The witty and wise Benjamin Franklin once said, “...in this world nothing can be said to be certain, except death and taxes.” We can think of no better quote to sum up the developing cryptocurrency economy. The owners of Bitcoin and other digital currencies have a vision for what they hope digital currency will evolve into, but for now, all that they can be assured of is that their assets will be taxed, and that someday they will die. Savvy crypto-holders are preparing for these two eventualities by incorporating their digital assets into their estate plans.
What is cryptocurrency?
If you are reading this post, you most likely know what cryptocurrency is from a technical and cultural standpoint. So, we’re not going to go into that. What we are more interested in is what the law says cryptocurrency is.
Right now, there are very few cases involving cryptocurrency, and most of them are criminal cases. On the civil side of things, the best legal definition we have comes from the Internal Revenue Service (IRS). According to the IRS, virtual currency is property.
Classifying crypto as property rather than as legal tender has some serious consequences that digital currency holders need to be aware of. As the IRS notes:
- Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2, and are subject to federal income tax withholding and payroll taxes.
- Payments using virtual currency made to independent contractors and other service providers are taxable and self-employment tax rules generally apply. Normally, payers must issue Form 1099.
- The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.
- A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.
From an estate planning perspective, this means that the IRS will include crypto in the deceased person’s estate like they would any other property, say, for example, a house. If the currency has increased in value since it was acquired, capital gains taxes and estate taxes will be assessed.
Beyond Taxes
In addition to thinking about the tax implications of holding cryptocurrency, one must also make plans for what will happen to the currency upon the death of its owner. Unlike traditional legal tender, virtual currency cannot be physically handed over to one’s heirs. Nor can ownership be automatically transferred to someone else after proof of death like most accounts at banks can be. And it is technically impossible for a court to order access to a deceased person’s crypto account.
Crypto owners must instead make plans for the transfer of their digital wealth by providing instructions for its transfer to the person who will ultimately inherit it. This means passwords, instructions, and a record of the cost basis of the assets must be securely stored.
Time Will Tell
The law will eventually catch up with current trends and provide some more answers about how cryptocurrency is to be incorporated into estate plans. For now, all any of us can do is document what steps we are taking and hope for the best.