given the level of buyer and seller anonymity the blockchain affords?
5. How and when do you determine the dollar value of an NFT given the fluctuations in cryptocurrency exchange rates; and how do you remit tax collected in cryptocurrency?
6. Are there varying tax treatments that occur when an NFT is minted versus when its transferred?
7. Do traditional entity and use-based exemptions like “manufacturing” and “resale” apply to NFT creation and transfer; and how do you account for exemption certificates?
8. What about all the varying types of NFTs – especially those that don’t entitle the holder to future digital assets?
9. Is there a tax implication to “burning” an NFT; which NFT investors often do strategically to create scarcity and increase the value of other NFT’s they may hold?

As additional comments were offered by the 75 or so taxpayers attending the Listening Session, the main refrain from the DOR representatives facilitating the meeting was “That’s a really good question.” While this tells us that Washington is still squarely in an extended “information gathering” stage, the state hopes to issue additional taxpayer guidance during the first half of calendar year 2023; likely cementing its position as the most thoughtful state on this topic.

Though many questions remain – the time to comply is now

Despite all the open questions, one thing remains clear: Washington’s official view is that NFT sellers and marketplaces need to be sales tax compliant now. The state views the Interim Statement as an articulation of existing Washington law that’s been in place since 2009, when it first began overtly taxing digital equivalents to tangible personal property. While it encourages taxpayers to seek letter rulings and other official guidance as appropriate, it clearly doesn’t view its rules as having only future effect.

To some extent, Washington may feel stymied by the strict rule of law. The state was squarely on the leading edge with respect to taxing digital property and technically, it’s true that it is using those same rules to tax NFTs that represent underlying digital products. But, from a practical perspective, Washington’s approach fails to recognize that this industry is only beginning to understand they may have a sales tax obligation and that there are dozens of fundamental questions that need to be answered before taxpayers have a clear and manageable path to compliance. In a world where these practical compliance barriers remain in place, hopefully the Washington DOR is taking the “informal” approach to not aggressively audit and penalize NFT marketplaces today.