INTEGRATING CRYPTOCURRENCY INTO ESTATE PLANNING

Those with crypto currency within their asset portfolio have more than likely repeated the phrase “Not your keys, not your coins” once or twice. For those that are unfamiliar with the concept, crypto currency owners hold their crypto within an on-chain (blockchain) “wallet.” Each wallet is recognized on the blockchain as the owner of a given amount of that specific cryptocurrency. Think of your wallet as your bank account for any given cryptocurrency. As discussed in our previous article entitled Blocks of Digital Assets- Bitcoin, Non-Fungible Tokens (NFTs), and Property (https://kempelaw.com/wp-content/uploads/2022/01/Newsletter-Winter-2022.pdf) , there are two general concepts on how blockchains are structured: proof of stake and proof of work. For proof of stake, crypto holders stake their currency on chain and receive interest for their staking, similar in concept to an interest bearing bank account, with the staked cryptocurrency functioning as the bank. This provides liquidity for others to transact, in a manner similar to bank lending capabilities. For proof of work, the blockchain is a chain of blocks with each block formed once a solution to a cryptographic equation is found by a crypto miner.

The blockchain provides an open ledger concept of crypto currency; the ledger of all wallets and their holdings is completely transparent on the blockchain. As such, assurance is provided that the party you are transacting with owns the crypto currency they state. To access your wallet at any time for either proof of stake or proof of work blockchains, you are provided a 16-phrase pass key.  With this pass key, you can access your crypto currency from anywhere, at any time. However, the pass keys are tantamount to accessing your crypto currency; without them, your crypto currency will be lost, forever. There is no Bitcoin or Ethereum headquarters to contact for a password reset or username recovery. While this concept does eliminate third party risk and provides the user complete privacy, it places all risk on the user. For purposes of estate planning, this increases the complexity of a seamless transition of such assets to the next generation that clients may not have begun to contemplate. Furthermore, it can lead holders to feel that stored wealth cannot be found by government agencies, such as the IRS, and lead them to a false sense of undiscoverable evasion.

The IRS has many methods of finding evaders, using technology or simple net worth audits- how have you acquired the assets you have on such little income and wealth? If you can’t use it, what good is it? Furthermore, the IRS is significantly intensifying its efforts to combat cryptocurrency tax evasion, utilizing advanced blockchain analysis and data analytics to track transactions and link wallet addresses to individuals, even when privacy tools are used. This surveillance is expected to lead to a substantial increase in crypto tax audits, with the agency preparing for real-time tracking of crypto activity for the 2025 tax year. The IRS has already demonstrated its capability to pursue criminal charges for willful evasion, as evidenced by the 2024 conviction of a man sentenced to two years in prison for tax evasion related to Bitcoin. The statute of limitations for evasion can be indefinite, and your heirs can become civilly and criminally responsible for failure disclose these assets.  This is similar to those who possess gold and other collectibles, and those assets pass-on to heirs at death.  The risks of conviction for evasion can be great!

Generally, we recommend that all assets be owned and pass to future generations in trust, in order to secure many levels of protection. To integrate these crypto assets into trust, there are multiple avenues that a client may consider. A client may maintain personal ownership and provide clear instructions to a spouse or the next generation with their pass keys maintained in a safe location (a safety deposit box, a personal safe, or within your estate plan file within our will vault). A client may decide to integrate their cryptocurrency with their base estate plan by transfer to a newly established wallet owned by their Revocable Trust to avoid probate, with the revocable trust’s pass keys secured as previously described. A client may choose to make a taxable transfer or sale to an irrevocable trust or other entity to shift these assets out of their taxable estate by utilization of their gift tax exemption during life if they foresee their crypto currency increasing in value. However, the risk of loss of the pass keys remains, unless the wallet requires multiple signatures.

A multi signature wallet solves the 1^st party risk issue by giving three parties pass keys and requires two of the three signatures to access the wallet. Each party maintains their own pass key. One set of pass keys is held by the wallet issuer, one set of pass keys is held by the client, and a set of pass keys may be held by a trusted third party such as a friend or your estate planning attorney. Therefore, even if the client or an individual who the client trusted to maintain the pass keys loses their pass key, there are two others. The multi-signature wallet mitigates such risk. We are willing and able to maintain your pass keys within our will vault or act as a trusted alliance to hold pass keys in a multi signature wallet. Within our Firm, we have multiple layers of security for crypto, accounts, and client property that are designed to mitigate risk of loss.  Please contact our office for a confidential and privileged discussion of these maters.

We are pleased to be of service!

Conner R. Kempe, Esq., LL.M.

https://kempelaw.com/our-professionals/conner-r-kempe-jd-ll-m/