Cryptocurrency’s popularity has rapidly increased in recent years, with more people buying and selling the digital currency. Here are three important concepts you need to know about cryptocurrency in relation to your estate plan.
1. Beware of the Tax Consequences
Transferring your cryptocurrency to other people, either during life or at your death, could have income, estate, and gift tax consequences that are important to understand.
- Potential income tax consequences. Essentially, the position of the Internal Revenue Service (IRS) is that the sale or exchange of a “convertible virtual currency” (a virtual currency that has a corresponding value to a real currency such as the US dollar or the Euro) may result in a taxable gain or loss just like the sale or exchange of any other property. Whether the gain or loss is characterized as a capital gain or capital loss depends on whether the convertible virtual currency was a capital asset in the hands of the taxpayer, for example stocks, bonds, or other investment property. If the virtual currency was not a capital asset in the hands of the taxpayer, such as inventory or other property held for sale in a business, the taxpayer would realize ordinary gain or loss.
- Potential estate and gift tax consequences. The IRS considers virtual currency to be property, so federal gift and estate tax laws apply. Because cryptocurrency can quickly increase in value, many people whose estate would otherwise have a value less than the estate and gift tax exemption amounts ($12.06 million for individuals and $24.12 million for married couples in 2022), must now include in their estate plans provisions for minimizing gift and estate tax consequences.
If you own cryptocurrency that has substantially increased in value, or if you anticipate that it will substantially increase in value, then it is important to discuss with your estate planning attorney ways to minimize potential income, estate, and gift tax consequences.
2. Laws Governing Cryptocurrency Are Slowly Developing
It is no secret that technological advances are moving faster than the law.
At the same time, as cryptocurrency increases in popularity, more people have cryptocurrency holdings that must be considered part of their estate. Because cryptocurrencies are generally stored in such a way that no personally identifying information is tied to them, owners of cryptocurrency must inform their beneficiaries that these assets exist, or they could be lost forever at the owner’s death. Further, owners (and their estate planning attorneys) must provide specific instructions for accessing the cryptocurrency, or the information could also die with the owner. Finally, because managing cryptocurrency requires some level of technological expertise, it is important to appoint trusted decision makers that have some basic cryptocurrency knowledge.
All of these factors create unique challenges when it comes to dealing with cryptocurrency in your estate plan. A comprehensive estate plan ensures that you and your beneficiaries know about and control what happens to your cryptocurrency upon your death.
3. How You Hold Cryptocurrency Affects Your Plan
The way you store cryptocurrency adds an additional layer of complexity to the issue. How you store your cryptocurrency is one of the most important considerations because if you have no plan for how to pass on your cryptocurrency, then it could be lost after your death.
- Custodial wallet. A third party, such as a crypto exchange, holds your cryptocurrency, similar to how a bank keeps your money in a checking account. While this is the most convenient option and there is little concern about “losing your keys,” the downside of leaving your crypto in another party’s possession is that they could freeze your funds or be hacked. With this type of wallet, your beneficiary can work with customer support to have the crypto transferred after your death.
- Cold wallet. A cold wallet is a physical storage device, such as a USB drive, that stores your crypto offline. The disadvantages of this option are the cost of the hardware and that the device may be a small object that is easily misplaced. On the other hand, this is the most secure option for storing crypto because it cannot be stolen by hackers when it is offline. You will want to ensure that your trusted decision maker or beneficiary knows where to find the cold wallet and has detailed instructions for accessing the stored crypto.
- Hot wallet. A hot wallet is a desktop, web-based, or mobile app that stores your crypto online. While a hot wallet is convenient, the big drawback is that crypto stored online is at the greatest risk of being hacked and stolen. Your estate plan will need to include instructions on how to access the hot wallet.
- Paper wallet. A paper wallet is a printout of keys, usually in the form of characters and scannable QR codes. It provides a great amount of security because it stores your crypto offline, but it is the least convenient, and includes the risk of losing the paper wallet.
No matter how you store your cryptocurrency, it is critical that your trusted decision maker knows how it is stored, where it is stored, and how to access it, including how to access all security keys, seed phrases, usernames, and password information.
How MM&C Estate Planning Attorneys Can Help
Because cryptocurrency and the estate planning laws surrounding it are rapidly evolving, it is essential that you work with an estate planning attorney who understands the unique challenges involved in planning for crypto.
MM&C estate planning attorneys advise clients on strategies to reduce the value of an estate for tax purposes. Maryland estate tax applies to estates valued over $5 million. The Maryland estate tax rate starts at 0.8% and tops out at 16%. For 2022, the District of Columbia estate tax applies to estates valued over $4,254,800 (this number will likely increase annually for cost-of-living adjustments). The District of Columbia estate tax rate ranges from 11.8% to a maximum of 16%.
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David Lucas is an attorney in the Estates & Trusts practice groups at Miller, Miller & Canby, licensed to practice in Maryland and the District of Columbia. He focuses his practice in Estate Planning and Trust and Estate Administration. He provides extensive estate and legacy planning, asset protection planning, and retirement planning. Contact David at 301.762.5212 or via email. To learn more about Miller, Miller & Canby’s Estates & Trusts practice click here.