Will Income Taxes Apply When Employees Receive Cryptocurrency as Income?

 Posted on July 20, 2023 in Taxation Law

The popularity of cryptocurrencies such as Bitcoin and Ethereum has continued to grow in recent years, and some companies are now offering these virtual currencies as a form of compensation to their employees. Freelancers and independent contractors may also receive cryptocurrency as payment for their services. This raises an important question: are people who receive cryptocurrency as wages or payments for services required to pay income taxes? By understanding the tax laws related to virtual currency, those who receive income in this form can make sure they are paying taxes as required and avoiding potential penalties.

The IRS and Cryptocurrency

In 2014, the Internal Revenue Service (IRS) issued a notice stating that virtual currency will be treated as property for federal tax purposes. This means that the general tax principles applicable to property transactions will also apply to transactions involving cryptocurrency. When property is received as payment for performing services, it is considered to be taxable income. This income must be reported to the IRS, and it is subject to federal income tax withholding. The fair market value of the cryptocurrency on the date of receipt by the employee is used to determine the amount of income that needs to be reported. When independent contractors receive cryptocurrency as payments, they will be required to pay self-employment taxes based on the fair market value of the virtual currency when it was received.

Federal Income Taxes and Capital Gains Taxes

Employees who receive cryptocurrency as income will need to report it as part of their gross income on their federal income tax return. Employers are also required to withhold federal income taxes from the amounts paid to employees. However, the IRS does not accept payments in the form of cryptocurrency. The employer may need to withhold taxes from other income paid to an employee, or the employee may transfer funds to their employer to cover the amount of taxes that must be withheld. However, it is the employer’s responsibility to withhold taxes and pay them to the IRS, and an employer who fails to do so may face penalties.

It is also important to note that if cryptocurrency received as income is held for investment purposes and later sold, any gain or loss will be subject to capital gains tax rules. The amount of time cryptocurrency is held before selling or exchanging it will determine whether the gain or loss is classified as short-term or long-term. Short-term capital gains generally involve property that is sold within 1 year after it was received, and they are taxed at the individual's ordinary income tax rate. Long-term capital gains taxes will apply if cryptocurrency was held for more than 1 year.

Contact Our San Jose Tax Lawyer

Given the complex and ever-changing nature of tax laws, it is important for both employers and employees to ensure compliance with tax obligations when dealing with cryptocurrency as income. If you are an employer or employee in need of guidance on tax matters related to virtual currency, the experienced San Jose, CA tax attorney at John D. Teter Law Offices can provide you with the advice you need. We can help you take steps to comply with the applicable tax laws or address penalties that may apply based on misreported virtual currency income, failure to withhold or pay income taxes on cryptocurrency, or other related concerns. Contact us today at 408-866-1810 to schedule a consultation.

Sources:

https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions

https://news.bloombergtax.com/tax-insights-and-commentary/cryptocurrency-as-compensation-a-tax-primer