Cryptocurrency has recently been down over 70% from its all-time high last year. So, what does this mean for crypto-millionaires or high-net-worth crypto “hodlers” in the United States? In America, there are two certainties—death and taxes. For crypto hodlers, there is a third—crypto will exceed its last all-time high in the next bull run. This article addresses all three certainties and how U.S. crypto-millionaires and high-net-worth crypto hodlers can capitalize from an estate planning perspective during the current crypto bear market.
Estate planning is the process whereby an individual legally formalizes who receives their assets, when, and how. While the individual is alive, asset transfer is usually through an outright gift or a gift in trust for beneficiaries. At the individual’s death, this may be accomplished through a Will and/or testamentary trust (that is formed upon one’s death). For high-net-worth crypto hodlers, comprehensive estate planning goals may include asset protection, minimization of gift/estate taxes, and income taxes.
U.S. Gift and Estate Tax
In the U.S., upon an individual’s death, the Federal estate tax is imposed on that estate when their net worth plus lifetime taxable gifts exceeds their lifetime gift/estate tax exemption (an amount that fluctuates based on legislation and inflation). Likewise, the Federal gift tax applies when an individual gifts (outright or in trust) during his life cumulatively more than their lifetime gift/estate tax exemption. The purpose of the gift tax is to ensure that individuals do not avoid the estate tax by gifting away their assets before they pass away. Therefore, every individual has one unified exemption for both gift and estate taxes; an individual’s lifetime gifts will reduce the remaining exemption that will apply at their death. When a gift or estate tax applies, the Federal tax rate is 40% of the value of the transfer.
Currently, the Federal gift/estate tax exemption per individual is just over $12,000,000 (the highest in its history), which is scheduled to be halved in 2026. Federal gift/estate taxes in their modern format have existed for approximately 100 years (the estate tax has existed since 1797 in an older format). In those 100 years, the Federal estate (but not gift) tax was repealed only once, in 2010. Notably, about seventeen states have their own estate or inheritance tax that operate independently from the Federal estate tax.
The following focuses on minimizing gift/estate taxes via “Irrevocable Trusts.”
Irrevocable Trusts
An Irrevocable Trust is a legal arrangement whereby an individual (i.e., trust creator or grantor) transfers assets to a trustee. The trustee takes legal ownership of and administers the assets for the benefit of the grantor’s chosen beneficiaries upon the terms of the trust. While there are many types of Irrevocable Trusts, their defining characteristic is that they generally cannot be revoked or reversed. A properly structured Irrevocable Trust allows an individual to minimize gift/estate taxes, provides asset protection, and may have state income tax benefits. Irrevocably gifting crypto to an Irrevocable Trust allows the grantor to lock in the current historically high gift/estate tax exemption before it halves in 2026. More importantly, the years or decades of growth in crypto while in the Irrevocable Trust will not be subject to any estate tax upon the grantor’s death. These assets can also escape estate tax upon the later death of one’s beneficiaries – essentially allowing the Irrevocable Trust to last many years or even forever.
Successful asset protection means that the crypto within the Irrevocable Trust will generally not be reachable in lawsuits or divorce/separation proceedings against the grantor or the beneficiaries of the Irrevocable Trust.
For individuals residing in high-income tax states, properly formed Irrevocable Trusts can provide state income tax savings. The Irrevocable Trust should be formed in a zero–income tax state. This would permit crypto capital gains (and certain other income) within the Trust to escape state income taxes that would otherwise apply in the individual’s high–income tax state. To do this, the Irrevocable Trust must have some connection to the non-taxing state. This connection could be through the Trustee’s state of residency.
In response, the vast majority of high-net-worth crypto hodlers in the U.S. might say: I have way less than the lifetime gift/estate exemption in crypto, so the Irrevocable Trust is not for me (“Situation”). Also, I am not ready to give away any crypto to anyone else (“Access Issue”) and I do not want someone else (i.e., the trustee) to invest and trade my crypto (“Control Issue”). The Situation and Issues are addressed below in a general and simplistic manner. There are countless other factual and legal considerations that are beyond the scope of this article.
