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NFT sales can lead to substantial income tax obligations

On Behalf of | Feb 21, 2022 | Tax Law |

At first, e-commerce largely involved businesses selling and shipping physical items either to individual consumers or other companies. However, the shift to fully-digital transactions has begun.

Some people and businesses traffic in digital currencies, like cryptocurrencies. There are also massive marketplaces that primarily facilitate the sale of digital items. Non-fungible tokens (NFTs) are a perfect example of a digital commodity now available for sale online.

NFTs are unique digital works, such as limited-edition graphic works, that creators or companies sell to others. Every NFT is unique and potentially valuable. If you have facilitated the sale of NFTs, created digital works for sale as NFTs or resold NFTs you purchased previously, those transactions may have a major impact on your taxes.

Tax returns need to include all income

Some people think that digital assets aren’t subject to taxation. For example, if someone uses Bitcoin that they mined themselves to purchase an NFT, they may feel like their entirely digital transaction should not be subject to real-world taxes.

However, the Internal Revenue Service (IRS) disagrees with that stance. There are income tax rules that apply to the creation or mining of cryptocurrency, as well as the gains made by trading or cashing out those currencies. The IRS has clarified those rules in recent years and have begin enforcing them. Those who don’t report and pay taxes on their digital currency holdings could find themselves facing an audit or even allegations of tax fraud or tax evasion.

The same could soon be a risk for those involved with NFTs.

What is the IRS approach to NFTs?

Although the IRS has not made a definitive statement about NFTs, people will need to report their income from the sale of these digital items. Tax experts have warned that the tax rate for investment returns may not apply to NFTs. Instead, the IRS may instead expect sellers to pay the 28% tax rate applied to certain capital gains.

Although there is no guarantee either way until the IRS makes a policy announcement on the matter, those who apply the lower 20% tax rate for investment returns may find themselves owing a major tax bill, along with interest and penalties. Learning more about changing tax laws can help you as you prepare your annual income tax return.

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