Is cryptocurrency subject to estate tax?
Cryptocurrency may be the future of global monetary policy, but it’s also going to be the future of massive headaches when people realize how it’s taxed.
Although the name implies it is a “currency,” the IRS has different ideas about how to treat this newly adopted technology. In a somewhat old IRS Notice (2014-21, issued March 25, 2014), they refer to “virtual currency” as being treated as property for tax purposes, but leave room for argument by saying:
“The character of the gain or loss generally depends on whether the virtual currency is a capital asset in the hands of the taxpayer.… [for example,] inventory and other property held mainly for sale to customers in a trade or business are examples of property that is not a capital asset.”
For most people, this means that you would treat your bitcoin and ether as you would treat a stock when it comes time to sell. The confusing part is that these currencies are supposed to be substitutes to the USD, but the IRS regulations in place (as of the time of this writing) make every purchase with cryptocurrency a taxable event!
To clarify my point, imagine every time you bought a pizza with US dollars, you got an income tax bill - that’s pretty much what the IRS is doing when you buy things with your bitcoin or ether. UPDATE: As of the time of this writing, there is new tax code proposal for crypto that would have an exemption on gains up to $200 when used to purchase goods or services. There has also been a shift to view cryptocurrency (or at least certain variations) as commodities which could change the tax rate.
All of this also highlights the need for a stable coin that is pegged to the dollar and therefore does not fluctuate in value for practical tax reasons (although Terra / Luna is the most recent example of how that can go bad, real quick)
So how does the tax work with my cryptocurrency for estate planning purposes?
Assuming you hold your cryptocurrency as a capital asset, it would work similar to your stock and/or real estate portfolio. You would have a cost basis (i.e., how much you spent on the cryptocurrency), and then you would have the fair market value to determine how much appreciation is built into the capital asset.
However, when you die holding cryptocurrency (assuming the law doesn’t change), then you would get a stepped up basis in the capital assets (under S. 1014 of the IRS Code). This means that the cost basis would “step up” to the fair market value as of your date of death. Therefore, when your children / family inherit your cryptocurrency, then they would pay little to no income tax on it depending on how long they wait to sell / use the cryptocurrency after your death.
But, that’s the income tax piece, what about the estate tax?
For estate tax purposes, you would generally report the fair market value of the cryptocurrency as of your date of death for estate tax purposes. This value would be reported on IRS form 706. If you are domiciled in Massachusetts, then your family also get the joy of doing an additional estate tax return called the M-706.
The good news is that virtually no one (less than 1% last time I checked) is paying estate tax under the federal 706 as of this writing because the estate exemption threshold is $12.06 million per person (with portability available for the surviving spouse, if applicable, that would effectively make it over $24 million). Keep in mind that the current exemption is expected to be cut in half by the end of 2025 (quickly approaching).
The bad news is that the state you are domiciled in at the time of your death (like Massachusetts), may have an estate tax exemption or threshold that is much lower than the federal rate - meaning you could still owe an estate tax at the state level. For example, in Massachusetts, if your taxable estate exceeds $1 million, then the entire amount may be subject to estate tax. Ouch.
What should I do with my cryptocurrency for estate tax planning purposes?
You have three options:
Start a gifting program - you can legally gift up to $16,000 per year (as of 2022) to each person without any gift / estate tax implications. You can double this exemption with split gifting if you are married. If gifting to your grandchildren, you may want to consider using an irrevocable trust to better protect the assets (making sure that each grandchild has their own trust to avoid negative tax implications). The donee would get a carryover basis in the cryptocurrency.
Use for Charitable Donations - if you are already donating a certain amount of your assets each year to causes you care about, then you may consider using cryptocurrencies as a way to fulfill your philanthropic inclinations. You could do this in several ways, the most popular being either outright direct gifts or by setting up a donor advised fund (which are becoming increasingly popular). You would get the benefit of a charitable deduction, but would pay no income tax on the appreciation and the charity would get the full benefit without owing a cent to the government.
Plan for the step-up. If you are hopeful that there will be no change in the current step up basis rules, then your family will likely be better off (from a tax standpoint) receiving the cryptocurrency upon your death since it will reset the cost basis to fair market value. In other words, even though there may be some estate tax on the asset at the state level, the income tax savings from the step up basis would outweigh the estate tax bill. PLEASE NOTE: this generally would only apply if your cryptocurrency has a low cost-basis relative to expected valuation at death, and only if you are NOT expected to be in the federal estate tax range. If you are a high net worth individual, you may not like this option.
Need help with your estate planning?
If you would like to review or update your estate plan, then give me a call at 781 202 6368, email jlento@perennialtrust.com, or click here to schedule your free personal consultation. I’m always happy to help!
Joseph M. Lento, J.D.
Your Local Estate Planning Attorney
www.PerennialEstatePlanning.com
477 Main Street
Stoneham, MA 02180
