Intro to Crypto Estate Planning
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Neither death nor taxes are something most crypto traders want to think about. However, estate planning is crucial, particularly for those with a large number of digital assets, which are by design difficult for others to access.
To make sure that in the event of your death your digital currency reaches the right people—without making them experience undue burden or excessive taxes—planning ahead is necessary. Although you should consult a crypto estate planning specialist to work out a tailored plan for your personal situation, below, we’ll discuss six preparations that have worked well for many of our clients.
1. Keep detailed and accessible records about your crypto
Blockchain technology is by nature anonymous and decentralized, making it difficult or impossible to identify all of a decedent’s crypto wallets—let alone gain access to them without the correct credentials.
For this reason, it’s important to securely record information about all of your crypto holdings in a place that your executor or trustee knows how to access. They need to know not only which digital wallets exist, but also which addresses, usernames, passwords, private keys, and seed phrases are associated with them.
It’s a good idea to keep these records somewhere very secure, like fire-proof safes or safe deposit boxes at a bank. Some go as far as to engrave seed phrases on metal plates to ensure they aren’t destroyed. Other security measures to consider include Shamir’s secret sharing or multisig wallets like those offered by Casa or Unchained Capital.
Additionally, your successor trustee/beneficiaries will need your transaction details for crypto tax reporting purposes. Wallets don’t necessarily include all of the information necessary, which can make tax reporting very difficult for an estate’s successor or beneficiaries. Pertinent information like cost basis, ETH gas, or transaction fees can get lost when assets are transferred between wallets, especially from hot to cold storage.
For this reason, in addition to records about wallet credentials, you should also leave instructions on how to access trading and tax planning information. This include:
Name and contact information of crypto tax advisors
Username and password for any crypto tax software accounts
Information about the exchanges used for trading, including username and password
A summary of all traditional and digital assets, including how each is titled, regardless of whether it is held individually or in an entity or trust
2. Make sure your will is valid in your state
There are two types of estates. Testate succession occurs when someone dies with a valid will in place. This is the ideal scenario, where your wishes are spelled out and you clearly state to whom you want to leave your assets.
Intestate succession, on the other hand, is what happens when you die without a valid will in place. In this case, your assets will be passed along according to the state’s laws for settling an estate, a process called probate. Probate is the court-supervised legal process of distributing your property after you pass. It can be very long and burdensome for your loved ones.
Note that each state has different probate laws and systems. This means that if you move from one state to another, you shouldn’t assume your will is still valid. After relocation, contact an estate attorney in the state in which you reside to make sure any necessary revisions are made.
3. Set up a revocable living trust
When crypto estate planning, you can choose between setting up a last will and testament alone or having a linked last will and a revocable living trust. Essentially, the difference between these two documents is how they transfer assets to designated beneficiaries.
A last will lays out your wishes, passing on your instructions to a named executor. It does not, however, let your heirs avoid probate. Your last will still need to be filed with a county probate court, which will oversee the process and adjudicate any disputes. A last will only becomes active upon your death.
A living trust, on the other hand, is a legal arrangement that goes into effect before your death, which means your loved ones can avoid probate for the assets placed in this trust. While you are still alive, you control your trust, but when you die, control transfers from you (the grantor) to another person (the “successor” trustee).
The successor trustee can then distribute digital assets according to your wishes in a timely and orderly fashion. The trust is “revocable,” which means you can change its terms while you are still alive.
You’ll need to name your trust, ie- John Doe Living Trust Dated 01/01/2022, and title any future transactions and accounts in the name of this trust. Existing real estate assets will need to be transferred to the trust by quitclaim deed , while other assets will be included in a signed statement of transfer
Non-tax features of a living trust
There are many benefits to having a trust rather than simply having a will.
Some non-tax benefits include:
Avoiding probate and related court fees for your beneficiaries
No delays in transferring assets
Maintaining privacy: A last will and testament goes in to public record, while a trust allows you and your loved ones to “keep everything in the family”
Preventing court control of assets in case of incapacity: If you are alive, but incapacitated, your trust allows your trustee to manage your financial affairs instead of the courts
Protecting against creditors: A trust may provide some spendthrift protections from creditors to beneficiaries after the grantor’s death
Flexibility: You can discontinue or change the terms of your trust at any time
Tax implications of a living trust
While you are still alive, a revocable living trust doesn’t affect your taxes very much. You don’t need to obtain a separate tax ID for it or file a separate tax return. The assets in your trust are reported similarly to how they would be taxed on your individual Form 1040.
However, the day after your death, your trust becomes “irrevocable”, so your successor trustee will need to obtain a federal tax ID for the trust and begin reporting its taxes. Your successor trustee has a financial responsibility to your heirs, and this may include making trades to protect assets from market volatility. This means the trust may realize capital gains or losses, which are reported on Form 1041.
One of the primary tax advantages of a living trust is a “step up” in cost basis when the grantor passes away. When this occurs, if the value of the assets in the trust is more than they were acquired for, the assets’ cost basis increases to its fair market value on the day the grantor died. This minimizes capital gains taxes for heirs.
Please note that all “inherited” assets automatically receive long-term capital gains treatment.
Step up in cost basis example
At the time of your death, you were holding one Bitcoin (BTC) that you had purchased for $10,000, but that was currently valued at $30,000. Two months later, when the estate was settled, BTC was valued at $32,000.
Without the step up in cost basis provided by a trust, your heirs would realize $22,000 of capital gains when they sold BTC. However, with the step up to the value on the date of death, they would only have $2,000 of long-term capital gains
4. Create a pour-over will
When you have a revocable living trust, you still need a pour-over last will that instructs your executor that any of your assets that weren’t part of your trust will be automatically transferred to your revocable living trust upon your death.
It works like this: imagine that when you were setting up your estate, you forgot to place one of your Polygon wallets into the trust. After your death, it turns out that the Polygon wallet contains an NFT worth $5,000. If you didn’t have a pour-over will, it’s possible that the NFT would have to go through probate. However, with a pour-over will, it would automatically be transferred into the trust at the time of your death, letting your beneficiaries avoid the probate process.
5. Consider an LLC or corporation for your crypto assets
You may want to consider setting up a single-member LLC or corporation for your crypto business and assets. Having a crypto LLC has multiple benefits, but from an estate planning perspective, it is good because it means your assets don’t need to be sold expeditiously after your death.
Additionally, an LLC, as an entity, may be eligible for a discount for minority interest or a discount for lack of marketability upon valuation of the member’s entity interest in the LLC. This means that your heirs would pay fewer taxes in recognition of the fact that either they have only a minority stake in the LLC or that the company isn’t traded on a public stock exchange.
If your crypto LLC is making significant profit, you may want to consider another entity type, like an S-corporation or C-corporation. We recommend speaking to your accountant about this decision.
6. Support your executor/trustee
Serving as an executor or trustee can be a difficult job. You may find that it’s a role that not many are excited to take. The more instructions and support you can provide your executor, the better.
We recommend working with a professional on a clear and detailed estate plan. You may even want to include your executor/trustee in the planning, so they can discuss it with you while you’re still here.
You may also want to connect your executor with advisors who can help after your death, such as estate planning attorneys and accountants familiar with digital assets.
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