COMP NEWS – With cryptocurrency becoming more popular as a form of compensation, what do you need to know about its tax implications?

To say that cryptocurrency is in the headlines is a bit of an understatement. In late April, Fidelity announced that it would allow the 23,000 employers who operate their 401(k) plans on the Fidelity platform to include bitcoin as a permissible investment alternative—in the face of a recent Department of Labor pronouncement that doing so is a glaringly bad idea from the perspective of the fiduciary obligations that inform how 401(k) plan investments are to be selected.

Cryptocurrency is still in many regards treated as a grey area, legally. However, the IRS has stated that cryptocurrency would be treated as property for tax purposes.

In a 2014 notice, the IRS stated that cryptocurrency is to be treated for tax purposes as property rather than money. The IRS also said that an employee who receives cryptocurrency as compensation for services has been paid income tax withholding wages—which means that cryptocurrency is includable in wages at its value on the date that the employee receives, or if later, vests, in the cryptocurrency.

This complexity is compounded when cryptocurrency is treated as compensation.

The price volatility of cryptocurrency can produce a potentially painful tax result to an employee paid in cryptocurrency. If on day one, an employee receives a bonus of 100 digital tokens with a value of $10,000, but the tokens decline in value to $2,000 at the time the employee sells them, the employee will have ordinary income of $10,000 and a capital loss of $8,000, which would be subject to the annual limit on the deduction of capital losses.

Compensating employees with cryptocurrency raises many of the same tax issues as compensating employees with employer stock and therefore requires thoughtful planning on the part of both the employer and the employee.

To read the full primer on the tax implications of giving employees cryptocurrency in compensation, click here.

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