The IRS classification of bitcoin and other so-called “virtual currencies” as property under the US Internal Revenue Code earlier this year created a variety of unanticipated and potentially undesirable consequences. Since many states incorporate the US Internal Revenue Code by reference, bitcoin’s classification as property at the federal level trickles down to the state level. While some states have explicitly ruled out consumption taxes on digital currencies, others have not.
In the United States, sales taxes are administered by state level taxation authorities. Not every state has a sales tax, just as all states do not have an income tax. In the Great State of Texas, sales tax (formally referred to as the “Limited Sales, Use, & Excise Tax) applies to the purchase or sale of almost all tangible personal property. The tax also applies to tangible personal property purchased outside and brought into the state to the extent that the statutory maximum tax (currently 8.25%) was not already paid to the taxing authority in the place of origin.
Texans enjoy a Constitutional prohibition on income taxes of any kind. As a result, the State has one of the most complicated sales tax regimes in the country. Interpreting the rules can often be more art than science, requiring a near encyclopedic knowledge of every conceivable business model that is or could be in operation here. Under the sales tax law in Texas, the sale of intellectual property is taxable, as are numismatic items with a value greater than $1000 (including gold and silver). Additionally, certain obviously intangible items, such as electricity, are nevertheless classified as tangible personal property and taxed (residential customers are exempt from taxes on electricity).
There is no statutory reason that the purchase, sale, or importation of virtual currencies would be exempt from collection of sales tax in Texas. Note that I refer here to the purchase OF bitcoin, not a purchase WITH bitcoin. A purchase of a taxable item using bitcoin as the means of payment would clearly fall within the tax rules.
While the Texas Banking Commission has stated that bitcoin will essentially be treated as an investment, that regulator does not administer taxation in Texas. That task falls to the Texas Comptroller, which has issued no formal guidance to date. Should the Comptroller, who is an elected official in his own right, determine that digital currencies fall into the category of tangible personal property, nothing short of legislative action would prevent taxation as such in the State of Texas.
This isn’t so unlikely. Outside the United States, tax treatment of digital currencies varies widely. Belgium, Finland, and others have exempted digital currency transactions from VAT (a form of sales tax). The UK has put them in the same category as gold, which creates different tax consequences in that country based on who is paying the tax. Sweden and Poland have declared that digital currencies are subject to VAT in those countries. Australia treats digital currency transactions in the same way as barter transactions, which means that they are subject to GST (yet another form of sales tax).
Texas law is but one example of the difficulties associated with figuring out how digital currencies fit into the established legal and regulatory framework. Chalk this up as a major impediment to the growth of digital currencies. Since governments enjoy a legal monopoly on the printing of money and the setting of monetary policy (and have little incentive to grease the skids for an alternative form of money), don’t expect a quick or painless fix.