In November, 2018, Ohio announced that it will allow businesses to pay state taxes in Bitcoin. The state Treasurer’s office will not actually collect Bitcoin; instead, taxpayers will send their Bitcoin to a private third party processor who will in turn send cash to the Treasurer’s office on the taxpayers’ behalf. There is no shortage of potential issues with this arrangement, but one that should be particularly concerning to taxpayers is whether they will incur additional tax liability by choosing to pay their state taxes with Bitcoin.

Under current IRS guidance, Ohio businesses that pay their state taxes with Bitcoin will have additional gross income to report on their Form 1040. The IRS announced that it will treat Bitcoin as property for federal income tax purposes. Accordingly, “[g]eneral tax principles applicable to property transactions apply to transactions using virtual currency.” The Internal Revenue Code specifically includes “gains derived from dealings in property” in the definition of gross income.

From the perspective of an Ohio taxpayer, the result may seem unfair. Why should one have to pay more in federal income tax for choosing to pay their state taxes with a different currency? There are two primary reasons for the disparate treatment. First, neither the Ohio treasurer’s office nor the IRS recognize Bitcoin as a currency. Robert Sprague, the state treasurer of Ohio, emphasized “[Ohio] will never accept won or renminbi or francs or cryptocurrency, or any other currency. You have to relieve your debts to the state of Ohio with U.S. dollars. That’s what we’re currently accepting. This platform just allows for that exchange, basically before that debt is settled to the state of Ohio.”

Second, as Sprague mentioned, businesses do not transfer Bitcoin directly to the state, rather there is an exchange that takes place through a private third party. That exchange is a taxable event.  Imagine, for example, a business simply sells Bitcoin that it owns on the market in exchange for cash. That transaction would certainly be a taxable event, and the business would realize a gain to the extent that the amount of money it received exceeded its adjusted basis in the Bitcoin. The IRS correctly recognizes that Ohio businesses opting to pay state taxes with Bitcoin are in fact selling Bitcoin and then assigning the proceeds to the state. This decision is in line with the IRS’s longstanding policy of looking to the substance, rather than the form, of a given transaction.

Erik Peterson

 

 

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