In the last few years, cryptocurrency has been all the rage in investing. More than 15% of Americans have traded in digital currency, looking for a reliable long-term way to maintain value. Because digital currencies are limited in number, governments can't manipulate them, and digital currency isn't subject to artificial inflation or devaluation. While the treasury of any government can print more money, devaluing their currency, cryptocurrencies have a limited supply capped by algorithms. The recent frenzy in digital currency trading drove Bitcoin, a popular cryptocurrency, to an all-time high of $68,000 in November 2021.
With the potential for big earnings, it's easy to see why many people are diversifying their portfolios by including digital assets like cryptocurrency or non-fungible tokens. But digital assets have some unique aspects that can complicate your estate planning. It can be easy to lose access to cryptocurrency if you don't leave a paper breadcrumb trail or otherwise secure your assets and their digital keys. To ensure that your loved ones can access and inherit your digital currency, you need to work with an experienced estate planning attorney.
Cryptocurrency or Digital Currency
A cryptocurrency is simply a digital currency or asset secured by cryptography. Cryptography makes it nearly impossible to counterfeit or double-spend digital currency. These cryptocurrencies are often spread across vast networks of computers using blockchain technology. Because no central authority issues cryptocurrencies, governments can't manipulate or interfere with them theoretically. Some popular cryptocurrency versions include Bitcoin, Dogecoin, Binance Coin, and Ethereum.
Another popular digital asset is the NFT or non-fungible token. An NFT is a one-of-a-kind token that can be anything digital such as artwork or music. NFTs are also supported by blockchain technology. An artist can sell their original digital artwork while retaining the right to make copies of the work or otherwise feature the artwork. The value of an NFT is in the social value of “owning” the original digital asset.
While digital assets are an exciting advance in asset diversification, the advent of cryptocurrency and noncurrency blockchain tokens has given rise to a new consideration when developing an estate plan – digital asset wealth management. The very nature of cryptocurrency, a self-sovereign asset with only one key for a significant digital asset, makes it a complex issue for generational wealth planning. You must effectively hand over the “keys” to your cryptocurrency to ensure that future generations can access and inherit that wealth.
Why You Need an Estate Plan for Digital Assets
If you have digital assets or cryptocurrency, you should consider this in your estate plan to protect your heirs and these assets.
- You Can Avoid Probate
Even if your heirs know about your digital assets and have your keys, they can't necessarily access or sell them. Instead, digital assets not covered in an estate plan may be subject to the long, drawn-out process of probate, a court-supervised process of collecting and distributing your assets. A well-organized estate plan can help your loved ones avoid probate.
- Blockchain Technology and the “Keys” to the Treasure
The nature of blockchain technology means that you must have a digital “key” to access your digital assets. If you lose it, you can no longer gain access to your cryptocurrency, and there's no way to regain access. You may have heard about the U.K. man who accidentally threw away the key to his 7,500 bitcoin in 2013. He's been fighting the Newport, South Wales town council for the right to excavate the town dump for years because it's the only way to recover his access to his cryptocurrency. That 7,500 bitcoin is now estimated to be worth about $500 million.
- Decentralized and Lack of Governmental Supervision
Cryptocurrency is, by nature, decentralized from financial and governmental institutions. There's no central bank involved in the process, and spreading the recording and processing of digital assets across a wide network of computers keeps the assets secure. The downside to this flexibility is that no governing body oversees cryptocurrency or digital assets. Until the law catches up, digital assets are the legal and financial Wild West. As a result, you need to ensure the security of your cryptocurrency and make a plan for your heirs to inherit your digital assets.
Formalize Your Crypto Estate Plan
If no one knows you have a digital asset and you don't leave a record or any way to access it, it's gone. Cryptocurrency is accessed through a private key, typically a series of alphanumeric characters. Only the asset owner knows the key and stores it in a digital wallet or cold storage. It's easy to lose or steal cryptocurrency because anyone with the key can use, sell, or buy it.
A last will and testament is the foundation of any estate plan and is a great vehicle for listing and distributing assets, naming guardians, and ensuring your niece inherits that antique sideboard she loves. However, a will also becomes a public document during the probate process or court proceedings. You can't exactly include your crypto key in your will; it won't be secure.
