Navigating the Emerging Risks of Onchain Sales Tax

As Web3 continues to reshape digital interactions, blockchain transactions are now integral to industries ranging from art to finance, and other real-world assets.

However, one critical aspect remains widely overlooked in this burgeoning landscape: sales tax.

While tax discussions around Web3 often focus on the IRS and federal obligations, state tax authorities also have a substantial stake - especially regarding sales tax compliance for digital goods, like NFTs, and other blockchain-based transactions. This includes cryptocurrency payments for tangible goods, SaaS subscriptions, and service-based transactions, all of which may trigger state-level sales tax depending on the jurisdiction.

As a leading crypto CPA, I take pride in being the foremost voice on emerging issues within the Web3 space. By staying ahead of industry trends, I’m able to warn my clients and the broader industry about new challenges like on-chain sales taxes and other critical issues I’ve been vocal about in the past.

By staying informed on these topics, you too can position yourself as a proactive advisor, helping clients navigate complex challenges before they turn into costly compliance risks. In this rapidly evolving landscape, anticipating changes and acting early will not only safeguard your business but also establish your expertise as a trusted resource.

This article delves into why sales tax compliance is crucial for Web3 businesses, the risks associated with non-compliance, and steps you can take to protect your business from costly audits and penalties.

🤔 What Are Sales Taxes

Sales tax, a consumption tax imposed by state governments on goods and services, is a longstanding part of traditional commerce but remains relatively unfamiliar territory in the digital realm - especially when it comes to NFTs and other blockchain-based transactions. 

Typically, sales tax is collected by the seller at the point of sale and remitted to the state government, with the amount owed depending on multiple factors, such as the locations of both seller and buyer and the type of product or service being sold.

👀 Why Sales Taxes Matters In Web3

In the fast-evolving world of Web3, many companies and creators are not fully compliant with state sales tax regulations, creating substantial financial risk. This growing trend of on-chain commerce parallels the surge of internet-based transactions that led to the landmark Wayfair ruling, making this “Wayfair 2.0” for the blockchain era. 

NFT artists, marketplace facilitators, and on-chain businesses are facing increasing exposure to state sales tax obligations, often without realizing it. As state governments roll out new guidance and heighten scrutiny of Web3 transactions, the risks of non-compliance such as audits, penalties, and fines are mounting significantly.

Sales tax is quickly becoming one of the top emerging issues in Web3 because, as the volume and complexity of on-chain transactions grow, state governments are accelerating efforts to ensure tax compliance across digital and decentralized markets. This shift places heightened scrutiny on digital asset transactions, making it critical for Web3 participants to stay ahead of evolving regulations to avoid unexpected liabilities.

⛓️ How Sales Taxes Apply On-chain

Sales tax generally applies to the exchange of goods and services. Applying sales tax accurately in the Web3 space requires a deep understanding of sourcing, nexus, and product taxability - three core concepts that shape sales tax obligations in the blockchain world.

Sourcing the Sale

Sourcing determines the location of a sale, which is essential since each state has its own tax rates. Some states base sales tax on the seller's location (origin-based), while others use the buyer's location (destination-based). To complicate things, remote sales rules and modified origin sourcing add layers of complexity. 

With NFTs and blockchain transactions, identifying the transaction location is uniquely challenging due to the decentralized and often pseudonymous nature of Web3. However, knowing where a sale is "sourced" is the first step in understanding potential sales tax responsibilities.

Nexus

Nexus, or a sufficient connection with a tax jurisdiction, is critical in determining if a seller must collect sales tax. Nexus can be established through physical presence, economic presence, or digital connections like affiliate relationships. 

For Web3, economic nexus often applies, where a threshold of sales or transactions in a state can trigger tax obligations - even if there’s no physical presence. Given the widespread reach of NFTs and on-chain commerce, many blockchain-based businesses could unknowingly create nexus in multiple states, exposing themselves to a web of state tax requirements. (Refer to the Economic Nexus State-by-State Guide)

For example, a seller based in Tennessee may establish economic nexus in Washington if their sales into the state exceed $100,000 in gross receipts or 200 separate transactions within a calendar year. If the seller meets either of these thresholds, they would be required to register for sales tax in Washington and collect tax on taxable sales, including those of digital goods or blockchain-based transactions like NFTs, SaaS subscriptions, or cryptocurrency payments.

