This is Part Two of a two-part newsletter. Part One was designed to educate readers about crypto-assets and the lexicon of associated terms. Part Two is a discussion of the challenges of estate planning for crypto-assets and some ideas for overcoming those challenges. 1
A set of unique challenges arise when it comes to estate planning for crypto-assets:
- Challenges in Locating and Accessing the Asset
- Private Contracts and Applicable Statutes
- Taxation and Challenges in Valuing the Asset
- Challenges in Transferring Crypto-Assets to Trust and Finding a Trustee
- Challenges in Regulation
Following discussion of these issues, I will make some suggestions for financial advisors, estate planning attorneys, and investors themselves, regarding ways to navigate these obstacles in order to achieve planning objectives.
Part One of this newsletter explained that crypto-assets are held in a “wallet” that contains both a public and a private key. The public key serves as the address to receive transactions and is used to verify that the transaction took place. The private key represents total control and ownership; it is necessary to access the asset itself. Both keys are necessary to transfer the asset on the blockchain. The blockchain system involves irreversible and indisputable verification of the authenticity of a transaction in an auditable record. Therefore, no third party is required to be part of a transaction, which arguably eliminates costs and inefficiencies in a traditional system. However, other risks of fraud and errors persist, including the possibilities of fraud, theft, and loss of the keys.
You will recall that a “fiduciary” in the estate planning context usually means an executor or personal representative of a will, a trustee of a trust, a legal guardian, or an agent or attorney-in-fact under a power of attorney.
CHALLENGES FACED IN ESTATE PLANNING FOR CRYPTO-ASSETS
Challenges in Locating and Accessing the Crypto-Asset
Once you are incapacitated or have passed away, your fiduciary must locate your crypto-assets along with all of your other property. The fiduciary must know of the asset’s existence in the first place. Otherwise, it can be inadvertently lost or accidentally disposed of.
Blockchain is a system that can exist without a custodian of assets. Locating a crypto-asset can be difficult because, unless the assets are held by a custodian, no account records, title, or tax trail exists, and there may be no physical hardware evidencing the property.
Even if the fiduciary knows the asset exists, access is a challenge. Keys are comprised of a lengthy list of characters. If the keys are lost, the asset is irretrievable. Unfortunately, many crypto owners, themselves, have lost their keys. In that case, the owner’s fiduciary and beneficiaries will not be able to access the crypto-asset.
If crypto is held in a hardware wallet, your fiduciary must know about the wallet’s existence and know how to find and access the keys. Some hardware wallets provide recovery words in case the private key is lost. A hardware wallet and its keys can be physically stored in a secure location.
Sometimes, more than just the keys alone may be required to access crypto. If crypto-assets are held on an exchange, the exchange itself may have requirements concerning access. Some may require multi-factor authentication. Some may permit the owner to impose extra security requirements, such as requiring a certain number of authorized devices to approve a transaction or imposing a waiting period on orders.
As I reported in Part One of this newsletter, anyone with access to the public and private keys to a crypto-asset can irrevocably transfer the assets in minutes. Consequently, owners of crypto-assets may be justifiably wary of sharing the keys with anyone, due to a risk of theft or accidental transfer leading to irresponsible loss. Substantial wealth may be at stake. If the owner does not share the private key with anyone, no one will be able to access the asset if the owner becomes incapacitated or dies.
For the reasons described below, your power of attorney should include language expressly and specifically authorizing your agent (or attorney-in-fact) to access specific digital assets. Otherwise, the agent likely will be denied access. The same is true for the executor of your will or for the trustee for your digital assets held in trust.
Private Contracts and Applicable Statutes
Digital assets are those that are stored in electronic form but are separate from the hardware used to hold that data. You probably have many online accounts, which are distinguishable from your devices, (meaning your physical computer, tablet, or smartphone). Some digital assets have inherent monetary value, such as investment accounts. Others have informational value, such as paperless statements, or those providing access to assets with financial value, such as usernames and passwords. Some of your digital assets may consist of contact lists or intellectual property. Finally, some such assets have only sentimental value, such as family photographs and emails.
