What Washington’s Interim NFT Guidance Means for Sales Tax Compliance

Charles Maniace
July 18, 2022

Earlier this month, Washington released an Interim Guidance Statement on the taxability of non-fungible tokens (NFTs). In short, the Washington Department of Revenue (DOR) suggested that certain types of NFTs would be subject to sales and use tax under existing rules applicable to digital goods and would also be subject to their business and occupancy (B&O) tax.

In its guidance, Washington did a decent job of explaining the underlying technology. Like most, it jumbles together the concept of an NFT and the digital asset the NFT represents. It’s the token that allows the asset to be traded on blockchain, but it’s the asset itself that stands behind the token (the good or service it represents) that has perceived value.

But what does Washington’s guidance potentially mean for the NFT industry? Here are some key things to keep in mind as NFT marketplaces consider their next steps.

  1. It’s clear that Washington is moving deliberately and obtaining insight from experts and other stakeholders along the way. This approach seems to stand in contrast to territories/states like Puerto Rico and Pennsylvania; both of which revised existing guidance to indicate that NFTs were taxable, with hardly any context at all. Additional published guidance from Washington is likely in the offing.
  2. At least to start, Washington has carved out some straight-forward scenarios, addressing digital assets that have the look and feel of “traditional” digital equivalents to tangible personal property. NFT sellers should know that many states have laws on the books that expressly tax digital equivalents to tangible property and that it’s possible that a good chunk of those states will look to apply those rules to similar NFTs.
  3. Washington didn’t fully articulate the role “smart contracts” play in transaction. Smart contracts are scripts of code that contain all sorts of details of what the NFT represents. It essentially creates the NFT by spelling out what it represents, what it might eventually unlock and whether the creator participates in the proceeds of any future transactions. Recognizing the role of smart contracts is important as Washington and other states move forward with additional guidance.
  4. The DOR suggests that “in some cases” consideration for NFTs is paid in cryptocurrency. Truth be told, it’s essentially all cases. NFTs are traded using the Ethereum cryptocurrency and states should recognize this in any new rules.
  5. The DOR specifies that payments to NFT creators earned in any subsequent transfers are characterized as “royalties,” meaning they are subject to B&O tax but not sales tax. While characterizing these payments as royalties is by no means illogical, it’s interesting to note that they are not considered royalties for federal tax purposes.
  6. Washington makes clear that its existing sourcing rules for digital products will apply to NFTs. Under those rules, tax is applied based on the location of their customer/purchaser if known to the seller at the time of sale, contained in their existing business records or provided by the buyer at the time of sale. If the location of the buyer is not known, then the tax applies based on where the item was first made available by the seller. This last-ditch “origin sourcing” possibility may come into play often given the anonymity permitted by blockchain.
  7. The guidance talks a lot about marketplaces and marketplace facilitator rules. Across the country, most states (including Washington) have rules on the books that hold marketplace facilitators responsible for collecting and remitting sales tax for transactions taking place over their platform. While the document says that NFT marketplaces may be responsible for registering to collect Washington tax, and while one of the examples talks about an NFT marketplace, it did not fully articulate an example showing exactly where and when the marketplace would be liable. For example, it would have been helpful to understand how the sourcing rules might apply when the marketplace does not know the identity and location of the buyer. Is tax based on the location of the marketplace seller or the marketplace facilitator?

There is a lot of public awareness around blockchain, cryptocurrency and NFTs these days, and now that Washington has opened the floodgates by issuing direct guidance, it’s likely that other states will follow.  It likewise seems probable other states with existing laws on the books taxing digital products will say that those laws equally apply to NFTs and will hold NFT marketplaces responsible for the requisite tax collection and remittance. Whether these new states take the time to understand the technology and work with impacted industry players to create thoughtful, comprehensive and most importantly manageable compliance requirements remains an open question. Either way, the industry needs to be ready.

Take Action

Download our ebook to learn more about the digital asset dilemma and how NFTs could potentially impact sales tax regulations.

Sign up for Email Updates

Stay up to date with the latest tax and compliance updates that may impact your business.

Author

Charles Maniace

Chuck is Vice President –Regulatory Analysis & Design at Sovos, a global provider of software that safeguards businesses from the burden and risk of modern tax. An attorney by trade, he leads a team of attorneys and tax professionals that provide the tax and regulatory content that keeps Sovos customers continually compliant. Over his 20-year career in tax and regulatory automation, he has provided analysis to the Wall Street Journal, NBC, Bloomberg and more. Chuck has also been named to the Accounting Today list of Top 100 Most Influential People four times.
Share this post

North America Tax Information Reporting
February 28, 2024
IRS Delays E-File Requirement for Form 1042: What You Need to Know

In a recurring theme, the IRS released communication this week that exempts the requirement to e-file Form 1042 Annual Withholding Tax Return for U.S. Source Income (Form 1042) information for 2023 transactions. Form 1042 for 2023 transactions must be filed with the IRS by March 15, 2024. Notice 2024-26 delays the new requirement to electronically […]

February 27, 2024
The Five Steps to Modern Compliance and Why They Are Critical for Your Business

Last week, we introduced the Sovos Compliance Cloud. The industry’s first and only solution that unifies tax compliance and regulatory reporting software in one platform, providing a holistic data system of record for global compliance. Accompanying this launch, our CEO Kevin Akeroyd wrote about the global landscape of tax compliance, how we got to this […]

North America ShipCompliant
February 22, 2024
Is Beverage Alcohol Self-Distribution the Next Big Thing?

A number of recent lawsuits filed by beverage alcohol producers have raised new interest in self-distribution rights, an often-overlooked area of the industry. Self-distribution is when a supplier of alcohol, such as an importer or domestic manufacturer, is authorized to sell directly to retailers without having to work with a wholesaler to get their products […]

February 20, 2024
Why the Market is Ready for the Sovos Compliance Cloud

The emergence of digital transformation fundamentally changed how many governments and tax authorities around the world handle modern tax and compliance. What is unique about this process is that each individual government operates under its own set of rules, and global businesses are expected to keep up. In their efforts to address compliance, ironically, many […]

North America Tax Information Reporting
February 16, 2024
ACA Reporting Deadlines and More for Tax Year 2023

Affordable Care Act (ACA) reporting has started for tax year 2023. ACA reporting can quickly become complicated and costly with IRS penalties if your business does not have an efficient process in place. Although regulations have generally stayed the same for this reporting season, there are some important updates all businesses should be aware of […]