The IRS has concluded that for tax purposes, Bitcoins and other virtual currencies are property, not currency or legal tender. Upshot: You may choose to pay employees in Bitcoins, but you must peg your Bitcoins to U.S. dollars. And all the usual withholding, depositing (in U.S. dollars) and reporting rules apply, as well. (Notice 2014-21, IRB 2014-16)
Just give me money. For employees, the fair market value of their Bitcoin payments is subject to income and FICA withholding and FUTA. W-2 reporting applies, just as if they had been paid in cash.
Likewise, the fair market value of Bitcoins paid to independent contractors is reported on 1099-MISC forms, if they receive at least $600 for services rendered to your business. Backup withholding applies if contractors didn’t provide you with their Taxpayer Identification Numbers prior to the first payment.
You must determine Bitcoins’ value as of the date you pay employees or independent contractors. If a virtual currency is listed on an exchange (Bitcoins are) and the exchange rate is established by market supply and demand, the fair market value is determined by converting the virtual currency into U.S. dollars at the exchange rate. Warning: Your conversions must be reasonable and consistent.
State wage payment laws. Even if you agree to pay employees with Bitcoins or other virtual currencies, be aware that state wage payment laws require employees to be paid in legal tender; they can’t be paid with script, tokens or similar media. However, paying in Bitcoins is similar to paying employees with property, such as stock or stock options—currencies that have a fair market value may pass muster under state wage payment laws.
To be on the safe side, check with your state labor department for clear guidance.
PAYROLL PRACTICE TIP: Employees’ direct deposits and paycards are FDIC insured, which means if their banks go bust, they’re protected, up to $250,000 per account. Not so with Bitcoins and other virtual currencies.
Other drawbacks: Bitcoins and other virtual currencies are easier to steal and more prone to fraud. Plus, their value is extremely volatile; the exchange rate for Bitcoins recently dropped more than 50% in one day.
Suggestion: Nip this in the bud by creating a policy that states that employees will be paid in U.S. currency only.