Cryptocurrency and Digital Assets

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This is my second blog post dealing with the increasing Brave New World of “digital assets” and how these assets fit with a person’s estate planning. Below are a few of my brief comments about cryptocurrency:

(1)  In the cryptocurrency world, a person’s “private key” is the crucial element separating access to one’s cryptocurrency and its loss (likely permanent). The private key is analogous to a password. My strong point here is to keep a backup of your private key, and let trusted family members know where they can find your private key in the event you are unable to provide it (your death, disability, etc.). There are hundreds of web references to individuals having permanently lost millions of dollars in cryptocurrency due to lost private keys.  Click here for an example from Wired magazine referring to a CEO who recently died;  and no one can find his private key to an estimated $137 million in cryptocurrency;

(2)  The above access / backup problem is particularly elusive, and difficult, as many cryptocurrency users are extremely private about this subject, often to the intentional exclusion of their family members, etc.;

(3)   As a related aside, the IRS, no doubt, is interested in your cryptocurrency.  IRS Notice 2014-21 is its first published guidance in the form of answers to frequently asked questions.  Click here to read this notice;

(4)  The above IRS Notice includes a great deal of information. Two points likely a surprise to most readers are:  (i) the IRS is treating cryptocurrency transactions for income tax purposes as a “sale or exchange”. For example, if you use $50,000 of  cryptocurrency to purchase an item;  you will trigger gain or loss on the $50,000 depending on your cost basis in your cryptocurrency, etc. I purposely do not include more detail about this gain / loss treatment for this post; and (ii) Notice 2014-21 expressly states the IRS will treat cryptocurrency as property, not as currency.  For estate tax planning purposes, this means cryptocurrency will be inludable in the owner’s estate at death, with a stepped-up (or stepped-down) cost basis based on the cryptocurrency FMV at the person’s death;

(5)  Finally, I strongly recommend an express provision dealing with crypocurrency be included in a person’s estate planning documents (trustee, executor, power of attorney powers, etc.). Below is my current draft of possible language for dealing with cryptocurreny (again, this is merely my example language for this post;  no reader may rely on this provision as legal or any other advice from me or my law firm):

“To handle on my behalf any of my digital asset “cryptocurrency“, defined for purposes of this DPOA [durable power of attorney] as digital assets that are exchanged electronically and based on a decentralized network or exchange, with such exchanges not requiring a reliable intermediary and managed using distributed ledger technology. In broad terms I give my agent under this DPOA the power to accept or pay on my behalf any cryptocurrency, digital asset currency, funds, or other value that substitutes for currency from one person to another person and the transmission of currency, funds, or other value that substitutes for currency to another location or person by any means. The above term “other value that substitutes for currency” encompasses situations in which the transmission does not involve the payment or receipt of cryptocurrency, but does include, but is not limited to, my private and public keys, blockchain and ledger information, bitcoins, bitcoin addresses, and any other cryptocurrency user or account data or information related to such transactions or to any convertible currency related thereto on my behalf. My intent also is that my reference to “cryptocurrency” under this paragraph be read together as broadly as possible in the broad context of my reference to electronic communications content and the definition of “digital assets” under O.C.G.A. Section 53-13-2 (as amended) included in paragraph (gg) below;”

The Difficulty with Retirement Accounts

Here is an important question: Who can (and will) oversee and help safeguard your tax-deferred retirement accounts? The absence of an easy answer creates the following difficulty. [1]

The point underpinning this difficulty is that the tax law does not allow ownership of a tax-deferred retirement account by the account owner’s living trust. The law allows no living trust option. Without this trust option, there can be no successor trustee who oversees and manages the living trust assets in the event of the account owner’s age-related incapacity, etc. [A qualifying trust is allowable only after the individual dies; but the point of this blog post centers on the owner while still alive.]

This lack of living trust oversight creates exposure, for example, for failing to make the required annual distributions, etc., resulting in substantial tax penalties; threats of Madoff investment scams; friends and others persistently pressing for financial handouts resulting in larger distributions from the account than what otherwise is prudent, etc.

Realistically, while the retirement account owner is alive, the tax law limits ownership either (i) in the owner’s name; or (ii) in a financial institution trustee’s name, called a “trusteed IRA”, that in most cases I do not recommend. The last paragraph of this blog refers to the unsuitability typically of the trusteed IRA option.

Due to this individual ownership option, I recommend a separate, well-drafted retirement accounts power of attorney (“RPOA”), expressly covering a broad range of specific powers for the named agent, plus with the RPOA designed to help overcome the following increasingly difficult hurdle.

This hurdle is the refusal of many financial institutions to honor a broader, more general power of attorney. This is where banks, financial institutions, etc., simply balk at acting under the directive of a power of attorney.

Why the hurdle?  Financial institutions are understandably concerned about their risks when dealing with an agent under a power of attorney (rather than directly with the principal), and the related significant pressure these financial institutions face for anti-terrorism transparency, and their need to avoid lawsuits among family members, etc. But, this institutional self-interest cuts against the interest of the retirement account owner.

The RPOA, therefore, helps balance these risks for both the institution and the account owner. And, although I can provide no guarantee these institutions will honor this specific, particularized RPOA, its detailed provisions arguably provide reasonable and substantive strength in support of the institution not so easily being able to deny the document. The RPOA might also support a position that a financial institution’s denial of the RPOA is unreasonable, potentially opening the door for damage claims against the institution.

As an aside to this RPOA situation, I am fully aware some financial institutions are mandating that account owners use only the institution’s power of attorney form. But, these institutional forms include overly-generous liability waivers with indemnification clauses favoring heavily the financial institution for its own protection; these institutional forms exist for the institution’s benefit, not for its customers.

As another important aside, below are the heading topics for the RPOA document I recommend:

  • Scope
  • Applicable Jurisdiction
  • Successor Designation of My Agent
  • Written Acknowledgment by a Successor Agent
  • Coordination With Other Powers of Attorney
  • Effective Date
  • Release and Indemnification of My Agent
  • Third-Party Reliance on this RPOA
  • Conservatorship / Guardianship
  • My Intent
  • Annual Minimum Distributions
  • Additional Distributions
  • Exclusive Power to Direct
  • Roth Conversion / Medicaid Annuity Planning
  • Checks on My Behalf
  • Spousal Roll-Overs
  • Modification / Change of Accounts
  • Naming of Custodians for Minors
  • No Power to Change or Revise Beneficiaries
  • Investment Delegation Powers
  • Tax Elections
  • Incorporation by Reference of Fiduciary Powers
  • Permitted Use of Certified Photocopies

Finally, back to “trusteed IRAs.”  Under the controlling tax law, a trusteed IRA (i) does not allow a spousal rollover for the surviving spouse and (ii) requires that the financial institution overseeing the account must be the sole trustee. I also find most often a trusteed IRA agreement locks the financial institution in as trustee after the account owner’s death, thus barring any change by the beneficiaries of the investment management platform or removal and replacement of that institutional trustee.

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[1] I refer to “IRA” in this blog post, but, the same discussion applies generally to corporate or self-employed (“Keogh”) pension, profit-sharing, defined-benefit, and stock bonus plans, SEPs, 403(b) plans, IRA and Roth IRA accounts, inherited IRAs, spousal rollover IRAs, 401(k) and Roth 401(k) plans, and 457 plans. It also applies to a judgment, decree or order for any retirement plan, for payment on the owner’s behalf of child support, alimony or marital property rights, referred to typically as a “qualified domestic relations order.”