Understanding How the U.S. Taxes Token Awards (2025 Guide)

Disclaimer:The content of this blog is for informational purposes only and is not intended as legal, tax, or financial advice. Consult a professional advisor or get in touch with Toku for specific advice related to your situation. Toku is not liable for decisions made based on this content.‍

As the crypto industry continues to mature, one reality is clear — taxation is catching up fast. Nearly one-third of the global crypto workforce operates in the United States, meaning a large share of token-based compensation falls under the scrutiny of the Internal Revenue Service (IRS).

For companies compensating employees with tokens, compliance isn’t optional — it’s essential. The IRS classifies tokens as property, not currency, which means every grant, vesting event, and transfer can trigger a taxable event. And for employees, misunderstanding the timing of these taxes can lead to unexpected bills or penalties.

Since the IRS first issued Notice 2014-21, the agency has continued expanding its guidance to cover areas like staking, airdrops, and token swaps. Today, both individuals and organizations are required to report and pay taxes on digital asset income just as they would for traditional compensation.

The challenge? Token compensation is far more complex than cash or equity. Employers must determine fair market value at vesting, withhold taxes in fiat, and comply with ever-evolving state and federal laws — all while managing volatility and employee expectations.

In this guide, we’ll break down exactly how the U.S. taxes token awards, including how the IRS views crypto income, how to value tokens accurately, what timing rules apply to vesting and exercise, and how employers can stay compliant when issuing token-based compensation.

Whether you’re an employee earning tokens or a Web3 company paying them, understanding these fundamentals is critical to avoiding tax surprises — and staying fully compliant in the world’s most closely watched crypto jurisdiction.

Tokens Are Property in Tax Terms

When it comes to U.S. taxation, the starting point is simple but significant: the IRS treats all cryptocurrencies and tokens as property. This definition, established in IRS Notice 2014-21, set the foundation for how digital assets are taxed today.

What does this mean in practice?

It means that whenever a person receives tokens as payment or compensation, they are receiving property — much like a company stock or other non-cash asset. And when property changes hands in exchange for services, that transfer is a taxable event.

How the IRS Views Token Compensation

Under U.S. tax law, if a company pays an employee or contractor in tokens instead of dollars, the fair market value (FMV) of those tokens at the moment of transfer must be recognized as ordinary income.

For example:

• If an employee receives 1,000 project tokens valued at $2 each when vested, the IRS considers that $2,000 of taxable income — even if the employee doesn’t sell the tokens.
• The employer must report that income, withhold applicable taxes, and remit those taxes in fiat, not crypto.

This framework makes token compensation far more complex than paying salaries or bonuses in cash. Every grant, vesting event, or transfer needs to be carefully documented and valued at the precise moment the tokens are delivered or become non-forfeitable.

Why Property Classification Matters

Because tokens are property, not currency, they also trigger capital gains tax when sold or exchanged later. This creates a two-step taxation process:

1. Ordinary income tax at the time of receipt or vesting.
2. Capital gains tax upon sale or disposal, based on the change in token value since vesting.

This dual-layer taxation can create cash-flow challenges for employees, particularly if token values rise quickly but the assets are illiquid or under lock-up.

The Importance of Proper Documentation

For employers, accurate reporting is critical. The IRS expects companies to maintain clear records of:

• The FMV of tokens at the time of grant and vesting.
• The date and nature of each taxable event.
• The withholding and remittance of applicable federal and state taxes in fiat currency.

Failure to properly document and report token-based income can lead to penalties, audits, or even reclassification of compensation under U.S. labor law.

In short, when tokens are issued to employees or contractors, they are not “just crypto” — they are property under U.S. tax law, carrying all the responsibilities and compliance obligations that come with it.

Valuation of Tokens for Tax Purposes

Determining the fair market value (FMV) of tokens is one of the most critical — and often misunderstood — steps in ensuring tax compliance. Under U.S. tax law, FMV establishes the dollar amount of income to report and withhold taxes on when tokens are granted, vested, or transferred.

The challenge? Tokens are not static assets. Their prices fluctuate minute by minute, and many have limited liquidity or no established market at all. This volatility means that even small timing differences in valuation can significantly affect taxable income calculations.

How the IRS Expects Token Valuation to Work

For liquid, publicly traded tokens — such as Bitcoin, Ether, or tokens listed on major exchanges — the spot price at the time of transfer is typically used to determine FMV

In other words, when an employee’s tokens vest or are transferred to their wallet, the market price on that date and time determines the amount of taxable income.

The IRS has made clear that this process mirrors how companies value other non-cash assets, such as stock awards or restricted shares. However, since token prices can change quickly, most compliant organizations record the average price over a specific window (for example, a 24-hour or hourly weighted average) to smooth out volatility and ensure consistency in reporting.

