There are available tax savings if you have cryptocurrency but be careful – there are lots of ways to screw this up and even lose your crypto for good!
First, some crypto estate planning basics: Your Will and/or Trust must specifically mention cryptocurrency, or you risk losing it all!
Most crypto trading platforms, such as Coinbase, where you can trade and keep Bitcoin, Ethereum, etc., do NOT allow you to name a beneficiary on your account/wallet. This is the opposite of most bank accounts. Most financial institutions allow you to name someone as “POD” or Payable on Death so that your assets in these accounts pass directly to the person/people that you designate. Not so with most crypto. And since you can’t name someone directly, the crypto must pass through your estate. Doesn’t sound too difficult, right? But the problem is account access. Your Will or Trust must specifically grant access to your executor for your crypto accounts. Otherwise, trading platforms like Coinbase can refuse to give them access, and the cryptocurrency can be lost forever!!!
If your estate planning documents are old, then they probably pre-date crypto. If you’ve since acquired crypto, it’s basically a ticking time bomb. Your plan should be updated to allow crypto access, or it can be lost for good. And there are no exceptions. Just look at this story of a young man who had crypto valued at half a BILLION dollars!!! The hard drive was thrown away and the money is GONE!! This is living proof that no exceptions will be made – you can simply lose it forever if you don’t plan accordingly.
So, what do you do about it?
First, update your Will, Trust, and Power of Attorney – make sure they specifically allow crypto access. Trusts can own crypto, so another option is putting your crypto assets in a trust, so that they go directly to your beneficiaries at your death, without going through probate or risking a loss of the money. Do it right, or you risk it all going up in smoke. Don’t be like the guy in the story – every day he watches the value of his crypto go up, and he knows it’s lost for good. I don’t think I could bear it! If you have crypto, call us to set up your Strategic Planning Session - we have the expertise to deal with this unique asset.
Tax planning with Crypto
There are ways to achieve tax advantages on the growth of cryptocurrency and even avoid capital gains taxes. It’s a bit complicated but worth it.
Crypto is being examined by the government because they hate that they can’t make the tax revenue they want. So, the rules today could change tomorrow, and then change back again multiple times.
Basically, the state is allowing for the creation of a Charitable Remainder Trust (called a CRT or CRAT) combined with an annuity. The basic premise is that money can be put into a charitable trust, causing you to get a charitable exemption on your income taxes, plus allow the asset to grow with deferred capital gains taxes, and in some cases, no capital gains taxes at all. The annuity allows you to put money in the trust, but then receive annuity payments from the trust, to supplement your income, so long as a portion of the trust funds is guaranteed to go to charity after your death.
Now, you can’t dump money into the trust and then pay ALL that money back to yourself, with nothing ever ending up going to charity. To do the trust with the annuity, it would have to be set up so that there is some guarantee that the charity will get a portion after your death. It's that portion that gives you a tax deduction. The trust promises to give the leftovers to charity upon your death, so the government will allow you to defer SOME of the income tax liability, with some conditions.
First, you must put the assets into the trust NOW, not at your death, to get the tax deduction.
The downside here is that we are tying up the asset a bit, which I don’t love, but you might still prefer it because of the potential tax savings even in Tax-achusetts! It would work like this:
You transfer the crypto asset into the CRT (there are some logistics steps to this) and the CRT pays a fixed income stream to you (the annuity) based on a set percentage of the fair market value of the crypto assets you put into the CRT. The amount of the payment to you does not change, which is why we call it an “annuity”. For example, if you put $1 million into the CRT, and choose a 5% annuity payment, the CRT would pay you a fixed $50,000 per year for the duration of the CRT. Here’s the catch – there are three limitations:
1. The set percentage of the annuity payment must be a minimum of 5% and cannot exceed 50%. No big deal, but that’s not the only limitation.
2. The payout rate is also limited to the max rate that will still provide to charity at least 10% of the value of the assets you put into the CRT. So, if you put in $1M, the charity still needs to end up with $100K in the end.
3. The payout is even further limited to an amount such that there is less than a 5% chance that the trust will leave nothing to charity. In other words, they are making sure that the charity gets something, and it’s a pretty good piece, even if the value of the trust goes down.
All of that boils down to the annuity payments being unable to exceed roughly 15% per year, at a max. So, if you put in $1M, you’d be limited to annuity payments to a max of $150K per year, and a minimum of $50k per year. With a CRAT, once you choose the annuity amount, it cannot be changed. No matter how much the asset grows in value, the annuity payment amount never changes.
The 10% remainder requirement requires that the charity or charities must be projected to receive at least 10% of the value of the initial gift to the CRT. And that 10% is the amount of the income tax deduction you get in the year you make the CRT. The 10% is the minimum – you can get a higher deduction if you promise MORE of the end product to charity. But assuming you’d want to leave the minimum, it’s 10%. The government is allowing a capital gains benefit as well, again on a limited scale. The capital gain on the growth of assets is bypassed, but you can’t increase the annuity payment amount, even if the asset grows. That’s another part that I don’t love, but it’s a trade-off for the tax benefits.
After the trust term ends, the charity you name gets the rest of the assets in the trust. Again, the year you establish the CRT, you receive the income tax charitable deduction, as long as you meet the requirements/limitations stated above. It’s NOT a deduction you get every year.
Here’s an example:
A 70-year-old man, places $100,000 of crypto in a CRT, paying a 6% annuity payment. Let’s assume the original cost of the crypto was $60k, so there has been $40k of capital gain so far. The annuity will pay at 6%, so $6,000 annually. In the year the CRT was established, he gets a charitable deduction of roughly $10K, because he’s the minimum 10% to the charity, but only in the year, the trust is created. But then he avoids the capital gains tax on the $40k of taxable gain. The annuity payment is $6k, but the annuity payment is taxable income though. That’s because, although the trust itself is a tax-exempt entity, the trust income distributed to beneficiaries is in fact taxable. So, you get the advantage of not paying capital gains tax, but the annuity payment is taxable income. The rules also say that you can’t withdraw all of the money out of the trust until the trust term expires. You can’t just change your mind and pull it all out because you need it.
In short, you get a 10% income tax deduction in the year you make the trust, and you get to avoid the capital gains taxes. Those are the positives. The negatives are that the annuity payment is taxable income to you, you must put the assets in trust now, the charity must be guaranteed a certain amount in the end (min 10%), and you can’t just change your mind and pull all the money out.
The potential tax savings are proving worth it for many taxpayers. If this is something you want to discuss, set up a Strategic Planning Session with us – we have the expertise to deal with this unique asset.