More People Would Pay Taxes With Crypto if Rules Were Clearer

As states weigh whether they should accept cryptocurrency for payment of taxes and other services, it’s easy to be cynical. Since adopting crypto as a payment method two years ago, for example, Colorado hasn’t collected enough to cover the cost of a single Bitcoin.

The problem is that current state payment systems aren’t practical for agencies accepting money or residents paying with crypto. What’s known in the federal tax code as a de minimis exemption is a simple fix that would encourage more individuals to pay taxes with crypto.

Colorado’s crypto payment system might seem like a failed experiment at first glance. If we’re to view Colorado’s two years as an appropriate sample size, people aren’t using crypto to pay their tax bills.

But let’s look at the states accepting payment—Colorado, Utah, and now Louisiana (for some state services, but not taxes). Because these states don’t hold the crypto they receive in reserve, they aren’t accepting the crypto directly. Instead, they contract with third parties to immediately convert digital currency into US dollars.

Like credit card processors, these third parties charge a processing fee, and that transaction fee is passed on to the person paying with crypto. Outside of offering the convenience of another payment option for residents to use, states accepting crypto see no financial benefit.

For taxpayers, the economic disincentive to pay with crypto doesn’t end with the transaction fee. That’s because of the confusing way in which crypto is taxed—our current tax laws view any crypto transaction as a taxable event. If you pay your tax bill with crypto, you’ll have a transaction that needs to be reported, and you’ll be taxed on that crypto’s capital gains.

That means you’d effectively be taxed twice. First, you’re paying the taxes you actually owe. Then, you’re paying taxes on any capital gain—the difference between the price you paid for the asset and the “sale”—that’s registered when you use crypto as a form of payment. Why would anyone pay their tax bill with crypto when they’re essentially penalized for doing so?

This issue illustrates why I’ve long advocated for reform that simplifies how crypto is taxed. The tax code is archaic and difficult for most people to understand, too often making crypto investors unknowing tax criminals.

A de minimis exemption for small transactions that mimics our existing rules for foreign transactions would allow more people to use crypto to pay for government services as well as everyday purchases. Under existing laws, if you buy something with a foreign currency and the gain from that transaction is less than $200, you don’t have to report that gain as taxable income.

Lawmakers could simplify tax reporting for everyday transactions by implementing a similar rule for crypto transactions. If you buy a carton of eggs with your crypto debit card, you shouldn’t have to worry about reporting that on your taxes.

If states want to improve the adoption of crypto as a tax payment method, they could expand this exemption to include tax payments, regardless of the gain amount. You’d pay your tax bill with a cryptocurrency such as Bitcoin, but you wouldn’t be taxed again simply for making that payment. Further, states could hold that crypto in reserve to avoid transaction fees and potentially see a return on investment.

Adding cryptocurrency as a form of tax payment is a step in the right direction. With the growing number of individuals interested in crypto as an investment opportunity, lawmakers should take actions that embrace, normalize, and simplify the use of digital payments. That starts with tax reform that’s fair and straightforward.

Crypto tax reform presents an incredible opportunity: The technology is designed to modernize how we think about the economy and make it easier to grow one’s wealth. Investors deserve a forward-thinking tax code that encourages diverse investing.

Streamlining the process also benefits the IRS. With simpler reporting rules, the government can help close the tax gap for people who want to comply but just don’t know how to do so.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Andrew Gordon is managing attorney of Gordon Law Group, a Chicago law firm focusing on cryptocurrency, tax, and business law.

Write for Us: Author Guidelines