Cryptocurrency has become a significant aspect of the global financial landscape, utilizing cryptography for security. As a result, it has become a crucial consideration in estate planning. This Dechert OnPoint offers an overview of the ownership and estate planning implications for both U.S. and non-U.S. individuals.
Access and Ownership
Cryptocurrencies, such as Bitcoin and Ethereum, can be owned by individuals or entities and are not tied to a physical location. They rely on digital wallets, which can be stored on local devices or traditional/cloud-based servers. Financial service providers like Fidelity, Binance, and Robinhood also offer third-party custody and trading services using digital wallets they control, rather than their customers. In January 2024, the Securities and Exchange Commission announced its approval of bitcoin exchange-traded funds (ETFs). The ownership of cryptocurrency can significantly impact estate planning, especially when determining the jurisdiction for tax and probate proceedings.
Access to cryptocurrency stored in digital wallets is secured by private keys, ideally only accessible to the wallet’s owner. In case of the owner’s death, accessing these assets can be challenging, depending on the wallet’s security features such as administrator policies. Losing a private key can also pose significant problems as it renders the cryptocurrency inaccessible.
Income Tax Classification and Treatment
For income tax purposes, the U.S. treats cryptocurrency as property and taxes it as capital gains. This means that it is subject to the same rules as any other property in terms of character of gain, loss carryforward, etc.
The IRS has announced specific rules for cryptocurrency, such as considering yields or rewards received from “staking” (similar to receiving interest on a loan) as taxable income and reporting them. Similarly, any cryptocurrency obtained through mining must also be reported as income. In 2023, the IRS announced that charitable donations of cryptocurrency exceeding $5,000 would only be deductible if a qualified appraisal is submitted by the taxpayer.
Estate Planning Considerations
Inclusion in Estate Plan
Cryptocurrency should be explicitly addressed in an individual’s will or revocable trust, whether they are U.S. or non-U.S. persons. If not addressed, the default rules under many state laws will treat cryptocurrency the same as other digital assets (e.g., digital photos, emails) and distribute them accordingly. A digital asset instruction letter can provide access and management instructions, though it may not be binding depending on the jurisdiction. If cryptocurrency is sold during estate administration, the sale may be subject to informational reporting and income tax filings to federal and state regulators.
Trusts
Contributing cryptocurrency to a trust can ensure it is managed according to the contributor’s wishes. However, not all jurisdictions recognize the validity of trusts. For cryptocurrency held in a digital wallet, proper checks should be in place to ensure all transaction records and distributions are adequately maintained, and the private key is securely managed by the trustee.
Cross-Border Issues for U.S. Persons
U.S. citizens are subject to estate tax on all their worldwide assets, regardless of their location. However, the estate tax rules of other countries may potentially subject a U.S. citizen’s cryptocurrency to double taxation. For example, if a U.S. citizen dies while their cryptocurrency is physically located in a country without an estate tax treaty with the U.S., it may be subject to both U.S. and that country’s estate tax. Similarly, if a U.S. citizen dies while their cryptocurrency is held through a foreign-based crypto exchange, the same double estate tax issue may arise.
Considerations for Non-U.S. Persons
Non-U.S. persons are only subject to U.S. estate tax on their U.S. situs property. However, the U.S. situs rules for cryptocurrency are still under development, leading to potential jurisdictional issues and double taxation concerns. Additionally, the U.S. has estate tax treaties with 14 countries that may affect the taxation of cryptocurrency. Some treaties, like the U.S.-Germany estate tax treaty, assign situs based on the decedent’s domicile, with exceptions for real property and permanent establishment property. Therefore, cryptocurrency of a decedent subject to this treaty may be subject to estate tax by their country of domicile, regardless of where the cryptocurrency is physically stored or custodied.
Non-U.S. persons may also have separate reporting requirements in their home country and should ensure their estate planning documents are valid in both their home country and the U.S.
Cryptocurrency classification and regulation vary by jurisdiction. For example, El Salvador classifies certain cryptocurrencies as official national currency and legal tender, while other countries like the U.S., U.K., and Canada treat it as property for tax purposes. Some countries, like China, have even banned or restricted certain cryptocurrency activities.
Given the complex and ever-evolving nature of cryptocurrency regulation and its implications for estate planning, it is crucial for holders of cryptocurrency to seek professional legal and tax advice.
