[co-authors: Darren Oswick and Heiko Stoll]

Ohio appears to be the first state that will accept bitcoin as payment for tax bills.^[1] Other states, such as Arizona, Georgia and Illinois, have considered allowing bitcoin tax payments, but the bills have not passed the relevant legislative bodies.^[2] Starting this week, Ohio reportedly will allow businesses to pay corporate taxes in bitcoin by sending the bitcoin to a payment processor called BitPay, which will then convert the bitcoin to dollars for the state treasurer’s office. In its move to rebrand the state as a tech hub, however, Ohio may also be introducing unexpected tax consequences to its taxpayers.

Economically, the use of cryptocurrency to pay state tax liabilities is the same as selling the cryptocurrency for cash and using the cash to pay the liability. There may be taxpayer savings associated with this process, such as lower transaction fees for payments made in cryptocurrency, or favorable exchange rates as the cryptocurrency is converted into dollars.

Important tax considerations also exist if a taxpayer uses bitcoin to pay for tax liabilities. For example, under traditional U.S. tax principles, using an asset (including cryptocurrency) to satisfy a liability is effectively treated as a sale of the asset. Thus, the actual use of bitcoin to pay taxes can give rise to additional tax liability in cases where the value of the taxpayer’s bitcoin has appreciated since its acquisition. Alternatively, the disposition can give rise to a loss where the value of the taxpayer’s bitcoin has depreciated. Additional issues will arise where the bitcoin that has been disposed of was acquired at different times, requiring the taxpayer to establish a separate tax basis for each distinct bitcoin balance disposed of. The taxpayer may also need to swap altcoin for bitcoin if the particular altcoin is not accepted by the taxing authority. In such an instance, the same issues described above relating to gains and losses will arise.

Some countries, such as Germany, may exempt from taxation gains recognized on disposition of cryptocurrency, including use for paying liabilities, where certain requirements are met (e.g., an individual’s holding of cryptocurrency as a private asset for more than one year).^[3] Similarly, other countries may have broader exemptions from tax that can apply to dispositions of cryptocurrency. The U.K. is one such country that allows an exemption where a taxpayer can establish that his or her position was sufficiently speculative in nature (as opposed to active trading or disposing of an asset within the chargeable gains regime). However, the U.K. tax authorities may be keener to disallow losses, despite allowing exemptions for profits or gains.

Not all taxpayers, however, will seek to turn off taxation when cryptocurrency is disposed of. Where an exemption from gain applies, deductions for losses will often be denied. This dichotomy gives some planning ability to taxpayers in deciding how to satisfy their tax and other payment obligations. Planning can be made easier with the use of certain tools that permit taxpayers to accurately track their transaction history in various cryptocurrencies.^[4]

[1] See https://finance.yahoo.com/news/mainstream-ohio-businesses-now-pay-013937128.html; https://www.wsj.com/articles/pay-taxes-with-bitcoin-ohio-says-sure-1543161720. This new development in Ohio follows the example set by Seminole County in Florida, which was reported to be the first tax authority in the United States to accept bitcoin (and Bitcoin Cash) as a means of paying tax liabilities. See https://bitcoinist.com/florida-county-first-us-accept-bitcoin-taxes/.
[2] See https://www.coindesk.com/ohio-becomes-first-us-state-to-allow-taxes-to-be-paid-in-bitcoin. The bill passed by the Arizona Senate would allow for payments in bitcoin as well as other cryptocurrencies recognized by the state tax authorities. See http://fortune.com/2018/02/10/arizona-bitcoin-taxes/.
[3] https://cointelegraph.com/news/germany-wont-tax-cryptocurrencies-used-to-make-purchases.
[4] See, e.g., https://www.node40.com/; https://libra.tech/.