Last week the State of Arizona’s senate passed a bill that would allow the state to accept tax payments in bitcoin and other recognised cryptocurrencies. The law hasn’t quite passed yet, but has moved on to the House of Representatives for consideration. While there are still many practical issues with the ways that cryptocurrencies are taxed in many parts of the world, moves such as this will likely prove helpful in encouraging mainstream acceptance of cryptocurrencies in the longer term. While the United States government has said that it is slowly moving towards the issue of regulating the cryptocurrency market, hopefully more states will start to engage with cryptocurrency and put measures into place that allow cryptocurrency to thrive grow. Willingness to engage with cryptocurrency on the part of governments will likely have a legitimising effect, fostering public trust in cryptocurrencies. Unfortunately, it doesn’t sound as though the Arizona department of tax revenue plans to hold the cryptocurrency they receive, but instead will be obliged to accept it and exchange it for U.S. dollars shortly after. This could mean that traders and investors aren’t forced to sell out to fiat currency in order to meet their tax bill. Instead, they can choose to pay taxes directly from their crypto holdings.
One factor that’s currently unclear is whether or not using cryptocurrency to pay tax bills from one financial year would trigger capital gains tax that carries over to the next financial year. This is probably the most likely outcome, especially as the Arizona bill will allow any income tax to be paid off with cryptocurrencies. So far in most countries, whether you sell your crypto for fiat, for another cryptocurrency or trade it for a Lambo (or even a coffee or pizza!), you trigger a sale for capital gains purposes and have to declare gains or losses. If the same applies to exchanging crypto to pay your taxes, it is still a good outcome, but not nearly as beneficial as a scenario where you could avoid paying taxes upon disposing of the crypto you hand over to the tax department.
While correctly reporting and paying tax on cryptocurrency isn’t impossible by any means, it is far from ideal, especially for those making frequent trades. The ability to pay taxes directly with cryptocurrencies could well simplify the process of paying tax (especially for those who don’t have cash reserves) and encourage more crypto enthusiasts to declare their profits and losses to the state. Several polls taken to date in the US have revealed that very few individuals are currently declaring their capital gains from crypto. It’s worth noting that some of these polls and audits of exchanges are a couple years out of date, so a review of how many people lodge their gains from the last and most profitable financial year would be beneficial. Regulating cryptocurrencies for tax purposes is very challenging, which is why many governments are resistant to crypto or are moving towards regulation very slowly. Despite this, the next couple of years will surely see an increase in audits, fines and arrests as authorities look to impose tighter regulations and crack down on tax evasion, money laundering, Ponzi Schemes and all sorts of other illegal or shady activities.