We know you’re busy, but missing the boat on cryptocurrency income tax laws can leave you in a sea of complication, from frustrated new hires to time-consuming and expensive audits.
To help you navigate these depths, we sat down with Liya Brook, our Managing Director for Cryptocurrency Valuation Services, for some real talk on IRS and crypto.
1. What are most companies missing about cryptocurrency compensation plans?
Many of our clients initially have no idea that issuing tokens to employees is a taxable event that needs to be reported to the IRS, both for employees and the company. This becomes problematic when they find out too late that they’ve stuck their employees and themselves with a giant tax bill, and possibly a huge legal bill to try to unwind their past mistake. Often, this revelation occurs at the tail end of due diligence or during an audit, so it can become an expensive distraction in the middle of a stressful period.
Many of our clients initially have no idea that issuing tokens to employees is a taxable event that needs to be reported to the IRS
2. How does the IRS view cryptocurrency tokens?
In 2014, the IRS determined that virtual currencies would be treated as property. This means that any incentive tokens you give to your employees or advisors will count as taxable compensation (cryptocurrency income, if you will). Individuals and companies will owe income taxes and payroll taxes respectively based on the fair market value (“FMV”) of the tokens on the day of issue. You’ll need to report these taxes to the IRS on your W-2 and 1099 filings.
3. When do we need to think about a token valuation?
You should get a token valuation if you are planning to use tokens to compensate your employees, advisors or outside contractors, and any of the following apply:
- You have never valued your tokens or it has been more than 12 months since your previous valuation.
- Your company has sold additional tokens through a SAFT or STO, or has reached a significant technical or financial milestone since your last valuation.
- People outside of your company are buying or selling your tokens amongst themselves and outside of established exchanges.
It’s time to consider a token valuation if you are planning to use tokens to compensate your employees, advisors or outside contractors.
If you fail to perform a valuation of the tokens prior to granting them, you will likely be required by your auditor to perform one as of the date of first token issuance to your employees. A later valuation study may be meaningfully more complex, so it is best to perform your valuation as early as possible.
A later valuation study may be meaningfully more complex, so it is best to perform your valuation as early as possible.
4. Where should companies look for help?
To determine the fair market value of your tokens, we recommend that you look to an independent third-party valuation firm in order to cover yourself under “safe harbor” rules. These protections shift the burden of proof to the IRS, meaning the company’s valuation is presumed to be correct unless proven grossly unreasonable.
Safe harbor rules shift the burden of proof to the IRS, meaning the company’s valuation is presumed to be correct unless proven grossly unreasonable.
Here are some additional questions to consider when seeking out a valuation partner:
- Do they have experience performing cryptocurrency valuations?
- Have their valuations been vetted by the Big 4 audit firms, national and regional audit firms?
- Are they knowledgeable about the correct valuation methodologies for your company's stage to help mitigate tax burdens and significantly reduce audit pain?
- Can they deliver an audit-proof valuation study in days, not weeks or months?
We’ve worked with thousands of early-stage companies and are experienced with both simple and complex valuations. If you’re not sure whether you need a valuation for your tokens, wonder what the process looks like, or want more info on the nuances of the IRS and crypto compensation, we’re here to help. Reach out anytime at firstname.lastname@example.org or schedule an appointment here.
Liya Brook is the Head of Cryptocurrency Valuation at Preferred Return, a valuation practice specializing in startup company valuation services for investor, audit and tax compliance. Her team offers strategic guidance and expert valuation studies to companies issuing tokens as compensation to employees and contractors, helping them mitigate taxes and tax penalties.
Preferred Return has performed over 4,000 valuations for startups, including Cruise Automation, Sift Security, Kickstarter, Hired and Blue Bottle Coffee; they have performed token-related valuations for Ripple Labs, Chia Networks, Promethean Labs and MobileCoin. The firm has logged hundreds of hours in audits with the Big Four, national and regional audit firms and they are regularly recommended by Cooley, DLA Piper, Gunderson, WSGR, Goodwin Procter, Orrick, and Perkins Coie.