Bitcoin’s value has ranged from less than a penny to nearly $20,000 since its inception a little over ten years ago now. Within the last year alone, bitcoin’s value has fallen from $11,000 to a low of around $3,500. Many other digital currencies and tokens, which are referred to as “ALT coins” have seen their values drop by 90% or more from there all-time highs.
These steep declines in crypto valuations can be a bit scary for even die-hard crypto fans or HODL’rs, crypto investors who are “Holding” on to their crypto no matter what the price action. However; for those who believe in cryptocurrency’s long-term growth potential, now is a great time to use crypto’s depressed valuations to do some savvy wealth transfer planning designed to reduce or even eliminate wealth transfer taxes.
Basics of the U.S. Estate & Gift Tax System
The current federal estate and gift tax rate stands at 40%, making estate & gift tax avoidance strategies an important component of any wealth preservation plan. While the estate tax exclusion amount was $5.49 million in 2017, the Tax Cuts and Jobs Act of 2017 increased the basic estate tax exclusion amounts for 2018 through 2025. In 2019 estates valued at $11.4 million or more per individual, $22.8 million for couples will be subject to the Federal Estate Tax. The annual Gift Tax Exclusion amount remains the same at $15,000.
Based on these high exclusion amounts many people mistakenly believe estate tax planning is only for the ultra rich. Think again. Not only are the tax cuts and higher estate tax exclusion amounts brought on by the TCJA set to expire after 2025, but there are already talks about drastically reducing the current thresholds in the future to broaden the number of estates subject to taxation.
Further, Seventeen states and Washington, DC, levy their own estate or inheritance taxes (Maryland levies both). State exclusion amounts vary considerably but are often much lower than the federal exclusion amount, making estate tax planning extra important for wealthy residents of those states. As an example, Massachusetts taxes estates valued at $1 million and above.
The annual $15,000 gift tax exclusion applies to each person you give a gift. As such, transferring ownership of cryptocurrency valued at more than $15,000 to another person would potentially subject you to gift taxes of 40% of the amount over $15,000 if you have exceeded your lifetime gift tax exemption. The lifetime exemption for federal gift taxes is a dollar amount you can give away without paying a gift tax.
In short, the federal lifetime gift and estate tax exemptions are tied together by what is referred to as the Unified Tax Credit. You can use the credit to reduce or eliminate estate taxes at your death, or you can use it to defray taxes owed on giving more than the $15,000 annual gift tax exclusion to any individual in a given year. In other words, you can use your unified credit while you are alive, through gifting, or at death.
Gifting Crypto to Reduce Future Estate Taxes
Now that you have a general understanding of how both estate and gift taxes work, we can begin discussing strategies that will allow you to take advantage of low crypto valuations to reduce current or future estate and gift taxes.
The first strategy is by far the simplest. As you are allowed to gift $15,000 to any person each year free of gift taxes, then it may make sense to gift $15,000 of bitcoin or any other cryptocurrency today to your loved ones, before values go up again.
With bitcoin at about $5,000 or so per coin on 4/15/2019, you can give away three bitcoins to as many people as you like without being subject to gift taxes, nor utilizing any of your Unified Credit. When bitcoin was worth nearly $20,000, you could gift less than one bitcoin to have the same result.
Once the coins are gifted, all the potential future appreciation is no longer taxed in your estate at death, thereby reducing your estate’s value and subsequent estate taxes that may be due.
Keep in mind when gifting, your cost basis in the coins gifted is transferred to the recipient. They will be subject to any income taxes due on any gains above that basis upon selling the coins if they so chose at a later date.
If you are worried about gifting your crypto outright, consider establishing an irrevocable trust that can hold your crypto from being distributed until your death, or some other later point in time such as for your grandchildren, or even great-grandchildren in a generation-skipping trust.
Gifting assets, of course, entails giving up control of those assets—another key consideration in any estate planning strategy. Gifting cryptocurrency adds a layer of complexity since the recipient needs to understand how to value it, access it, and protect it. A financial advisor and a tax attorney with a solid understanding of cryptocurrency can be invaluable in formulating your strategy. (For more, see What Estate Planning Attorneys Need to Know About Cryptocurrencies.)
Gifting Large Amounts of Crypto
If you are sitting on a substantial amount of crypto, trying to stick within the gifting limits of $15,000 per person’s annual gift tax exemption amount may do very little in terms of reducing your overall estate value and tax burden. As such, you may decide to utilize some or all of your Unified Credit now, instead of waiting until death, especially if you believe your crypto is likely to rise in value in the future.
As an example, unbeknownst to many people, you could, if you so chose, gift $11.4 million (Exclusion amount) of bitcoin, crypto or other assets to one or any number of people at anytime prior to your death and not have you or the recipient owe any gift, estate, inheritance or income taxes on the amount gifted. In other words, you are not bound to stay within the $15,000 annual exclusion amount.
You read that right; you could gift 11.4 Million dollars worth of crypto today and remove all the future appreciation, if any, out of your estate. Practically speaking, if your estate is under $11.4 Million today, removing some or all of the growth of your crypto portfolio could potentially keep you from paying estate taxes in the future.
