2023 Marcum Year-End Tax Guide

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THE MARCUM YEAR-END TAX GUIDE 2023

Amid the rise of non-fungible tokens (NFTs), state tax laws are grappling with these new digital assets. In last year’s Marcum year-end tax guide, we delved into the trend of states expanding their sales and use tax bases to include digital products like NFTs. This year, our focus shifts to the potential tax strategies related to those digital assets, primarily from a sales/use and gross receipts tax viewpoint. But caution remains paramount: As the NFT landscape evolves, so does the uncertainty over its state tax implications. Notably, while Mattel’s recent venture into NFT-linked tangible products like Barbie and Hot Wheels may serve as an innovative marketing blueprint, it also spotlights the intricate tax questions that arise from the blend of tangible and intangible assets. STATE TAX CONSIDERATIONS FOR NFTS BY TRI HOANG AND JOSE SAMPEDRO

Over the last year, while the NFT market has slowed, some businesses have introduced NFTs as service or product offerings. For example, Mattel markets both Barbie and Hot Wheels collectible NFTs in conjunction with tangible product sales. Typically, a consumer will purchase a Mattel NFT at launch and, shortly thereafter, be entitled to claim a time-sensitive “air drop,” allowing them to redeem a physical form of the NFT purchased. While this may be a great marketing strategy to boost physical product sales, the intangible NFT sometimes continues to appreciate. For sales and use tax purposes, numerous questions around tax implications remain unanswered. The two primary issues sellers and taxing authorities face in the NFT space are (1) taxability and (2) sourcing. In the Mattel example, several questions arise from a taxability perspective, “is the consumer purchasing a collectible digital asset, tangible personal property, or both?” For sourcing purposes, it’s also important to ask,

“Is tax assessed at the purchaser’s location, where the physical air drop will be shipped, the retailer’s physical location, or somewhere else?” As with nearly all aspects of state and local taxation, the answer is, “It depends.” Washington’s guidance is the most robust among states that have issued guidance on the sales and use tax implications of NFTs. Washington generally imposes a sales or use tax on certain digital goods, and many NFTs are likely subject to the state’s tax. The state’s guidance indicates that if the NFT confers certain rights or benefits, the true object of the sale will determine whether a tax applies. Traditionally, the true object test comes into play in the case of the sale of a service or intangible that incidentally includes some tangible personal property. Under the true object test, the purchaser’s intent (whether the purchaser intended to receive a service or to acquire tangible personal property) typically controls the classification of the underlying sale. Unfortunately, this

standard is much more challenging to assess in the digital asset space. Some consumers purchase NFTs as collectibles or investments and may ignore any potential underlying benefit or rights the NFT may confer. In contrast, others simply want the underlying benefit or rights. Due to this subjectiveness, should the retailer decide what the true object of the transaction is? This is another of the many unanswered questions that taxpayers and taxing authorities will need to address. In the case of transactions that are considered bundled transactions, generally defined as a transaction that includes both taxable and nontaxable elements, the entire transaction is generally deemed taxable if the sales contract or invoice does not clearly separate or clearly state the sales price of each element. For some marketers of NFTs, this could be a trap for the unwary. Accordingly, prudent tax planning and a risk assessment should always be conducted before adopting NFT technology.