These rules are part of Washington and other states’ broader approach to sales tax compliance for out-of-state sellers, which was influenced by the South Dakota v. Wayfair Supreme Court decision in 2018, which allowed states to impose sales tax obligations on sellers with no physical presence, provided they meet certain economic nexus criteria.

Product Taxability

Even with sourcing and nexus established, sellers must assess whether the product or service is taxable. Not all digital goods are subject to sales tax; some states tax items like music or virtual events, while others do not. For NFTs, taxability depends largely on the asset type: Is it a digital artwork, access to an event, a membership, or a collectible that confers rights to physical goods? 

With varying state approaches to digital products, sellers need to watch emerging guidance closely to ensure compliance. For instance, while some states may treat NFTs as digital goods and tax them, others might not yet have clear rulings.

As I predicted in my book, Navigating the NFT Sales Tax Maze: Wayfair 2.0 for Web 3.0, the growth of on-chain commerce is creating conditions for a "Wayfair 2.0" moment in Web3, with blockchain-based businesses potentially facing the same scrutiny that online retail encountered after the Wayfair decision. With states increasingly clarifying sales tax rules around blockchain transactions, the risk of non-compliance is rapidly mounting, making sales tax a crucial issue for Web3 entities.

📚 Emerging Guidance on NFT Sales Tax

States are beginning to issue specific guidance on sales tax for NFTs and on-chain transactions, highlighting an emerging regulatory landscape. Washington and Minnesota have been particularly proactive, treating various digital products, including NFTs, as taxable. 

In these states, digital goods like music, video games, or event admissions fall under sales tax obligations, meaning that NFTs containing these elements may require tax collection. For example, Minnesota taxes NFTs tied to tangible personal property, like digital collectibles or event tickets. 

As more states broaden their definitions of taxable digital goods to include NFTs, compliance will be essential to avoid potential penalties.

🌏 International Considerations for Onchain Sales Tax

As NFTs continue to grow in popularity, global taxation on these digital assets is also evolving, with significant differences in how countries treat sales. In the European Union, Spain has been a leader, applying VAT at a rate of 21% on NFTs, setting a precedent that Belgium has also followed.

However, other EU countries, like Norway, have taken a different approach, exempting NFTs from VAT when sold. The European Commission has recommended analyzing each NFT transaction on a case-by-case basis, meaning compliance requires understanding the specific tax rules of each country.

Outside Europe, several countries are establishing their own tax frameworks for NFTs. In India, there is a proposal to classify NFTs as virtual digital assets under the GST regime, potentially imposing a 30% tax rate. Australia’s tax authorities have ruled that NFTs are subject to a 10% GST, while Switzerland and New Zealand apply VAT/GST at 8% and 15%, respectively, though neither country taxes NFT creation. 

As international NFT sales grow, sellers must navigate these varying tax obligations, including registering and remitting VAT or GST in multiple jurisdictions, making compliance complex.

🔎 Challenges in Collecting Sales Taxes On-chain

Collecting sales tax for NFTs presents unique obstacles in the Web3 space. Like traditional transactions, sellers on-chain need specific customer details, like location and address to properly source sales and apply the correct tax rate. But in blockchain environments that emphasize decentralization and pseudonymity, requesting such information can feel invasive. 

Nevertheless, without these details, sellers may risk non-compliance. For example, Washington may assume all sales are sourced there if an address isn’t provided, meaning sellers could be liable for sales tax—and potentially penalties and interest—on transactions assumed to be within that jurisdiction.

Additionally, once sellers obtain the necessary information, they face the complex task of calculating the appropriate sales tax rate, converting it to cryptocurrency pricing, and retaining transaction records for tax filings. Given the scale and rapid pace of on-chain transactions, relying on automated technology solutions is crucial to streamline tax compliance in Web3.

