Paying Income Taxes With Bitcoin? A US State May Accept Cryptocurrencies By 2020

This article originally appeared in the Motley Fool.

Though the cryptocurrency market has hit a few speed bumps over the past month, its value has still soared relative to where it began 2017. As of Feb. 13, cryptocurrencies were worth an aggregate of $410 billion, representing a more than 2,200% increase from 13 1/2 months prior. Those are gains that investors traditionally wouldn't see without holding an asset for decades.

Plenty Of Intrigue, And Questions, Surround Bitcoin

As you might have rightly guessed, bitcoin has mostly led the charge higher in virtual currencies. Bitcoin easily remains the world's most valuable cryptocurrency by market cap, is accepted by more merchants worldwide than any other digital token, and is credited with pushing blockchain technology into the spotlight. For those unfamiliar, blockchain is the digital, distributed, and decentralized ledger underlying cryptocurrencies that's responsible for keeping an immutable record of all transactions without the need for a financial intermediary.

Bitcoin brings a lot of excitement to the table for crypto-enthusiasts. For example, its blockchain technology has been the basis of evolution for other currency and non-currency applications. Blockchain may be able to significantly speed up processing and settlement times for traditional banking transactions and payments, while at the same time lowering transaction fees since there is no middleman involvement from banks.

There's also intrigue surrounding the use of cryptocurrency as a medium of exchange for goods and services as opposed to cash or credit. As noted, no digital currency is used more for the purchase of goods and services than bitcoin, and no virtual currency has more brand-name payment partners than bitcoin.

Nonetheless, bitcoin's use has remained constricted in the U.S. and in quite a few countries abroad. Since bitcoin lacks the traditional governmental backing found with fiat currencies, few governments have been willing to recognize it as an acceptable form of tender. In fact, a half-dozen countries have gone as far as to ban bitcoin and related cryptocurrencies.

But times could be changing.

This State May Allow You To Pay Your Income Tax With Bitcoin Or Litecoin

On Feb. 8, the Arizona Senate passed a bill (SB 1091) by a 16-to-13 vote that would allow its residents to pay their income taxes using bitcoin or other cryptocurrencies recognized by the state's revenue authorities, beginning in 2020. The measure also passed the Senate Finance Committee by a 4-3 vote. More specifically, the bill states that residents would be allowed to use "a payment gateway, such as bitcoin or other cryptocurrency recognized by the department, using electronic peer-to-peer systems." SB 1091 will next move onto the Arizona House of Representatives for debate and vote.

In addition to accepting cryptocurrency as a form of payment for income taxes, the state would be required to convert any and all cryptocurrency received into U.S. dollars within 24 hours of receiving payment. Doing so should help shield the state against wild virtual currency price fluctuations.

What's particularly notable about the passage of SB 1091 in the Arizona Senate is that it would signify the first widespread adoption of virtual currencies in the United States. It's been argued that bitcoin's value is difficult to determine because it has no backing or guaranteed use from the government. SB 1091 would give bitcoin, Litecoin, and other "recognized" cryptocurrencies a real-world function, and presumably real-world value.

Rep. Jeff Weninger (R-Ariz.), one of the co-sponsors of the bill, had this to say when interviewed by Fox News: "It's one of a litany of bills that we're running that is sending a signal to everyone in the United States, and possibly throughout the world, that Arizona is going to be the place to be for blockchain and digital currency technology in the future."

Don't Expect This To Be A Success

While this development out of Arizona is encouraging for crypto-enthusiasts, it's not guaranteed to be a success right out of the gate.

One of the gray areas in this bill is what happens if there is excessive volatility between the time a resident pays income taxes and the time the Arizona revenue department converts those bitcoin, Litecoin, or other approved cryptocurrencies into U.S. dollars.

According to the bill, "The Department shall convert cryptocurrency payments to United States dollars at the prevailing rate within twenty-four hours after receipt and shall credit the taxpayer's account with the converted dollar amount." Note that last part that about the "converted dollar amount." That means -- at least to me, and I'm no lawyer -- that if a resident paid in bitcoin, Litecoin, or some other cryptocurrency, and that digital coin dropped, say, 10% overnight, this resident would still have to fork over the remaining balance to cover his or her income tax bill following that conversion.

It also isn't clear what would happen if cryptocurrency values vault higher in the overnight hours before conversion. Would the taxpayer get a refund, or would the state simply pocket the difference?

It also remains to be seen how widespread the use of cryptocurrencies to pay income taxes would be in Arizona, assuming this bill becomes law. Bitcoin, for example, has a network that's been slowed to a crawl in recent years. An inability to gain community consensus has pushed average transaction processing times to north of an hour, while lifting fees to around $28 per transaction. That's roughly the same cost as a bank wire. Bitcoin's purportedly groundbreaking peer-to-peer payment platform has certainly lost its luster in recent months, and it may not be a go-to option for many Arizonans.

Admittedly, I'm talking about step 12 when Arizona's lawmakers are on step two or three. Nonetheless, it's worth keeping a close eye on SB 1091 and its progress in the Arizona state legislature.

Sean Williams has no position in any of the stocks or cryptocurrencies mentioned. The Motley Fool has no position in any of the stocks or cryptocurrencies mentioned. The Motley Fool has a disclosure policy.