Quick answer

Cryptocurrency paid as employee compensation is taxed as ordinary income when received, using the U.S. dollar fair market value at that time. Employers generally must treat it like cash wages for withholding, FICA, and reporting on Form W‑2; employees may later have capital gains or losses when they dispose of the crypto (IRS guidance: Virtual Currencies and How Are Cryptocurrency Transactions Taxed?) (https://www.irs.gov/businesses/small-businesses-self-employed/virtual-currencies; https://www.irs.gov/newsroom/how-are-cryptocurrency-transactions-taxed).

Background and legal basis

  • The IRS treats cryptocurrency as property for tax purposes (see IRS Notice 2014‑21). When crypto is paid as wages, it’s still taxable as compensation and reportable in dollars at the time of payment. Employers must apply payroll rules to crypto wages the same way they apply to cash wages (IRS Virtual Currencies guidance).

How payroll reporting and withholding typically work

  • Valuation: Employers determine the fair market value (USD) of the crypto at the time the employee has earned the compensation (pay date or when constructively received). Use a consistent, documented method tied to a major exchange or a weighted average price.
  • Withholding: Income tax withholding and employee and employer payroll taxes (Social Security, Medicare) apply to crypto wages. Employers can withhold by (1) converting crypto to USD to make withholding payments, (2) withholding a portion of the crypto paid, or (3) collecting cash from the employee to cover withholding. The chosen method should be disclosed, consistent, and documented.
  • Reporting: Report the USD value of crypto wages on Form W‑2 in boxes for wages and applicable taxes. See the employer guidance page on reporting cryptocurrency compensation for practical steps and examples (employer reporting guidelines).

Employee tax consequences after receipt

  • Basis on receipt: An employee’s cost basis in the crypto equals the USD value included in income when received.
  • Later disposition: If the employee later sells or exchanges the crypto, any difference between the sale price and the basis is a capital gain or loss (short‑term or long‑term depending on holding period). Report gains/losses on Schedule D and Form 8949 where required (IRS: How Are Cryptocurrency Transactions Taxed?).

Examples

  • Example 1 — Paid in Bitcoin: An employee receives 0.02 BTC on payday. If the market value is $50,000/BTC at payment, the employee recognizes $1,000 of wage income, employer withholds payroll taxes on $1,000, and the employee’s cost basis in the BTC is $1,000.
  • Example 2 — Later sale: If that BTC is sold later for $1,200, the employee reports a $200 capital gain. If sold for $800, the employee reports a $200 capital loss.

Valuation and recordkeeping best practices

  • Pick a reliable exchange or pricing source and document the time and method used to determine USD value. Keep screenshots, API records, or a valuation log.
  • Track: dates of receipt, amounts in crypto and USD, how withholding was satisfied, and dates and USD proceeds of any later sales.
  • Keep records at least as long as the statute of limitations for tax returns (generally three years), or longer if you have unreported income or carrybacks.

Common mistakes to avoid

  • Understating income by using an incorrect valuation time or unreliable price source.
  • Failing to withhold payroll taxes or to report the USD value on Form W‑2.
  • Forgetting that employees still have capital gains tax reporting obligations when they sell or exchange received crypto.

Practical checklist

For employers:

  • Establish a written policy for crypto payroll (valuation method, withholding method, timing).
  • Implement payroll systems that can convert crypto value into USD for withholding or collect cash for tax withholdings.
  • Report crypto wages on Form W‑2 and deposit payroll taxes timely. See employer guidance (employer reporting guidelines).

For employees:

Common questions (brief)

  • Must employers provide a W‑2? Yes. Crypto wages are reportable and should be on Form W‑2 for employees (IRS employer guidance).
  • Do payroll taxes apply? Yes. Social Security, Medicare, and Federal income tax withholding apply to crypto wages.
  • How is the basis determined? Basis equals the USD fair market value included in income when the crypto was received.

Practical note from the author

In my 15 years advising clients on complex pay arrangements, the biggest problems I see are inconsistent valuation methods and weak documentation. That increases audit risk and creates surprises for employees at sale time. A written payroll policy and robust recordkeeping eliminate most issues.

Disclaimer

This article is educational only and does not replace personalized tax advice. Tax rules change and facts matter. Consult a qualified tax professional or payroll specialist for guidance specific to your situation.

Authoritative sources

Internal resources