related practices

Virtual Currency Tax Consequences


A growing number of startups are offering virtual currencies to investors through initial coin offerings (ICOs) as a way to raise capital, often with little or no awareness of the tax consequences of their actions. Many startups sell specially created cryptocurrencies to initial project backers who expect the currency to increase in value if the startup succeeds. These cryptocurrencies, or tokens, are initially issued in fixed, limited amounts which generally can be used only in connection with the venture associated with the cryptocurrency. The cryptocurrency may increase in value if the venture succeeds. Investors may then seek to sell the appreciated cryptocurrency on the secondary market. Those same currencies can be used to compensate executives of the company, including as incentive compensation. But what does the Internal Revenue Service (IRS) have to say about these uses of virtual currency?

The IRS speaks

The IRS has well-established principles, under Internal Revenue Code § 83, regarding the receipt of property as compensation for services. And it has ruled, in Notice 2014-21, I.R.B. 2014-16, that virtual currency is treated as property for federal income tax purposes. Generally, the IRS requires an owner or employee to include the fair market value of the virtual currency, measured in U.S. dollars on the date the virtual currency was received, in his or her income. (see Notice 2014-21, Q&A 3).

If the virtual currency is listed on an exchange under which an exchange rate is established, payment and receipt of unvested virtual currency will generally be taxed as follows:

  • the currency will not be taxable to the service provider on receipt,
  • rather, the currency will be included in the service provider’s ordinary income as it vests,
  • the service recipient will be entitled to an income tax deduction commensurate with the service provider’s recognition of income, and
  • appreciation or depreciation in the value of the currency after it is included in the provider’s income will be characterized as capital gain or loss upon disposition of the currency.

Absent a timely §83 election – the rule allowing an individual to pay fair market value for property immediately upon receipt – a larger ultimate tax bill may result if the property appreciates in value between the time of receipt and vesting. If the property is not taxed until vesting, the appreciation of the asset during the delay between receipt and vesting would be taxed at ordinary income tax rates, rather than the reduced capital gains rate.

The taxpayer’s options

To alleviate the adverse tax consequences described above, a taxpayer who receives unvested property (such as convertible virtual currency) as payment for services may make an election under IRC §83(b) to include in income the fair market value of the unvested portion of such property at the time of receipt.

By making the election, the service provider will “close” the ordinary income element of the compensation as of the date of receipt, so that all subsequent appreciation in the property will constitute capital gain. The downside of a Section 83(b) election is that if the service provider is required to forfeit the property for not having completed the requirements of vesting, the service provider will only be entitled to a capital loss measured by the difference between the amount (if any) paid by the service provider for the property and the amount received by the service provider upon forfeiture of the property. The service provider in such circumstances will not be entitled to a loss for the amount included in income by making the IRC § 83(b) election.

This client alert addresses the issues involved in the income tax treatment of executive payments through cryptocurrencies. It is NOT intended as an in-depth treatment of differences in cryptocurrencies, or issues of ICOs as securities. Those important issues are matters of concern but are addressed by other Carlton Fields practice groups.


©2018 Carlton Fields Jorden Burt, P.A. Carlton Fields practices law in California through Carlton Fields Jorden Burt, LLP. Carlton Fields publications should not be construed as legal advice on any specific facts or circumstances. The contents are intended for general information and educational purposes only, and should not be relied on as if it were advice about a particular fact situation. The distribution of this publication is not intended to create, and receipt of it does not constitute, an attorney-client relationship with Carlton Fields. This publication may not be quoted or referred to in any other publication or proceeding without the prior written consent of the firm, to be given or withheld at our discretion. To request reprint permission for any of our publications, please use our Contact Us form via the link below. The views set forth herein are the personal views of the author and do not necessarily reflect those of the firm. This site may contain hypertext links to information created and maintained by other entities. Carlton Fields does not control or guarantee the accuracy or completeness of this outside information, nor is the inclusion of a link to be intended as an endorsement of those outside sites.