Non-fungible tokens: Circle of tax authorities as risks of tax evasion increase

The popularity of non-fungible tokens (NFTs) skyrocketed in 2021. The multi-million dollar sale of the blockchain-based certificates of ownership included everything from a signed tweet to virtual sneakers. Not everyone is impressed. The steep carbon footprint of digital assets angers environmentalists; their opacity worries those fighting money laundering and tax evasion.

The art market already offers opportunities for money laundering. Secrecy is pervasive, a U.S. Senate report last year found. But the difficulty of transporting and storing art does not apply to NFTs. By purchasing and reselling NFTs, criminals can move coins associated with illegal activities to wallets that are not associated with them.

Selling individual NFTs at record prices is too popular to be suspicious. But the tax authorities don’t have a handle on the NFT market. It's worth $14 billion this year and growing fast, according to Jefferies. NFTs are inherently invisible, Internal Revenue Service chief Charles Rettig said earlier this year as he warned that cryptocurrencies were contributing to a $1 trillion annual shortfall in U.S. tax revenue.

Tax rules need to be better defined. Most tax authorities consider cryptos a type of property, like stocks or paintings, so taxes can be levied on profits. However, there are disputes over which jurisdiction should have taxing rights. There is also debate about which NFTs should be taxed. The latest global money laundering guidelines only target NFTs with investment or payment applications.

Tax authorities need better data. The biggest revenue stream in President Joe Biden's infrastructure bill - estimated at $28 billion over a decade - includes rules requiring brokers to disclose crypto transactions, potentially including those involving NFTs. Controversially, this could drive blockchain projects abroad. A new bill attempts to water down the reform.

Tax collection was likely always going to be difficult for an industry with libertarian roots. But financial authorities will not be willing to overlook a market that is expected to grow fivefold to more than $75 billion over the next four years. Nor should they, given the opportunities for circumvention that NFTs offer.

The Lex team is interested in hearing more from readers. Please let us know what you think about NFTs and tax evasion in the comments below.