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In this context, California requires markets in which the exchange operates
taxpayers to reasonably approximate (i.e., it is likely reasonable to conclude Failing to account
the location of the use, taking into that the exchange places servers into
for state and local
consideration all sources of available service in markets that it heavily ex-
information to determine the location ploits, so including the populations of income tax effects
of the use of the intangible property. As those countries in the denominator
the term “reasonably approximate” sug- of the approximation ratio is likely can add to the
gests, the method used to approximate reasonable and provides a more ac- owner’s tax liability on
the location of the use must be reason- curate result). As with any reasonable
able. California does not require any approximation method, documentation sale of a partnership
particular method; however, the state and consistency are paramount to main- and minimize return
has issued guidance that applies when taining revenue assignment positions on on investment.
certain reasonable approximation meth- state corporate income tax returns.
ods are used. As cryptoasset transactions become
In cases where the reasonable more prevalent in the business environ-
approximation method involves geo- ment, the states will continue to adapt filed returns as partnerships in 2019,
graphic locations, California requires and develop rules that more clearly de- the most recent year for which data
taxpayers to include in the numerator of fine how taxpayers must report income is available. Additionally, economic
the approximation ratio the population and losses resulting from those transac- uncertainty caused by the COVID-19
of the jurisdiction where the purchaser tions. In the meantime, taxpayers should pandemic, potential increases in interest
uses the intangible property at the seek formal instructions from the states rates and income tax rates, an aging U.S.
time of the sale and the total popula- regarding the treatment of specific population heading into retirement,
tion of the purchaser’s country in the transactions or look for guidance in and other factors are spurring owners
denominator. To the extent the taxpayer more well-settled areas (e.g., the Cali- of PTEs, among others, to consider
can demonstrate that the intangible fornia treatment of sales of intangible divesting from or selling certain business
property is being materially used outside property described above) for guidance. operations. However, failing to account
the United States, the populations of From John Yoak, J.D., LL.M., MBA, for state and local income tax effects
those other countries of use must be Tampa, Fla. can add to the owner’s tax liability
added to the denominator of the ap- on these sales and minimize return
proximation ratio (Cal. Code Regs. tit. State tax considerations on investment.
18, §25136-2(b)(7)). around the sale of a To increase tax efficiency while
Given the nature of cryptoasset partnership interest minimizing risk, owners of PTEs that
transactions completed through an One of the most significant decisions conduct business in multiple state and
exchange, it is unlikely that the taxpayer the owner of a business classified as local taxing jurisdictions should evaluate
will have any information regarding a partnership for U.S. federal and how taxing authorities may treat the
where the purchaser is located. As such, state income tax purposes can make sale of partnership interests. This item
it is likely reasonable for taxpayers to is choosing whether to sell his or highlights key considerations owners
approximate the location of the use her interests. Sale transactions have selling partnership interests should ad-
based on where the purchaser could become more common as the appeal dress as part of the sale, including which
potentially be located based on their use of passthrough entities (PTEs) — states may attempt to tax the entire gain,
of a particular exchange. In theory, any including partnerships, limited liability how taxation of the gain may be divided
particular purchaser could be located companies (LLCs) taxed as partnerships, among the states where the partnership
anywhere in the world; however, Cali- and S corporations — to business does business, compliance consider-
fornia would likely deem including the owners and investors grows due to ations, and technical developments and
global population in the denominator their benefits, such as a single layer of trends that may affect the transaction.
of the approximation ratio to be unrea- taxation (unlike with C corporations) While states generally tax PTEs simi-
sonable. Instead, taxpayers may wish to and certain legal protections available larly to each other, there are nuances
consider where the purchaser is most to some owners. The most recent IRS among them that are not addressed in
likely located. data shows that the number of PTEs this discussion (e.g., entity-level taxa-
One method for making this de- has more than quadrupled since 1980. tion or treating single-member LLCs as
termination could be considering the Approximately 3.8 million entities regarded entities).

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