Paying people in tokens: structures, valuation, and withholding.

The structures teams actually use

Token compensation is not one thing. The label covers several structures with materially different mechanics, and the differences matter far more than the label does — particularly for when income arises and who is responsible for reporting it.

What the IRS has actually said

The foundation is Notice 2014-21, which established that virtual currency is treated as property for federal tax purposes and that a taxpayer receiving it as payment for services includes its fair market value, measured in U.S. dollars as of the date of receipt, in computing gross income. The IRS digital assets page states the same principle in current terms: for U.S. tax purposes, digital assets are considered property, not currency, and a digital asset is any digital representation of value recorded on a cryptographically secured distributed ledger or similar technology.

There is a practical consequence buried in that table that surprises people every time. Withholding obligations are denominated in dollars. If a project pays an employee entirely in tokens, it still has to remit dollars to the tax authority, which means it needs either a dollar balance to fund the remittance or a mechanism to convert part of the award. Paying purely in tokens does not remove the cash requirement; it moves it.

The valuation problem

Fair market value on the date of receipt is easy to state and hard to compute for a token. Several situations recur, and none of them has a clean answer.

• Pre-launch tokens. The award is made before any market exists. There is no observable price, and constructing one involves assumptions that a tax authority may or may not accept.
• Locked tokens. The recipient holds an asset they cannot sell for years. Whether and how illiquidity affects the valuation is contested, and the answer can differ between jurisdictions.
• Thin markets. A token trades, but on low volume across venues with divergent prices. Which price, from which venue, at which timestamp, is a policy the project has to set and apply consistently.
• Volatility between grant and settlement. For structures that settle later, the value at settlement can differ enormously from the value the parties had in mind when they agreed the grant.

This is where 26 U.S.C. § 83 enters. Section 83 governs property transferred in connection with the performance of services, generally including value in income when the rights become transferable or are no longer subject to a substantial risk of forfeiture, whichever occurs earlier. Section 83(b) allows an election to include the fair market value at the time of transfer instead, and states expressly that the election must be made not later than 30 days after the date of the transfer.

The employment and jurisdiction layer

Tax is only one of the regimes involved. In the United States, federal regulations under the Fair Labor Standards Act provide that the prescribed wages, including overtime compensation, must be paid in cash or negotiable instrument payable at par. State wage payment laws add their own requirements — California Labor Code section 212, for example, prohibits paying wages by anything redeemable in merchandise or purporting to be payable otherwise than in money, and requires that the instrument used be negotiable and payable in cash, on demand, without discount.

None of that necessarily prohibits token compensation. It does mean that token awards are commonly structured as something in addition to a compliant cash wage rather than as a replacement for it, and that the analysis differs sharply between an exempt employee, a non-exempt employee, and an independent contractor. Those are different legal categories with different protections.

Then the structure compounds it. In the two-entity pattern described at /equity/dual-cap-table, the employer is one company and the token issuer is another, often in a different country. That raises questions with no generic answer: who is the payer for reporting purposes, whose withholding obligation is it, does the granting entity create a taxable presence where the recipients live, and what does local securities or labour law say about a foreign entity delivering an asset to employees of a domestic subsidiary. Multiply by every country where the team lives.

What it does to the cap tables

From a record-keeping perspective a token grant creates a row on the token cap table with a schedule attached, and typically nothing at all on the company cap table. That asymmetry is why contributors at token projects so often have an incomplete picture of what they hold: their option grant is in cap table software with a portal they can log into, and their token grant is a line in a spreadsheet someone maintains by hand.

The reconciliation discipline is the same one that applies to the register generally. Model both clocks against the same calendar, record the instrument each entitlement came from, and check modelled unlocks against what the vesting contracts have actually released. The mechanics of the token side are covered at /equity/token-vesting; the register as a whole is at /equity/token-cap-table.

One adjacent point. Some teams reach for token compensation when what they actually want is to pay people quickly across borders without correspondent banking. That is a payments problem rather than a compensation-design problem, and paying a compliant cash wage in a dollar stablecoin is a different question with a different analysis — see /equity/stablecoin-payroll.