Key Considerations & Strategies for Digital Currency in Texas Estate Planning
Digital assets, like cryptocurrency, have proliferated wildly over the past decade or so, presenting exciting, yet risky, investing opportunities while raising complex new legal issues, particularly in the area of estate law.
From tax liabilities and fiduciary responsibilities to accessibility and asset administration, digital currency requires unique considerations and prudent strategies to ensure its proper treatment in estate planning and administration in Texas.
Unpacking these intricate issues, this guide to cryptocurrency and blockchains in estate planning covers:
Cryptocurrency & Blockchains Defined
To understand the role of digital currency in estate planning, it’s first crucial to discern what cryptocurrency is, how it works in general, and the blockchain technology underlying it. Cryptocurrency is essentially virtual money created and exchanged online via a digital ledger, a blockchain, that verifies and publicly records each transaction.
With cryptocurrencies and blockchain technology:
- Cryptocurrency owners can remain anonymous despite the transparency of blockchain trading. So, while trades are publicly recorded on the blockchain, the individuals behind those trades retain their anonymity.
- Cryptocurrencies can be traded via exchanges, like Coinbase, Gemini, Robinhood, and eToro, by transferring wallet numbers.
- Crypto owners have a unique, complex, multi-character passcode to access their funds. If that passcode is lost or forgotten, it can be practically impossible to retrieve or access the crypto it’s tied to. In fact, lost passcodes have lost crypto owners hundreds of millions of dollars. Banking heir Matthew Mellon is one of the most notorious examples of this, with his family losing about $1 billion in XRP because they didn’t know Mellon’s private passcode after he passed away.
While there are currently dozens of blockchains and at least 19,000 different types of cryptocurrencies available today, some of the most popular ones include (and are not limited to):
The privacy, transparency, and low transaction fees associated with cryptocurrency have attracted many investors, contributing to recent crypto booms. Simultaneously, that has also ignited a scramble for more oversight, regulations, and laws to deal with the previously unforeseen challenges of this digital asset.
How the IRS Currently Defines Cryptocurrency
Cryptocurrency is treated as property, not currency, per Internal Revenue Service (IRS) Notice 2014-21, which clarifies that, “general tax principles applicable to property transactions apply to transactions using virtual currency.”
Consequently, cryptocurrency, like real estate, can be associated with capital gains and appraisals, pricing crypto at fair market value, as opposed to the dividends and interest that are tied to other traditional assets, like stocks and bonds. Cryptocurrencies can also be traded for fiat currency, meaning government-backed cash.
While IRS Notice 2014-21 has been the most comprehensive crypto guidance federal authorities have issued to date, it has left several unanswered questions and gray areas in its wake. That includes an absence of guidance on what type of “property” crypto is, whether crypto cold storage constitutes separate property, and more.
All of this boils down to one critical point:
Digital currencies require special treatment in estate planning and administration to ensure tax and legal compliance while minimizing risks, costs, and other potential liabilities.
How Cryptocurrency Fits into Estate Planning
Estate planning with cryptocurrency requires certain language, tools, and devices to create the right balance of access and protections. While the details of these estate plans will vary from case to case, based on individual needs, circumstances, and objectives, at minimum, the language and terms of these documents should address matters including (but not limited to):
- Access to cryptocurrency passcodes: Fiduciaries need passcodes for digital currencies to manage, invest, and/or distribute these assets, according to the terms of the estate plan. Crucially, fiduciaries may NOT need to know the exact passcode in order to access crypto accounts. “Cold storage,” which involves the use of USB drives (and similar devices) to store crypto account information offline, can be used to provide a fiduciary with access to accounts and passcodes while encrypting those passcodes, so they remain secret. This can preclude certain challenges and issues, like former fiduciaries from retaining passcodes and accessing crypto wallets.
- Permission to use crypto passcodes and access certain devices: Estate plans should explicitly permit fiduciaries to use crypto passwords, as well as the cellphones, laptops, and other devices that may contain crypto information. This is critical, even if the fiduciary knows every character in the passcode, in order to avoid running afoul of any state or federal laws, like privacy laws, data protection laws, fraud laws, and more (like the Uniform Prudent Investor Act and the Federal Computer Fraud and Abuse Act, among others).
Beyond specific language and terms, estate plans for cryptocurrency can be devised with various types of trusts that are funded by digital currencies. A couple of options include:
- Irrevocable trusts: Funded by crypto and other assets, irrevocable trusts can be drafted to pay beneficiaries the appreciated value of the trust’s holdings over a certain period of time, with minimal estate and/or gift tax obligations.
- Grantor retained annuity trusts (GRATs): As a type of irrevocable trust, GRATs allow the grantor to retain control over the trust while also passing certain assets, like crypto, to beneficiaries without being subject to gift tax. With GRATs, the grantor reserves the right to retain the assets used to fund the trust, but the beneficiaries may be entitled to any appreciation of those assets.
It’s worth pointing out that, currently, there are NO laws in place that:
- Bar grantors from funding any type of trust with digital currency or other digital assets, like non-fungible tokens (NFTs)
- Dictate the rules or methods for documenting the funding of trusts with digital currency or how crypto passcodes should (and should not) be transferred
Fiduciaries, Crypto, & Estate Plans
Choosing an executor, a trustee, or any fiduciary to oversee an estate plan is always an important choice. With estate plans that include digital currency, however, selecting a trustworthy executor may be more crucial than ever. That’s largely due to the few checks on fiduciaries managing crypto accounts, as opposed to the many checks on their counterparts who oversee more traditional assets.
As a result, major problems and additional complications can arise if unethical individuals find themselves in the role of fiduciary with access to passcodes and digital wallets. If that happens, those fiduciaries have nothing stopping them from making unauthorized transfers or investments with cryptocurrencies, whereas banking institutions could have stops in place to prevent unauthorized transfers.
Making matters worse, if a fiduciary completes an unauthorized crypto transfer, tracing that transfer would be possible, but it may be nearly impossible to recover the actual cryptocurrency itself.
Given these facts — as well as the volatility of crypto, the lax regulatory environment, and the potential for unethical fiduciaries — devising an estate plan with crypto is generally best done with an experienced attorney, like an Austin estate planning lawyer.
The Future of Crypto & Blockchains in Estate Planning
With digital currencies shaking up traditional estate planning, most of the focus has centered on how to shoehorn this new digital asset into existing frameworks for estate planning devices and processes. Remarkably, however, some companies are pushing the boundaries and forging new paths, exploring how to use blockchain technology as the basis for certain types of estate planning documents and transactions themselves.
Specifically, these companies, like Will and Testament Coin, Heir, Proof of Existence, and Blockchain Apparatus, are dabbling in the future of blockchains in estate planning with offerings like (but not limited to):
- Notarizing estate planning documents via blockchain
- Executing wills and trusts with blockchain
Some are also working to expand the use of blockchains in estate planning even further, looking into how this technology can be used to:
- Register estate plans as a way to prevent will contests or other complications after death
- Create specific protocols to instantly distribute trust holdings or inheritances to beneficiaries
While it could take years for these innovations to be viable options, they do shed some important light on the future of crypto, blockchains, and estate planning.
Get More Answers About Crypto in Estate Planning & Administration
An Austin estate planning attorney is ready to share more about your options for handling cryptocurrency in estate planning, estate administration, and/or probate. For confidential advice, simply reach out for your no-cost, no-obligation consultation.
Todd A. Wilson
Todd A. Wilson has been practicing law since 2007 with a view to educate all strata of society on the importance of planning their estates and probate administration.
We offer affordable estate planning and probate administration services. Contact us for more information.