Crypto Payments Carry Potential Compliance Obstacles

Employers can pay employees in cryptocurrency, but they should be aware of logistical and compliance-related concerns before diving in, payroll professionals said June 23.

Cryptocurrencies, or digital assets and virtual currencies that often rely on blockchain technology for heightened anonymity and security, are seen by some investors as volatile, the professionals said during the American Payroll Association’s 2022 Virtual Congress. The value of a currency can fluctuate sharply and frequently.

“Truthfully, all investments experience some measure of volatility, or change over time,” said Daniel Thompson, Jr., CPP, director of payroll operations at Bath and Body Works. “As with any investment or security, knowing how it makes or loses its value is a critical data point in understanding if it’s a risk you’re willing to take.”

Paying in Cryptocurrency

There are multiple methods for paying employees with cryptocurrency, said James Medlock, CPP, payroll compliance educator for Medlock & Associates. For each payment method, the employer must ensure that the employee has authorized payment of some or all of their wages in cryptocurrency.

One method is for the employer to purchase cryptocurrency and transfer the amount to the employee, Medlock said.

He noted that each cryptocurrency has its own virtual wallet, and that an employer would need to have a wallet for each cryptocurrency option made available to employees. Software wallets can be made available on a mobile phone or computer, but are more susceptible to hacking and hardware wallets tend to be more secure, he said.

The first step is to calculate the employee’s net pay through the normal payroll process, Medlock said. Then, on the date that processing is completed, the pay is sent to the employer’s cryptocurrency wallet and converted from US dollars to the equivalent value in the chosen currency.

On payday, the cryptocurrency is then transferred to the employee’s wallet from the employer’s wallet, he said.

There can be issues with managing the process internally, Medlock said.

In particular, the employer must track the US dollar value of the cryptocurrency at the time the transaction was made, and it is possible for the value to fluctuate between the date that the employer made the transaction and payday, Medlock said.

“The closer we are to the actual payday, the less likely we’ll have volatility,” he said.

Employers can also work with crypto-payroll service providers and avoid becoming directly involved in maintaining wallets and purchasing cryptocurrency, Thompson said.

“We should think of these payroll providers as gateways, or intermediaries, to the crypto exchanges,” he said. “They do not require any special hardware or software changes to your current payroll solution, and they generally take less time to set up.”

The employer is responsible for transferring the employee’s net pay in US dollars to the provider, which will then purchase the cryptocurrency on the employee’s behalf, Thompson said. Some services may have a tiered transaction fee structure, while others may charge a flat fee.

Compliance Considerations

Medlock noted that the IRS does not use the term cryptocurrency and instead refers to virtual currency and virtual transactions. The agency treats virtual currencies as property for which the fair market value is taxable at the time the employer transfers the amount from its own wallet to an employee’s wallet. Transfers between two of the employer’s wallets are not taxable, he said.

“The value of the property is going to be taxable at the point in time of transfer—when the employee can do with that cryptocurrency whatever they want,” Medlock said. “So we’ll see that become taxable for federal income tax, Social Security, and Medicare taxes.”

The amounts also must be reported on Forms W-2, Wage and Tax Statement, and Form 941, Employer’s Quarterly Federal Tax Return, he said.

Employers may violate the Fair Labor Standards Act if a currency’s volatility causes its value to drop the employee’s wages below the minimum wage, Thompson said.

Employers also must perform due diligence when selecting a crypto-payroll provider, Medlock said. Providers covered by the requirements of the Bank Secrecy Act should be properly registered as a money service business.