Over the decades, compensation for work has evolved to become a significant tool for employee motivation and goal alignment. Equity-based compensation emerged in the 1950s as an alternative to cash incentives, offering employees a stake in the company's success through stocks or options. This approach fostered ownership and loyalty while aligning employee interests with organizational goals.
Since the introduction of cryptocurrencies as a viable electronic form of payment, token-based compensation has emerged as a new approach, aiming to similarly incentivize employees while also benefiting from the unique characteristics of cryptocurrencies.
Token Equity vs. Stock: Differences in Functionality & Taxation
Token compensation is interpreted in many jurisdictions as being very similar to equity compensation. Vesting, eligibility, reporting, tax withholding - you will find that the structures and terminology for providing tokens to employees are similar to traditional equity-based compensation. However, tokens function and are taxed in ways that are different from stock, which we will cover in this article.
Regardless of the technological possibilities, tokens are another form of non-cash asset that are taxed as intangible personal property, similarly to non-qualified stock based compensation (according to IRS Notice 2014-21). And like stock grants, the legal plans and contracts granting tokens have similar options for designing and implementing the compensation plan and agreements. Tokens themselves create unique nuances because the fact of on-chain transfer of tokens has its own legal implications given that tokens are generally considered owned by the person who controls the digital wallet the tokens are in.
This nuance and complication compounds on a global scale when considering that every country’s laws and approach to crypto is unique. For example, we often see organizations make mistakes by not withholding taxes correctly alongside fiat payroll when paying payroll in tokens or vesting token grants. When organizations do withhold taxes correctly, organizations often do not communicate to employees what the tax consequences related to token payroll and grants will be, which causes unnecessary friction with employees.
Challenges and Mistakes in Equity Token Offering Plans
As of August 2023, there are still no clear answers to the question of “Is X token a security?” in most places. Some jurisdictions are much further ahead than others in passing crypto regulations, such as the European EU Markets in Crypto-Assets Regulation (“MiCA”), which entered into force June 2023.
This has unfortunately led to many people in the industry to put together token compensation plans that lack the regulated, structured precedents that many startups follow when issuing equity compensation plans. We strongly suggest that organizations work with qualified administrators, consultants and law firms to understand the structures, taxes and regulations related to token grants.
Due to the lack of precedents in the crypto industry, we have come across many token compensation plans that create problems such as:
- Violating local labor laws by not considering the fringe benefits, bonuses or gratuities rules related to token compensation;
- Errors in the administration of token grants, such as incorrectly setting up and using multi-signature wallets, and errors with “unlocking” tokens granted under restricted token agreements post-genesis;
- Not withholding the right amount of taxes on the tokens, leading to both the company and recipients being penalized, and potentially held criminally liable for tax evasion (Failure to report taxable income is a felony offense in most countries and can leave companies and workers open to tax audit indefinitely)
How to Remain Compliant in Token Compensation
Interest in token incentive plans and grant agreements for employees and contractors has grown along with the increasing regulatory and compliance maturity of the crypto industry overall. While significant progress has been made in raising awareness and acceptance of token grant agreements among founders, executives, and workers, there remains a critical knowledge gap when it comes to the structure, communication and implementation of token grants.
Toku’s goal is to provide clarity for the industry and peace of mind for its customers to be able to legally and compliantly provide token compensation to their employees.
Make your Token Grant administration simple. Skip out on those sleepless nights by working with Toku today.