When Tokens Are Illiquid or Pre-Launch

Valuation becomes far more complex for illiquid or pre-launch tokens — i.e., those that have not yet been listed on a public exchange.

In these cases, the IRS expects companies to use a reasonable and defensible valuation methodology, often supported by an independent third-party valuation expert.

Comparable to a 409A valuation used for private company stock, this appraisal takes into account:

• The project’s overall tokenomics and supply schedule.
• The utility and expected market demand for the token.
• Any prior token sales or private placements.
• Market comparables — i.e., similar tokens with known values.

Because pre-launch token valuations lack market transparency, these estimates should be updated frequently, especially before any major event like token generation (TGE), exchange listing, or liquidity release.

Why Valuation Accuracy Matters

Accurate valuation isn’t just about compliance — it protects both the company and its employees.

If a token is undervalued, the IRS may later deem that the company underreported income, leading to tax penalties and interest. If a token is overvalued, employees could pay excessive taxes upfront on assets that later lose value — creating unnecessary financial hardship.

This is why leading crypto organizations rely on crypto-native partners like Toku to calculate FMV using real-time data from multiple exchanges, historical averages, and consistent methodologies. The result is a valuation approach that stands up to regulatory scrutiny and minimizes audit risk — while keeping employees confident that their tax reporting is accurate and fair.

Timing of Taxation

When it comes to token compensation, timing is everything.

In the U.S., income tax liability doesn’t occur when tokens are promised — it occurs when the employee actually receives them or gains full control over them. This timing determines how much tax is due, when it must be paid, and whether the income qualifies for capital gains treatment later.

Because crypto tokens are treated as property rather than currency, the IRS focuses on the moment of transfer and forfeiture risk to determine when a taxable event occurs.

1. Tokens Granted Without Vesting or Restrictions

If tokens are granted outright — meaning there are no vesting schedules, lock-ups, or forfeiture conditions — the IRS considers the full fair market value (FMV) of those tokens as ordinary income at the time of the grant.

Example:

If an employee receives 500 tokens worth $10 each immediately upon signing their contract, they recognize $5,000 of taxable income on that date.

From that point on, any future gain or loss when they sell the tokens is treated as capital gains or losses.

2. Tokens with Vesting Schedules (RTUs, RTAs, TPAs)

For most Web3 organizations, token awards come with vesting schedules to encourage retention — similar to restricted stock units (RSUs).

These are not taxable when granted but when they vest — i.e., when the tokens become non-forfeitable and are transferred to the employee’s control.

Example:

If an employee’s Restricted Token Units (RTUs) vest monthly over 4 years, each monthly vesting event triggers a taxable event based on the token’s FMV that day. Even if the employee doesn’t sell or transfer the tokens, the IRS considers the vested tokens as income.

3. 83(b) Election for Early Taxation

Employees who receive Restricted Token Awards (RTAs) or Token Purchase Agreements (TPAs) may have the option to file an 83(b) election with the IRS.

This election allows the employee to pay taxes at the time of grant rather than at vesting — a potentially huge advantage if the token value is low at that time.

Example: 

An employee receives 2,000 tokens worth $0.10 each at grant. If they file an 83(b) election, they pay taxes on just $200 of income. If they don’t, and the token value rises to $5 at vesting, they would owe taxes on $10,000 instead.

However, this election carries risk: if the employee leaves before vesting or the token’s value drops, the taxes paid upfront are not refundable.

For this reason, the 83(b) election is most commonly used for early-stage, pre-launch tokens where the token value is minimal.

4. Token Options

For token options, taxation happens when the option is exercised, not when granted. The taxable amount is the difference between the FMV at exercise and the strike price — similar to traditional stock options. Later, when the employee sells the tokens, capital gains or losses apply based on the new sale price.

Why Timing Matters

Timing determines not only how much tax is due, but also which type of tax applies — ordinary income or capital gains. Getting it wrong can result in underpayment penalties, while smart planning (like using 83(b) elections strategically) can significantly reduce tax liability.

For employers, correctly identifying taxable events ensures accurate withholding and reporting — key steps in avoiding IRS audits or reclassification issues later.

The Employer’s Withholding Obligations

For companies paying employees in tokens, the most overlooked — and often the most challenging — part of compliance is withholding and remitting taxes correctly.

The IRS treats token compensation the same way it treats cash or stock-based compensation: employers must withhold income and payroll taxes, report them accurately, and remit the required amounts to federal and state authorities in fiat currency.

That last part is key. Even if your company pays workers in crypto, the IRS won’t accept crypto for tax payments. This means employers must calculate taxes owed in USD, then either convert tokens to fiat or set aside cash reserves to meet those obligations.

