Colorado Now Accepts Crypto for Tax Payments

On 9/1/22, Colorado became the first state to accept cryptocurrency for all tax payments. There are many ways this could have been structured and I think the state picked an interesting one which I assume makes it easier for the state.

Payments have to come from PayPal Cryptocurrencies Hub. The PayPal account has to be a personal one rather than a business one. Per the DOR website on this:

"A sufficient amount of cryptocurrency to cover the tax, obligation and fees is converted to dollars and remitted to DOR to complete the online transaction. Service fees include an additional $1.00 plus 1.83% of the payment amount. You must have the entire value of your invoice in a single cryptocurrency in your PayPal Cryptocurrencies Hub. Effective on the date initiated, USDs will transfer in 3-5 business days." [also see https://www.colorado.gov/revenueonline/_/#1]

Per the PayPal crypto website, you can buy, transfer or sell Bitcoin, Bitcoin Cash, Ethereum, and Litecoin.

So, sounds like if I owe $100 to the Colorado DOR, I can only pay in crypto if I have at least $103 worth of one of the four cryptocurrencies in my PayPal account. If I have $50 of Bitcoin and $53 of Litecoin, that won't work. I'd need to acquire more of one of those cryptocurrencies via my PayPal account to do the transaction.

Tax considerations: Per the website, PayPal is converting my crypto to dollars and remitting to the DOR. So, any broker reporting falls on PayPal. The taxpayer has a barter transaction per Notice 2014-21 and needs to calculate gain or loss using the value of the crypto used less their basis in that crypto.

Why might Colorado be doing this? Well, this question has been posed by many people for years - can I pay my taxes in crypto? I think this is only of interest to someone who happens to have sufficient crypto in an account to make the payment or doesn't want to convert it to cash first to pay. I think few crypto owners will pay taxes this way, but it is good to have the option. And it looks like for Colorado, they are just getting the cash as they typically would.

And Colorado will know which taxpayers have crypto because they received payment via PayPal Cryptocurrencies Hub.

But the state has to devote resources to explaining this. At 10/2/22, they even have 10 FAQs on this payment technique. 

FAQ #5 is interesting - Taxpayer changed their mind mid-transaction but realize afterwards that their crypto is gone from their PayPal account. What happened? "If you leave the process after selling your cryptocurrency in your PayPal Cryptocurrencies Hub, but before completing the entire checkout process, your cryptocurrency will still have been sold and the US dollar equivalent deposited into your PayPal balance."

So, be sure you want to pay via crypto before starting your tax payment transaction.  The FAQ should add here (and other places) - and you need to calculate the gain or loss from that conversion (whether or not it resulted in cash used to pay your taxes or for a transaction cancelled mid-point, cash in your PayPal account).

FAQ #10 - If I need a refund, will it be based off the current exchange rate of the cryptocurrency? "If a refund is to be provided for any reason, this will only be provided in US dollars for your invoice amount."

A few observations on FAQ #10:

• Why not just make it really clear on the website that taxpayers are converting crypto in their PayPal account to cash with PayPal submitting that cash to the DOR?  And adding that you are really paying in cash and creating a gain or loss from the conversion of your crypto to cash. Then it would be more clear that, of course, any refund is going out from the DOR in US dollar. But perhaps taxpayers might think that the DOR will send the dollars to PayPal who would use it to buy more of the crypto that had been converted to US dollars to pay the tax.
• If a person pays too much to the DOR and the value of the crypto converted to cash to pay the tax bill goes up, they lost out on that value by converting too much (or even using any of it to pay their taxes) and don't get any relief because the refund is NOT done by having that same quantity of crypto that was overpaid going back to them as a refund.

What do you think? Should more states and even the IRS do what Colorado DOR is doing?  Or allow another payment structure or just take the crypto directly and hold onto it?

Digital Asset Reporting in H.R. 3684 Infrastructure Legislation

Late on November 5, 2021, the House passed (228-206) H.R. 3684, INVEST in America - the infrastructure bill that has received a lot of attention this year. It already passed in the Senate on August 10 (69-30).

One of the few tax items here and added for tax gap concerns is to expand the definition of broker under §6045 to require additional reporting for certain digital asset transactions. A few observations:

1. There are much bigger tax gap concerns than misreporting or non-reporting of digital asset transactions such as underreporting and non-reporting by some cash businesses.

2. The text added to §6045 requires actions by the IRS and is confusing and potentially too broad to be administrable (unless the IRS addresses that broadness). The issue is that "broker" is expanded to include: "any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person." While the goal was likely to make virtual currency exchanges such as Coinbase and Kraken be brokers, the reach is potentially wider. For example, what about a company that provides various software for transfers or wallets? 

Digital asset is also broad and warrants input from IRS: "Except as otherwise provided by the Secretary, the term "digital asset" means any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the Secretary."

That last phrase reminds me of the cryptic item in the 2020 Form 1040 instructions on the broadness of "virtual currency." The instructions for the virtual currency questions included for 2020: "Regardless of the label applied, if a particular asset has the characteristics of virtual currency, it will be treated as virtual currency for Federal income tax purposes." [page 17 of 2020 Form 1040 instructions] What does that mean?

I have a track changes version of §6045 and related provisions that were modified by H.R. 3684 (Sec. 80603), which can help see the set of changes to broker reporting that were made.

These changes are effective for statements required by be furnished after 12/31/23 so there is time for the IRS to issue proposed regulations and get public comment.

What do you think?