🫡 Steps for Compliance

As the sales tax landscape for Web3 transactions continues to evolve, it’s crucial for businesses in this space to take proactive steps to ensure compliance and avoid future risks. 

Here are the essential steps to get your Web3 business on the right track.

1. Understand the Basics of Sales Tax in Web3

Familiarize yourself with key concepts like sourcing, nexus, and product taxability as they apply to on-chain transactions. Determining where a sale occurs (sourcing), the jurisdictions that require sales tax (nexus), and whether the goods or services you're selling are taxable (product taxability) are essential first steps.

2. Gather Customer Information

To correctly source sales and apply tax rates, you need to collect specific customer data, including their location. Given the pseudonymous nature of blockchain transactions, this can be challenging, but it’s crucial to comply with state sales tax laws. You may need to ask customers for their location and other necessary details during the transaction process.

To sell an NFT, a company would typically use an NFT marketplace like OpenSea, Rarible, or Foundation, where digital assets like art, music, and collectibles are tokenized and traded. On these platforms, buyers often make purchases using their cryptocurrency wallet without needing to provide personal information, such as name or address. 

While this pseudonymous method of payment offers privacy for users, it poses challenges for sellers when it comes to compliance with state sales tax laws. For instance, to correctly source sales and apply tax rates, companies need to know where their customers are located, information that is typically gathered through billing addresses in traditional e-commerce. With blockchain transactions, especially when buying NFTs, customer location data is not always readily available.

Consider an example of Company A, which is selling NFTs through platforms such as OpenSea. Opensea currently does not require buyers to provide personal information like their location, making it difficult for Company A to accurately apply the correct sales tax rates based on the buyer's state.

In this scenario, Company A may face risks of non-compliance with state sales tax laws, as they may not be able to gather enough customer data to determine the correct tax jurisdiction. Additionally, Opensea itself could also be at risk for non-compliance, as marketplaces typically share the responsibility for sales tax collection.

This lack of compliance is common in many NFT marketplaces, and it's a significant concern for businesses selling NFTs. Most NFT marketplaces, like OpenSea and others, do not actively collect customer location information for tax purposes. This creates a shared risk for both sellers and the marketplace, as neither is properly collecting data to ensure compliance with state sales tax laws.

As another example, if a company is selling NFTs directly on its own website or marketplace, they would need to implement processes to gather customer information, including their location, to comply with sales tax regulations. This involves asking customers to provide their address at the point of sale. 

By collecting this data, the company can accurately source the sale and apply the appropriate sales tax rates based on the customer's location. Failing to collect such data and comply with state sales tax rules can lead to significant legal and financial risks, including back taxes, penalties, and fines.

3. Calculate and Collect the Right Sales Tax

Ensure that you are applying the correct tax rate based on the customer’s location. Sales tax rates vary from state to state and vary within each state, and it's essential to use technology that can accurately calculate and apply these rates in real-time, especially when dealing with cryptocurrency transactions.

4. Retain Transaction Records

Properly maintain detailed records of all transactions, including customer information, sale amounts, sales tax collected, and the cryptocurrency used. This will be vital for future tax reporting and to ensure you’re prepared if you face an audit.

5. Leverage Technology to Automate Compliance

Given the complexities and scale of on-chain commerce, manual tracking and reporting can be nearly impossible. Implementing tax technology designed for Web3 transactions, such as Digital Impost by Camuso CPA, can help automate the collection of customer information, calculation of sales tax in cryptocurrency, and storage of transaction data for future reporting.

6. Consult with Tax Professionals

Sales tax compliance in Web3 is complex, and state rules can vary widely. Partner with tax professionals like Camuso CPA who understand both blockchain transactions and sales tax law to ensure you’re not just following the rules but staying ahead of future changes in the regulatory landscape.

As sales tax enforcement ramps up, businesses in Web3 need to act now to mitigate the risks of future audits and penalties. The key is to work with technology and tax professionals who understand both the complexities of blockchain transactions and the nuances of sales tax law.