Should blockchain technology be taxed?

Should blockchain technology be taxed? If so, should local governments be able to tax it, or should tax policies be left to the federal government and/or states? Lawmakers nationwide are deliberating these and other questions as the blockchain becomes more ubiquitous. Currently, the issue of location taxation is up for debate in Arizona.

But before diving into Arizona, here’s a brief review of the blockchain.

A blockchain is a digital database, a sequential ledger that encrypts each new bit (or block) of data and merges it with the prior entry to create a chain of time-stamped and highly secure data. There are numerous blockchains, including Bitcoin, Ethereum, and TRON.

Blockchain technology allows information to be shared simultaneously and securely within a decentralized network, which can be public or private. It can be used for a variety of purposes including but not limited to:

• Data storage, including non-fungible tokens (NFTs)
• Digital currency transactions, including sales in the metaverse
• Financial exchanges
• Money transfers
• Medical records
• Smart contracts
• Supply chain monitoring
• Voting

Though blockchain technology seems esoteric to noncoders, its many possible benefits and uses are building up its fan base. And the more widely it’s adopted, the greater the need for government officials to decide whether and how to regulate and tax it.

Yes, and no. The U.S. Government Accountability Office (GAO) has “found gaps in regulatory authority” related to blockchain technology. In a 2023 report on the issue, GAO recommended Congress consider legislation for federal oversight of nonsecurity crypto-asset spot markets and stablecoins. It also recommended financial regulators identify and address blockchain-related risks.

As for the states, 28 considered bills concerning blockchain, smart contracts, and verifiable credentials in 2022, according to the National Conference of State Legislatures (NCSL). During the 2023 legislative session, 39 states, the District of Columbia, and Puerto Rico introduced bills or deliberated pending legislation related to digital assets and/or the blockchain.

“There have generally been two approaches to regulation at the state level,” observes Global Legal Insights. Some states are establishing favorable policies to promote blockchain technology, while others are “making it harder for blockchain companies to operate within their borders.” 

Whether states want to promote or inhibit blockchain technology is shaping the tax policies they’re developing. 

“State and local governments have several options to incentivize or discourage blockchain,” explains David Lingerfelt, Senior Director of Indirect Tax at Avalara. “They can exempt from property tax the personal property used in blockchain mining (e.g., computers and servers), or tax it. They can exempt from sales tax the purchase of material and equipment used in blockchain mining, or tax it. They can impose an excise tax on the mining activity to discourage it; this is largely done to counter the excessive energy consumption the industry is known for. Finally, states can prohibit local impositions to simplify compliance.”

These are actions the general business community would like states to take broadly, reminds Scott Peterson, VP of Government Relations at Avalara. He says the question should be why states would grant incentives for blockchain technology when they don’t provide a similar incentive for traditional technology.

Wyoming is decidedly pro blockchain and related technologies, and policies such as the exemption of virtual currency from Wyoming property tax have helped the industry to boom in the state. Along that line, Kentucky has adopted sales tax incentives to increase cryptocurrency mining in the state.  

Montana also holds that “digital asset mining provides positive economic value for individuals and companies.” In 2023, the Big Sky State passed a law clarifying that digital assets are personal property and prohibiting “unduly discriminatory” tax rates on digital asset mining, digital asset mining businesses, or home digital mining. 

Several other states are considering exemptions for certain blockchain technology, For example:

• Kentucky may exempt computer system nodes from sales tax
• Oklahoma and Texas may create a sales tax exemption for machinery and equipment purchased for commercial crypto-asset mining 
• Arizona may exempt virtual currency from property tax (2023 Senate Bill 1240 and SCR1007)

Arizona law currently prohibits a city or town in the state from prohibiting or otherwise restricting an individual from running a node on blockchain technology (aka, “providing computer power to validate or encrypt transactions in blockchain technology”) in a residence. According to the statute, “the regulation of the act of running a node on blockchain technology in a residence is of statewide concern.” 

A handful of lawmakers in Arizona want to make the law a bit broader. Senate Bill 1127, introduced on January 22, 2024, would prohibit cities, towns, and counties in the state from imposing a tax or fee on running a node on blockchain technology in a residence.

Scott Peterson notes that most local zoning authorities prohibit commercial business from operating in a building zoned as a residence. He noticed that SB 1127 says nothing about overriding zoning authority. 

This isn’t the first time such a bill has been introduced in the Grand Canyon State. In fact, the Arizona Legislature narrowly passed a substantially similar bill (Senate Bill 1236) in 2023. Governor Katie Hobbs vetoed it, noting that it “broadly defines ‘blockchain technology’ and prevents local policymaking concerning an emergent and potentially energy-intensive economic activity.”

SB 1127 is unlikely to make it to the governor’s desk this year, and frankly, Governor Hobbs would probably veto it if it did. However, her veto message for SB 1236 said she’s looking forward to finding “bipartisan solutions that support a thriving economy and technological innovation,” so we probably haven’t seen the last of this issue.

Peterson reminds that while cryptocurrency may be used as a form of payment, it isn’t actual money. Crypto is an asset, like gold. “Logically, exempting crypto mining should follow how a state treats mining for other types of assets.” 

According to the Arizona Department of Revenue, anyone in the business of mining, quarrying or producing for sale, profit, or commercial use any nonmetal mineral product is subject to the transaction privilege tax under the mining classification.

Read more about the blockchain and related technologies and tax trends in the software section of our annual report, Avalara Tax Changes 2024.