By Eric C. Jansen
The current low values of bitcoin and other cryptocurrencies, down substantially from their all-time highs about a year ago, create opportunities for estate-tax planning for clients with substantial crypto holdings. Among the strategies that the low values suggest is wealth transfer through gifting.
Since its inception in 2009, bitcoin’s value has ranged from less than a penny to nearly $20,000. Over the past 12 month its value has fallen--from nearly $10,000 in April 2018 to about $3,200 in Dec. 2018. Though bitcoin has since risen—edging above $5,400 in late April and then zig-zagging before resuming that same level—it was then still well below its 12-month peak. And many other digital currencies, referred to as ALT coins, have seen their values drop during the same period by 90% or more from their all-time highs.
Estate and Gift Taxes
Although the higher exclusion amounts introduced by the Tax Cuts and Jobs Act of 2017 (TCJA) reduced the number of client estates subject to federal estate tax, the TCJA is scheduled to expire after 2025. And forces are already at work seeking to reduce the number of estates escaping transfer taxes. Further, 17 states and the District of Columbia currently have estate or inheritance taxes (Maryland has both). These exclusion amounts vary widely, but they are typically well below the federal exclusion.
State taxes and the short shelf life of the current estate-tax exclusion underscore the importance of attentive tax planning for wealthy, crypto-holding residents of those states.
Client Service Points
Here are some takeaways for serving crypto-holding clients in wealth-transfer strategies:
- Clients who wish to give away substantial amounts may have the common misconception that they can only gift $15,000 per person annually without triggering gift tax. Yet this is only true if they’ve already used their entire unified credit.
- Clients should be informed that when gifting, their cost basis for gifted virtual currency is transferred to the recipients, who will be subject to income tax on any gains above that basis upon selling.
- For those who believe that their current virtual currency holdings will substantially appreciate in their lifetimes, the unified credit is often presumptively of more ultimate benefit to their estates when used for gifting rather than letting it be applied to estates after death. Carried to its extreme, this strategy would enable an extremely crypto-heavy client to gift $11.4 million worth of virtual currency, using up the entire credit to remove this value from his or her estate, precluding potential appreciation that would add to the estate’s total value and push it into, or further into, the taxable realm.
- If not avoided, this potential appreciation inside estates can be costly. For example, if $11.4 million in crypto were to triple, to $34.2 million, after it’s gifted, the $22.8 million in appreciation wouldn’t be part of the client’s taxable estate. Under the current rules, this would save $9.12 million in federal estate tax.
Creative Use of Trusts
Depending on their individual circumstances, clients with large amounts of virtual currency may find it advantageous to incorporate it into one or more trust strategies.
One option is an A-B trust, also known as a bypass trust. Couples confident that their crypto will appreciate over time can fund an A-B trust with low-value crypto, hoping to eventually pass it along it to heirs at a higher value and free of estate tax upon either spouse’s death, assuming that it’s part of the B trust of first spouse to die. Further, by using a generation-skipping A-B trust, the appreciation of any asset in it, including cryptocurrency, may avoid estate taxation for generations to come, potentially saving millions in estate taxes.
Another trust strategy involves using an Grantor Retained Annuity Trust (GRAT). Irrevocable trusts that are typically used for assets expected to appreciate over time—such as real estate, stock, and business interests—GRATS tend to work well in low-interest rate environments. The goal in creating a GRAT is to transfer assets and their potential future appreciation out of your estate while avoiding gift taxes, thus retaining as much of the unified credit as possible. A GRAT will be in a position to accomplish a client’s goals if the crypto transferred into it appreciates faster than the tax code (IRC section 7520) rate, which was 3% in April. However, if the value of the assets depreciates or grows at a rate lower than the IRC rate, the strategy will not accomplish its goals, so using a GRAT requires high client confidence in crypto appreciation.
As with any asset, where cryptocurrency values are headed, no one knows. Yet the current low values prompt a re-examination of tax avoidance strategies in estate planning.
Eric. C. Jansen, ChFC, is the founder, president, and chief investment officer of Westborough, Mass.-based Finivi Inc., an SEC-registered investment advisor.