Situation
An individual has $1,000,000 in crypto, which is their entire net worth. The individual is 28 years old, unmarried, and does not have children. Assume that the individual dies unmarried years in the future when the Federal exemption is $10,000,000 and estate tax rate is 40%; the applicable state exemption is also $10,000,000, and the state estate tax rate is 10%. At this time, the individual’s crypto has gone up 22x from the current bearish price. Assume that in consideration of the individual’s expenditures and other income throughout the years, they have $20,000,000 in crypto remaining at their death.
If the individual did no or minimal estate planning, then the estate tax liability would be $5,000,000. That is, $20,000,000 crypto less the $10,000,000 exemption, times the 50% combined Federal/state estate tax rate. Generally, the estate would have to pay the $5,000,000 to the IRS and the state within 9 months of the individual’s death. Administration and distribution of the $15,000,000 crypto ($20,000,000 crypto less $5,000,000 estate taxes) would likely be under the supervision of a probate court. This process can impose a delay of several months before the beneficiaries will receive their crypto and can also result in expensive probate and legal fees.
If the individual creates an Irrevocable Trust and transfers the entire $1,000,000 in crypto to the Irrevocable Trust during this bear market, that $20,000,000 in crypto at the individual’s death would be subject to zero gift/estate taxes. The transfer into Trust would be exempt from the gift tax because it is below the current Federal lifetime exemption. Upon the individual’s death, the entire $20,000,000 (less relatively nominal trust administration fees) can be distributed outright or in further trust to/for the individual’s beneficiaries without any delay or expense of probate court.
Access Issue
When many think of the term Irrevocable Trust, they think that they are parting with their assets. However, this does not need to be the case. While most states prevent self-settled Irrevocable Trusts, which the individual sets up for the benefit of him/herself, some states permit such Trusts (often referred to as Domestic Asset Protection Trusts or “DAPTs”). For example, Nevada and South Dakota permit self-settled Irrevocable Trusts and also happen to be zero–income tax states.
Essentially, as a beneficiary, the individual retains the right to distributions from the Trust. Generally, such distributions are limited by the ascertainable standard of “health, education, maintenance, or support” of the individual. The individual can request and receive such distributions from the trustee as a matter of right. In addition, the trustee can make discretionary distributions of any amount under given circumstances. For instance, if the individual wants to start a business, the individual can receive a large amount (e.g., $2,000,000) from the Trust.
Alternatively, in virtually all states, a grantor can create an Irrevocable Spousal Lifetime Access Trust (“SLAT”) for the benefit of the grantor’s spouse. This permits the grantor to retain indirect access to the SLAT’s assets while the grantor’s spouse maintains direct assets to the assets—all while gaining creditor protection and reducing the value of their taxable estate at death.
Control Issue
Most individuals, especially those who have been highly successful with their crypto holdings, generally do not want a random trustee to manage (i.e., trade and invest) their holdings. With a DAPT formed in Nevada or South Dakota, this does not have to be the case. In those states, the individual can appoint a Trust company to be the administrative trustee and/or benefits trustee/advisor, while appointing him/herself to be the investment trustee/advisor. As such, the individual remains in control of how the crypto is traded and invested.
Alternatively, or in addition, the individual may create a Family Entity and appoint him/herself as manager, before gifting the Family Entity interest to the Irrevocable Trust. The Family Entity would be the owner of the crypto, and as manager, the individual would be free to trade and invest the crypto.
With respect to a SLAT, the individual can appoint their spouse and/or another as a trustee. This permits the grantor to retain indirect control over the SLAT’s assets.
Also, a middle passage is possible. One can create an Irrevocable Trust for half or another part of their crypto, while retaining individual ownership over the remaining part.
In Closing
U.S. based crypto–millionaires and high-net-worth crypto hodlers should not dismiss Irrevocable Trusts because it is too early or because they do not want to give up their crypto. Given the enormous upside potential of cryptocurrency, too much is at stake from a tax perspective. Such individuals can retain significant access to, and control over, their crypto within a properly structured Irrevocable Trust and via the middle passage option. All the while achieving savings of millions of dollars in gift/estate taxes and state income taxes.
For more information about estate planning and irrevocable trusts as they relate to cryptocurrency investments, or other assets, please contact Mikhail E. Lezhnev. Mikhail is Counsel in Leech Tishman’s Estates & Trusts and Tax Practice Groups and the Emerging Cyber Technologies Industry Group. He is based in the firm’s New York City office. Mikhail has been a Cryptocurrency investor since early 2017 and welcomes your questions.
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