Digital assets are not limited to crypto; they include your accounts on social media, search engines, and other organizations, including utilities, retail businesses, social and professional groups, and insurers. Companies like Facebook, Instagram, Google (Gmail), and Twitter are known as “custodians” of their customers’ digital information, communications, and accounts. When you open an account with one of these businesses, you must sign a contract. The contracts contain “terms of service” and “privacy policies” that typically restrict access by others to your digital information. Custodians are reluctant to allow others to see clients’ digital information due to concerns about customers’ privacy, business complications, and exposure to potential liability. Some custodians flatly prohibit transfer of ownership of digital assets after a customer has died. Unfortunately, although simply providing someone with your username and password may provide them with access, it may be illegal access, exposing the user to liability for hacking into your account! Arranging for your executor or trustee to access to your digital accounts is a definite issue in estate planning.
If a custodian has an online tool for granting someone access to a disabled or deceased customer’s accounts, such a tool takes precedence over “terms of service” in account contracts. (For example, Google has a tool called Inactive Account Manager and Facebook’s tool is called Legacy Contact.) Still, these programs limit the designated person from access to certain information the custodian is not comfortable releasing. Worse, if a customer opts into one of these tools, the custodian’s program terms trump the instructions in the customer’s validly executed estate planning documents.
If the custodian does not have such a proprietary tool in place, any legal instruments executed by the customer will govern access. If no such written authorizations exist, the custodian’s contractual terms of service will govern.
The Revised Fiduciary Access to Digital Assets Act (“RUFADAA”) has been enacted in whole or in part in most states, including Florida and Minnesota. RUFADAA gives fiduciaries, such as executors, trustees, guardians, and attorneys-in-fact under a power of attorney the authority to access an online account if the owner becomes incapacitated or dies, but this access is permitted only if the owner explicitly consents. A specific, written, authorization will be required.
Consequently, you should have a clear and legally effective estate plan for your digital assets. If you fail to provide legal, written, express authorization regarding your digital accounts, the “terms of service” will govern. Your photos, communications, and other digital content can be irretrievably lost. If the assets in question are crypto-assets, that loss could be sizeable. A comprehensive digital estate plan will include a complete and up-to-date inventory of your digital assets, along with the information needed to locate and access the assets. All of this information is especially critical with regard to crypto-assets.
Taxation and Challenges in Valuing the Asset
Determining the value of a crypto-asset can be difficult because these assets trade on multiple exchanges, twenty-four hours a day and seven days a week. The tax basis for a crypto-asset is the value at the time of the trade.
You are required to report your crypto participation on your income tax return. By 2024, all exchanges will probably be required to report to the IRS. (Already, any transfer of value in excess of $10,000 is subject to SARS, meaning a report must be filed to aid the government in detecting money laundering. Crypto exchanges are required to file such reports.)
Valuation of crypto that has been airdropped (meaning distributed free as a marketing technique) or forked (similar to a stock split) is an ongoing problem. Some exchanges have the right to decide whether to take advantage of an air drop or fork by the crypto issuer, so the investor may not have control. And there is a question as to whether a fork is a recognition event for income tax purposes.
When it comes to accounting for, and reporting, the value of an estate for estate tax purposes, crypto-assets must be included. Note that, due to the fluctuations in value of cryptocurrency, a holding can inflate the value of an estate to a level at which the estate is suddenly subject to federal or state-level estate tax.
Another valuation issue in estate planning is whether and when a crypto-asset is “community property” in those states where the law requires that marital property is deemed to be held jointly by the spouses, in equal parts. If property is brought into Minnesota or Florida from a community property state, it retains is character. Wisconsin is a community property state and many Wisconsin couples move to Minnesota. Florida now permits married couples to elect to treat their property as community property by transferring it into a community property trust. This is something couples with highly appreciated assets should consider because the step up in basis at death is 100% for the surviving spouse.