Keep in mind if you use some or all of your Unified Credit while alive that will reduce or eliminate its availability at your death. But as you will see, if the assets gifted substantially appreciate in the hands of the receiver, the credit may be far more valuable to use while you are alive through gifting than at death.
Let’s look at an example
If you were to gift $11.4 Million of crypto today (or a smaller amount that is still above the $15,000 annual threshold), there would be no tax due. If that $11.4 Million of crypto triples in value to $34.2 Million after its gifted, the $22.8 Million appreciation would no longer be part of your taxable estate, saving $9.12 Million in Estate Taxes under current tax rules.
A second estate planning strategy for taking advantage of low cryptocurrency valuations involves A-B trusts, also called credit shelter trusts or bypass trusts. Married individuals can use an A-B trust funded with undervalued cryptocurrency with the hope of passing a much greater amount of cryptocurrency to heirs in the future, free of estate taxes and with the asset protection that trusts provide.
Most married couples don’t need to use A-B trusts to avoid federal estate taxes because they can combine their individual estate tax exemptions under the portability law that became effective in 2011. However, individuals and married couples who want to avoid state-level estate and inheritance taxes, as well as two other key groups—unmarried partners and remarried individuals with children from a prior marriage—may still find an A-B trust helpful.
In an A-B trust, a couple establishes either a single trust that splits in two when the first partner dies or two separate trusts in each if their names. In either instance, the trusts are revocable until the first spouse passes away.
When the first partner dies, trust A becomes the survivor’s trust, and trust B (the bypass trust) becomes the decedent’s trust. Trust assets totaling up to the value of the estate tax exemption get transferred into the B trust. That trust becomes irrevocable, which restricts the survivor’s ability to use it but still allows them to receive income (and other amounts) from the trust.
Since the value of the assets placed in the first spouse to dies B trust does not exceed the Estate Tax Exemption amount, and the remaining assets, if any, pass to the surviving spouse with an unlimited marital deduction, there generally will be no estate taxes due upon the death of the first spouse.
Also, any future appreciation of the crypto or other assets transferred into the B trust will not be taxed when the second spouse dies, as trust B is not considered part of the taxable estate at the second spouse’s death.
Further, any appreciation in the assets in the trust, including cryptocurrency, may avoid estate taxation for generations to come if set up as a generation-skipping trust, thereby saving potentially millions of dollars in future estate taxes.
In summary, by funding an A-B trust with low-valued cryptocurrency that is expected to appreciate, a much greater amount than was used to fund the trust could one day be passed down estate-tax free while also providing asset protection to heirs.
The third strategy involves a type of irrevocable trust called a Grantor Retained Annuity Trust (GRAT). It’s often used for assets expected to appreciate over time, such as real estate, stock, and business interests, and can work particularly well in low-interest rate environments.
The goal for creating a GRAT is to transfer assets and their potential future appreciation out of your estate for federal (and/or state) estate tax purposes while avoiding gift taxes and retaining as much of your Unified Credit as possible.
The crux of this strategy is two-fold:
- As a general rule when an individual makes a transfer of an interest in property that is regarded as complete for federal gift tax purposes, only the value of the interest transferred (and not the interest retained) constitutes a gift.
- The GRAT will accomplish its goals if the Crypto transferred into it grows faster than the IRC 7520 Rate, currently 3.0 % as of 4/2019.
Here’s how you could implement this strategy with cryptocurrency.
Working with an estate planning attorney and financial advisor who thoroughly understands cryptocurrency, you would create a GRAT and transfer bitcoin, or another crypto that you will not need during your lifetime into the trust. Name your beneficiaries (children or grandchildren, for example).
You would then determine the amount of income (annuity payments), and over what time frame you would want to receive them, from the GRAT that would effectively result in the actuarial value of the remainder interest passing to the trust beneficiaries being as close to or equal to zero as possible, based on the then current IRC §7520 Rate.
Even though transferring assets to a GRAT would be considered a taxable gift, the taxable gift is not the value of the assets transferred to the GRAT. instead, the gift is reduced by the actuarial value of the annuity you retain.
There are a couple of important caveats to note regarding GRATS.
- If the grantor dies before the GRAT term expires, the assets in the GRAT will become part of their taxable estate although that leaves the grantor in no worse financial position than if they didn’t do the GRAT at all.
- If the value of the assets depreciate or grow less than the 7520 rate, the strategy would not have accomplished its goals.
At the end of the annuity period, the GRAT terminates. Any remaining cryptocurrency and other assets in the trust are distributed to your beneficiaries. The goal again is that your bitcoin or another crypto in the trust has appreciated significantly over the trust’s term so that you can pass a much larger amount to your heir’s tax-free than you would have been able to otherwise.
Gifting low-valued cryptocurrencies under the annual gift tax exclusion or placing them into properly structured A-B trusts or GRATs can be a solid strategy for reducing estate taxes, especially for residents of states that levy their own estate or inheritance taxes.
High net worth individuals and couples who own bitcoin and other cryptocurrencies should use a team-based approach in their estate planning. Working with both a financial advisor and an attorney who both specialize in cryptocurrency planning is key. Cryptocurrencies are like no other asset and in addition to making sure you have an updated estate plan that includes them. Having a well-thought-out access plan for your crypto at death or if you become disabled is equally important so that your crypto is passed on and not lost or stolen.