Digital assets, like Bitcoin, have provided a new asset class for investors and traders, minting new millionaires in the process.
Cryptocurrencies, DeFi and stablecoin staking, non-fungible tokens (NFTs) and other digital assets have given high-net-worth investors diversification, enhanced liquidity and the potential for significant appreciation (along with a hefty dose of risk).
Most business owners and entrepreneurs who come into wealth when they exit their companies will turn to wealth management and financial planning firms to help them with their newfound riches.
By stark contrast, a cryptocurrency whale who has suddenly come into great wealth tends to have a higher risk appetite and yet generally lacks the experience of handling the rigors and complexities of administrating their newfound abundance. The skill set it takes to create wealth is a very different skill set required to preserve and protect wealth.
Despite their advantages, digital assets for the inexperienced investor pose unique challenges. The regulatory environment for digital assets is still evolving, which can lead to legal uncertainties and potential compliance issues, including the arduous tax reporting and basis tracking rules promulgated by the IRS. Furthermore, the pseudonymity that attracts many to digital assets can complicate estate planning and asset transfer upon death or incapacitation.
Strategies for mitigating tax liabilities
Even when your cryptocurrency investments like Bitcoin pump, they are exposed to two significant threats: estate taxes at death and lawsuits from creditors and predators. Without advance estate tax planning, the value of your cryptocurrency holdings when you die could be subject to a 40% estate tax. If the predictions for the future value of Bitcoin are anywhere near accurate, without proper estate tax planning, your heirs could unexpectedly owe tens of millions or more in death taxes. That would require significant assets to be sold to cover the taxes due, depriving your beneficiaries of the future growth and benefits of owning Bitcoin and other cryptocurrencies.
Moreover, recent tax proposals aimed at lowering the national debt may further increase this burden. One potential strategy is to use your current (2024) lifetime gift tax exemption to transfer up to $13.61 million of assets you expect to appreciate (like Bitcoin) to a Nevada irrevocable third-party dynasty trust. Once in the trust, the value of your Bitcoin is removed from your taxable estate, and the taxman will not collect a penny of death taxes on this asset class for literally hundreds of years. However, it’s important to act before January 1, 2026, when the lifetime gift tax exemption will be reduced by half.
However, it’s important to act before January 1, 2026, when the gift tax exemption will be reduced by half.
For active traders, setting up an LLC to hold your cryptocurrency can be advantageous. By gifting the LLC interest to an irrevocable trust, you can avoid estate taxes on the appreciated value of your crypto. If your investment exceeds the gift tax exemption, consider selling the excess amount to the trust for a long-term promissory note. The note’s face value will be included in your estate, but the appreciation will not, providing substantial tax savings to your heirs.
Protecting against lawsuits
Lawsuits pose another significant risk of loss of your stack. Many HODLers, individuals who own and frequently trade in cryptocurrency, are unaware they can protect their digital assets from lawsuit creditors and litigators by using an LLC and an asset protection trust. By placing your LLC interest in the proper trust, your assets may be shielded from future unforeseen personal creditors.
Structured correctly, this strategy ensures that, absent fraud, your cryptocurrencies remain inaccessible to creditors following a lawsuit.
Conclusion
With tens of millions of lawsuits filed annually in the United States, and the majority settling for pennies on the dollar, it’s essential to remove financial incentives for becoming a defendant. Strategically implementing these legal strategies can provide options for protecting your wealth, ensuring your digital assets remain secure and preserving those gains for future generations.
If you have questions about digital assets and protecting yours, feel free to address them to author Jeffrey Verdon at JVerdon@frblaw.com, chair of the Comprehensive Estate Planning Group at Falcon Rappaport & Berkman LLP.