Challenges in Transferring Crypto-Assets to Trust and Finding a Trustee
An assignment of interest to a trust will not provide the trustee with access to a digital asset. The trust instrument must include language specifically authorizing the trustee with regard to digital assets, and it is wise to define the terms used in the instrument. The Trustee must have the private key.
Institutional and corporate trustees may be reluctant to accept responsibility for direct holding of crypto-assets because they are high risk due to their volatility, risk of loss, and difficulty to value. Many traditional custodians will only accept indirect investment through funds. Some states, however, including Texas and Virginia, have passed legislation allowing state-chartered banks to hold virtual currency. Wyoming passed legislation to charter special purpose depositories to hold crypto-assets; they are awaiting approval for access to the federal reserve.
Challenges in Regulation
Currently, it is unclear to market participants what authority will be regulating crypto-assets, because different federal agencies claim to have jurisdiction. The SEC and the CFTC have claimed regulatory authority over cryptocurrencies and derivatives of crypto, respectively, while the Department of Labor has issued warnings to investment professionals about the risks of investing in cryptocurrencies, especially for those held in trust, subject to the fiduciary duty of prudent investment. A number of legislative proposals have been made in Congress, designed to regulate digital assets in order to balance the goals of protecting investors and maintaining orderly markets, while encouraging innovation and capital formation. In March, President Biden signed an executive order creating the first comprehensive federal digital asset strategy for the U.S., which would promote digital asset innovation, while balancing benefits and associated risks. The Order directs the Justice Department, U.S. Department of the Treasury, the Board of Governors of the Federal Reserve System, the Consumer Financial Protection Bureau, and many other federal agencies to study the legal and economic implications of a central bank for digital currency.
With this federal regulatory vacuum, 80% of states are passing legislation to promote crypto investment in order to benefit from the corresponding job creation and economic fuel. Florida, for example, recently adopted state legislation making it easier to buy and sell crypto. Governor Newsom in California issued an executive order establishing a comprehensive regulatory framework for blockchain and crypto-assets.
KEY STEPS FOR ESTATE PLANNING WITH CRYPTO-ASSETS
Employ techniques to ensure that crypto-assets are transferred on death as planned, while reducing the risks of theft, inadvertent loss, and unnecessary payment of capital gains tax. Recommended steps include:
1. Work with an estate planning attorney to establish a digital estate plan. Update it frequently. The law and the technology in this area are constantly changing.
2. Consider appointing a digital fiduciary for digital assets, including crypto or limited to crypto. This may or may not be a family member. You may wish for some assets to remain private. Consider having the fiduciary post a bond. Provide this fiduciary with instruction, direction, and guidance as to the management and disposition of the assets.
3. Put assets in trust to maintain privacy. Wills are public record.
4. When working with your estate planning attorney, fill out an inventory form detailing the following information in connection with each digital asset:
a. Identification of which device or devices are used to access the asset.
b. The identifying information for the asset (name).
c. The location of the wallet for the asset (whether a custodian, an exchange, or physical hardware).
d. The location of the information needed to access the key and/or the asset itself (paper in safe deposit box or safe? Or, for an exchange, the username and password.) Has the information been provided to your fiduciary or not?
e. Explanation as to how access to the asset is constrained (methods of security required to obtain access).
f. The purchase price and date the asset was acquired to establish basis for income tax purposes.
g. A description of where, in your estate planning documents, the provisions for management and disposition of the asset are located. This includes business succession plan documents, including an operating agreement, if such materials are relevant.
5. Keep your inventory up to date. Update it every few months. At any given time, you must be aware of what you own in terms of crypto-assets. Trading of crypto can occur monthly, or even daily; if your inventory is not updated whenever you complete a transaction, your appointed fiduciary may not be able find your asset.
6. Ensure that your fiduciary knows where to retrieve your username, password, and answers to security questions in order to access your account with an exchange or other custodian. Physically recording that information and storing it offline in a secure location is advisable.