Options for Crypto Plans
If you have only a small amount of cryptocurrency, you can list it in your schedule of assets and ensure that your fiduciary or successor trustee can find and access your account. However, if you have significant digital assets, you'll probably need to consult an experienced estate planning attorney to establish a trustee for your digital currency. Some options include:
- Sharing your private key and seed phrase with a trusted family member: while this ensures that you aren't the only person with access to your digital assets, your trusted person can also lose access to the assets in the same ways you can.
Splitting your private keys and seed phrases among multiple trusted family members or friends: While this can ensure that no one person loses access to all your digital assets, having your keys in multiple locations can be unwieldy. Your estate may still lose access to some of your assets if even one person loses or misplaces the key information.
Creating a trust: You can transfer ownership of your cryptocurrency to the trust and designate a trusted family member or corporation to manage the trust. A trust is a robust option to protect digital assets, ensuring that they won't be lost and placing the trustee in a fiduciary relationship with your heirs. This fiduciary relationship legally obligates your trustee to act in the best interests of current and future beneficiaries of the trust. You can also appoint multiple trustees to manage the trust.
Using a cascading multisignature walletinstead of a self-sovereign wallet: A multisignature wallet will give more than one person access to your digital currency. However, you can also establish “M of N” controls, which require a certain number of agents to work together to perform certain high-security actions. In other words, one person with access to your multisignature wallet can't simply sell off your assets and pocket the proceeds.
Placing your cryptocurrency in a custody solution: A custody solution is an independent storage and security system for cryptocurrency. This system uses a combination of hot and cold wallets. Hot wallets are online and connected to the internet, making them vulnerable to hacking or online theft. Cold wallets store your wallet offline, keeping them more secure but less accessible. As a result, crypto custody solutions using a combination of the two can offer more flexible storage with higher security.
- Trigger the transfer of your digital assets with a dead man's switch app: A dead man's switch app stores your crypto keys privately until a later time. You can set up notifications for specific people and save them. The app then requires you to “check in” at periodic intervals. If something happens to you or you fail to check in at a specified time, the app will send your information to the specified individuals.
Some companies also offer crypto-custody services, which you can use alongside trustee services. You can also appoint a Trust Investment Advisor to manage and distribute digital assets.
Tax Consequences of Inheriting Digital Assets
Your estate plan should also include plans for what to do with the cryptocurrency once successfully transferred, considering the tax implications of transferring or selling digital assets. A trustee can transfer cryptocurrency to new wallets for multiple beneficiaries for in-kind distributions. Or the trustee can liquidate the cryptocurrency and distribute the proceeds to beneficiaries.
- Cryptocurrency and U.S. Tax Laws
While many people attempted to circumvent U.S. tax laws while dealing in cryptocurrency for years, the IRS is now cracking down. When you file your taxes, your Form 1040 now asks, “At any time during 2021, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” If someone inherits cryptocurrency, they have to tell the IRS or risk lying on their tax return, putting themselves in legal jeopardy.
- Cryptocurrency and Tax Liability
If you have a trustee liquidate cryptocurrency and distribute the proceeds to your heirs, this can create a tax liability. Every time someone exchanges virtual currency for real currency or goods and services, they create a taxable event and potential capital gains tax liability if the value of the goods or services is above the cost basis of the cryptocurrency.
However, when your heirs inherit your digital assets, they also may inherit a stepped-up basis, which is the fair market value at the time of your death. This stepped-up basis can allow your heirs to avoid capital gains taxes on any significant gain in the value of the cryptocurrency over the original basis, which is typically your original purchase price. To ensure that yours will minimize any inheritance taxes, capital gains taxes, or unnecessary probate costs, you should work with your attorney to ensure that your estate plan covers all your digital assets.
- Inheritance Tax and Digital Assets
U.S. tax law treats inherited digital assets the same as any other inherited capital asset. They could be subject to inheritance taxes if the value of your estate exceeds a certain threshold. Your estate can be subject to the federal inheritance tax if the value of your estate is over $12.06 million in 2022. Michigan repealed its inheritance tax in 2019.
Concerned About Incorporating Cryptocurrency in Your Estate Plan?
If you're concerned about how to incorporate your digital assets, including cryptocurrency and NFTs, into your estate plan, it's time to consult a professional. At Great Lakes Family Probate & Estates PLLC, our team can help you plan for the future, maximizing the assets you'll pass on to your loved ones. For years, we've been guiding our Michigan clients with forward-thinking estate planning and proactive tax strategies. We can help you too. Give us a call at (888) 554-5373 or contact us online to set up your consultation.