Colorado is accepting crypto for tax payments — it could be a mess or a shining example

Colorado is now accepting crypto for tax payments — but if you choose to use that option, it could change the amount you owe.

Colorado is accepting crypto as payment for any taxes owed to the state as of Sept. 1. It was the result of a promise made earlier in the year by Colorado Governor Jared Polis, who has proven his commitment to establishing the state as pro-cryptocurrency.

Colorado isn’t the only U.S. state trying to incentivize cryptocurrency investment within its borders, as legislatures in Arizona, Wyoming and Utah have all previously introduced bills to accept tax payments in the form of digital currencies in varying degrees.

There is much to gain economically for states who embrace blockchain technology and the crypto sector. Savvy governments are beginning to pitch their locale as the next center of the crypto economy, hoping to attract new businesses and intelligent, young, wealthy constituents involved with crypto.

Taxpayers should be warned, however, of the tax consequences of making payments with crypto, as making such a payment is a taxable event that has the potential to further increase the amount of taxes one has to pay.

Let’s hope more states follow Colorado’s lead, but they should also learn from where Colorado’s initiative falls short. If states, in the future, want to find success in accepting crypto as payment, they need to understand the tax dilemma inherent to making payments with crypto and lean into the solution of accepting stablecoins as a means of payment.

The issue with making payments with crypto

The big knock on states accepting taxes paid in crypto is that using crypto to pay state taxes is considered taxable disposal for individuals — making a payment triggers its own income event.

The IRS treats cryptocurrency as property, which means if the price of the crypto you're using to pay state taxes has appreciated in value over time, you have taxable income equal to how much the price appreciated since you bought it.

It's important for people to know that paying off their tax bill with crypto will trigger another taxable event for the following tax year.

For example, let's say that, after calculating your 2022 taxes, you have a tax bill due to your resident state in the amount of $10,000. You pay this with $10,000 in Bitcoin (BTC  $20,033) by the due date, April 15, 2023. If you bought that Bitcoin for $2,000, you now have triggered an $8,000 gain by disposing of that Bitcoin. You'll now have to pay tax on your $8,000 gain for the 2023 tax year — solely from paying your taxes with appreciated crypto.

Most people who are invested enough to want to use crypto as their primary payment method very likely have grown their wealth in crypto. These individuals may be hesitant to use their appreciated crypto to pay state taxes in order to avoid the additional tax.

If those who have the ability to pay their taxes in crypto are unlikely to do so, states may find that their initiatives never garner the expected traction. Thus, these programs could end up being more costly than they’re worth.

How states can make paying taxes in cryptocurrency viable

Currently, the only way to pay your Colorado state taxes in crypto is via PayPal’s “Cryptocurrencies Hub,” which does not include stablecoins as a means of payment. If states decide to accept stablecoins as a means of payment, there is potential that paying with crypto will find success across the nation.

Cryptocurrency tokens pegged to the price of the United States dollar remove tax from the conversation when using crypto to make payments. Although disposing of these stablecoins still needs to be reported on your tax return, stablecoins do not fluctuate materially in value.

Any gain or loss would likely be zero or only a few dollars at most and would not significantly impact how much taxes you pay.

Of course, converting any Bitcoin or any other cryptocurrency to a stablecoin is a taxable transaction in itself. Still, it's very likely that, as the crypto ecosystem matures, it will be common for crypto natives to hold a more significant percentage of stablecoins in their overall portfolio.

These crypto natives are looking to cryptocurrencies and decentralized finance as an alternative to the banking system. It's realistic that, in this alternative system, people will hold a certain amount of liquid assets with which to make payments, including their state tax payments.

When stablecoins are used and no tax bill is involved, paying state taxes with cryptocurrency would no longer be disincentivized by our tax system, and these programs may begin getting the traction they deserve. Many people may decide that the best way to make their tax payments is through crypto.

These states have a lot to gain — if accepting crypto, especially stablecoins, for tax payments is implemented correctly and is successful, states have an opportunity to grow into centers for crypto commerce, all while bringing in additional revenue from a growing economic sector.

Will Colorado and other states find success in accepting crypto tax payments? Or will the tax consequences and crypto being in the midst of a bear market stomp out all potential enthusiasm for such government initiatives?

Let’s root for these states and hope they plan to accept stablecoins. Blockchain technology has the potential to play a significant role in how our governments function in the future. Before our local governments can secure our elections through blockchain, they first have to dip their toes in the water and succeed in accepting tax payments in crypto.

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