7. With the help of your attorney, determine which regulatory rules apply to your digital investments, and comply with those rules. Check your state’s laws. You may be able to select a state with legislation that assists crypto investors. Wyoming, for example, has passed legislation authorizing trust companies to custody digital assets. Some states’ laws permit stronger asset protection than others, and some states require custodians to maintain insurance and capital reserves, to protect investors.
8. Include the requisite legal language in your digital estate plan documents granting your appointed fiduciary access to your digital account assets. If you want to dispose of your digital investment assets separately from your traditional investments, you may wish to expressly exclude digital assets, records of access information, and associated devices from the provisions in your will and trust applicable to other, traditional types of investment assets. Make sure the language authorizing your fiduciary is compliant with statutes governing access to digital assets.
9. Include the requisite legal language granting your fiduciary access to your hardware wallets and hardware devices. Exclude these assets from the definition in your instrument of tangible personal property, or the devices may be transferred along with your clothing and furniture. Again, be sure to include language compliant with any applicable statutory law regulating access to such property.
10. Advise your digital fiduciary to instruct your beneficiaries not to dispose of your personal devices, such as phones, tablets, and computers, until all digital assets have been marshalled.
11. Instead of arranging for your beneficiaries to inherit private keys, you could provide for them to inherit new wallets to which the crypto-asset is transferred upon your death. This will reduce the possibility that another person may have access to the keys associated with existing wallets.
12. Another strategy is to wrap the crypto-assets in an LLC and devise the LLC ownership interests, with the added benefit of discounts for lack of marketability.
13. According to a commentary by Mike Jones, C.P.A., cryptocurrency may not be contributed into an IRA, but there is no prohibition against purchasing cryptocurrency in an IRA. From there, it can be rolled over within 60 days of distribution to another IRA, including a Roth IRA, if certain conditions are met.2
14. Plan for capital gains minimization, as you would with any asset. Maintain records of purchase price, date, and time to establish tax basis. Record and save your trade confirmation. If you have no records, remember that companies known as blockchain explorers can track transactions and determine the value a crypto-asset at the time of transfer based on the value of the asset received in exchange.
15. Consider charitable planning to avoid taxation of built-in-gain. Provide that if, at the time of death, the crypto has built-in-losses, the asset should be sold, the losses recognized, and the proceeds donated.
16. Treat your assets as community property by transferring them to a community property trust.
17. For better physical and digital protection and security, transfer assets held in digital wallets and exchanges to hardware wallets while you are alive. And store the hardware wallets in a secure location.
18. For those estates subject to estate and gift taxation, generation skipping transfer tax, and state level income tax, more planning strategies should be employed. Planning to situs the assets in a state that does not impose state-level income or estate tax would be desirable. Using irrevocable non-grantor trusts and business entities as part of an estate plan can minimize estate tax and offer asset protection. High net worth investors should consult a tax attorney.
1 I wish to acknowledge Pamela Morgan, Esq., an expert in this area of the law, whose book is available on Amazon, at the link below. Her webinar presentation inspired and informed my ideas. Cryptoasset Inheritance Planning: a simple guide for owners: Morgan, Pamela, Antonopoulos, Andreas M.: 9781947910119: Amazon.com: Books
2 ISI Employee Benefits & Retirement Planning Newsletter #775
(January 3, 2022) at http://www.leimbergservies.com.
Natalie A. Roberts
THIS ARTICLE IS PROVIDED FOR GENERAL INFORMATION PURPOSES ONLY AND SHOULD NOT BE CONSIDERED LEGAL ADVICE OR RELIED UPON AS COMPLIANCE, LEGAL, OR TAX ADVICE. LEGAL ADVICE IS NOT PROVIDED IN THE ABSENCE OF AN ENGAGEMENT AGREEMENT FOR A SPECIFIC MATTER AND THE EXISTENCE OF AN ATTORNEY-CLIENT RELATIONSHIP BETWEEN YOU AND FLAGSHIP LAW. LEGAL ADVICE WILL ALWAYS DEPEND UPON YOUR SPECIFIC SITUATION.