As more jurisdictions contemplate whether to accept cryptocurrency for the payment of taxes and other government services, the complexity and ambiguity in tax rules are seen as significant barriers to widespread adoption. States like Colorado, which has allowed crypto tax payments for two years, have seen minimal uptake, raising questions about the practicality and benefits of such systems. Colorado’s inability to collect enough digital currency to even cover the cost of a single Bitcoin underscores challenges faced by states implementing these systems.
The current state mechanisms for processing crypto transactions are inefficient, with states contracting third parties to convert digital currencies into U.S. dollars. Much like credit card transactions, these third-party services impose processing fees, indirectly burdening taxpayers opting for cryptocurrency payments. Importantly, these mechanisms do not offer any direct financial benefit to the states, other than providing an additional payment option.
From the taxpayer’s perspective, the economic incentive to pay taxes using cryptocurrency is overshadowed by the transaction fee and the involved tax implications. Present tax legislation deems any cryptocurrency transaction a taxable event, turning the act of paying taxes with crypto into a dual tax obligation. Taxpayers not only pay the taxes they owe but must also report and potentially pay taxes on any capital gains realized during the transaction. This effectively results in being taxed twice, a disincentive that deters many from using crypto for tax purposes.
There is a push for reform, akin to the de minimis exemptions in the federal tax code for foreign currency transactions. Introductory reforms that would allow small-scale crypto transactions without the burden of complex tax reporting could encourage more usage. Such a de minimis rule exists for foreign currency gains less than $200, where such gains are not taxable. If applied to crypto, this could simplify transactions, making paying with crypto for government services and everyday purchases more accessible.
For increased adoption of crypto as a tax payment method, expansions to these exemptions could include tax payments, irrespective of the gains involved. Such a move could not only foster usage but also allow states to keep cryptocurrencies, reducing transaction fees and potentially reaping financial returns.
Encouraging crypto as a form of tax payment is part of a broader effort to embrace and normalize digital payments. Tax reform, aimed at clarity and fairness, is essential to cater to the growing population of crypto investors. Simplifying these processes could also benefit the Internal Revenue Service (IRS) by closing the tax gap with clear, straightforward reporting rules.
Attorney Andrew Gordon, managing attorney of Gordon Law Group, argues for a tax code that reflects modern economic landscapes, helping investors from inadvertently breaching tax laws and promoting diverse investment opportunities. For a detailed discussion on this issue, refer to the original analysis by Attorney Andrew Gordon on Bloomberg Tax.