Employer Responsibilities

When token awards vest or are exercised, employers are responsible for:

• Calculating the fair market value (FMV) of the tokens at the exact time of vesting or transfer.
• Determining the total tax due, including federal income tax, Social Security, Medicare, and applicable state or local taxes.
• Withholding the correct tax amount from the employee’s compensation.
• Remitting the withheld taxes to the IRS and state agencies in fiat currency by required deadlines.
• Reporting the transaction on appropriate forms — such as Form W-2 for employees or Form 1099 for contractors.

Failure to withhold and remit properly can result in severe penalties for underpayment or misreporting, as well as potential personal liability for company officers.

Common Withholding Strategies for Token Compensation

Because crypto compensation creates unique liquidity and valuation challenges, organizations typically choose from one of three main withholding strategies. Each has trade-offs in terms of cash flow, complexity, and employee experience.

1. Cash-to-Cover

In a cash-to-cover approach, the company withholds taxes by deducting the required amount from the employee’s cash salary (if any) or by requesting that the employee provides fiat funds to cover the taxes.

This is the simplest approach for payroll teams but can strain employees who receive mostly or fully crypto-based pay. It’s also not always legally permissible in certain jurisdictions, as employers — not employees — are generally responsible for ensuring taxes are remitted.

2. Net Settlement

Under net settlement, the employer reduces the number of tokens delivered to the employee by the amount needed to satisfy tax withholding.

Example:

If an employee’s token grant is worth $10,000 and their tax obligation is $3,000, they receive tokens worth $7,000, and the employer withholds $3,000 worth of tokens for conversion to fiat.

This method ensures taxes are paid on time while minimizing employee cash burden. However, it requires reliable market liquidity and a mechanism to convert withheld tokens into fiat immediately.

3. Sell-to-Cover

The sell-to-cover method involves automatically selling a portion of the employee’s vested tokens on the open market to generate fiat for tax withholding.

This strategy is common among large crypto organizations because it ensures liquidity and removes the need for manual fiat contributions. However, it demands careful execution to avoid adverse market impact or insider trading concerns — especially for newly listed or low-liquidity tokens.

Why Withholding Strategy Matters

Choosing the right withholding approach affects everything from company cash flow to employee satisfaction.

More importantly, it ensures that both the company and its employees remain compliant with IRS and state tax laws.

Crypto-native payroll platforms like Toku automate these calculations, convert tokens seamlessly to fiat, and ensure taxes are remitted accurately across jurisdictions — removing the operational and compliance burden from internal finance teams.

Understand U.S. Token Taxation with Confidence

Navigating token compensation under U.S. tax law is anything but simple. Between evolving IRS guidance, volatile token prices, and the complexity of multi-state payroll reporting, even well-intentioned organizations can find themselves exposed to compliance risks they never anticipated.

The reality is clear:

Tokens are property, not currency.

They’re taxed as ordinary income at the time of vesting, transfer, or exercise.

They must be valued precisely based on fair market value. And companies have an obligation to withhold, report, and remit taxes in fiat — regardless of how compensation is delivered.

That combination creates a perfect storm of operational and regulatory complexity, especially for crypto-native teams managing payroll, grant vesting, and reporting across multiple jurisdictions.

The Cost of Getting It Wrong

The IRS has already signaled that digital asset compliance is a top enforcement priority.

Misreporting or underpaying taxes on token awards can lead to:

• Heavy fines and penalties for inaccurate payroll filings.
• Retroactive tax liabilities and interest on unpaid balances.
• Reputational damage with investors and employees.
• Audits that drain time, resources, and focus from your core mission.

Even small administrative errors — such as using the wrong valuation date or miscalculating withholding — can compound into major compliance issues over time.

The Smarter Way Forward

Instead of managing these complexities manually, leading Web3 organizations like Protocol Labs, Gnosis, and dYdX Foundation rely on Toku — the first crypto-native Employer of Record (EOR) and token compensation platform purpose-built for compliance.

Toku automates every critical part of the tax lifecycle:

• Accurate FMV valuation of tokens across multiple exchanges.
• Automated tax withholding and sell-to-cover execution.
• Jurisdiction-specific reporting for both employees and employers.
• Audit-ready records that stand up to IRS scrutiny.

By partnering with Toku, crypto organizations can ensure that every token grant, vesting event, and payroll transaction is 100% compliant — from issuance to tax remittance.

Make Crypto Taxation Simple Today

Compliance shouldn’t be a burden that slows innovation.

With Toku, you can pay your team in tokens, stay fully compliant with IRS rules, and scale confidently across borders — all without losing sleep over audits or penalties.

Make crypto taxation simple today.

Book a demo or talk to our experts at toku.com and see how we help the world’s leading Web3 organizations stay secure, compliant, and ahead of every regulation.