Considerations in Estate Planning for Bitcoin, Ethereum, and other Crypto-Currencies
While success in crypto-currency investing is far from assured, death, sadly, is. Accordingly, it is vital that investors in Bitcoin and other crypto-currencies are prepared for the unique estate planning factors that apply to digital assets. The following are five estate planning factors that should be addressed immediately by crypto-currency investors to ensure that their digital assets are effectively passed on to their heirs or beneficiaries.
- Custody of Private Keys and Other Information to Access Digital Assets
Unlike bank accounts which can be accessed post-mortem, digital assets typically require a variety of private information to be accessed. This information (and an investor’s digital assets) may be lost forever if an investor fails to record it or share it with a trusted third party before they die. To avoid this, it is crucial that investors physically record the following private access information and provide for custody of this information in their will:
- Private Key: Most crypto-currencies use a public-private key system to ensure that transactions are valid. While the public key is made public every time the investor buys or sells crypto-currency, only the investor knows the private key. Private keys are essential to verify ownership and access digital assets, and should be recorded. Gaining access to a private key is similar to gaining ownership of a bank account, so it is vital that private keys are kept safe. Creating a physical copy of your private key and securing it in a bank safety deposit box insulates your private key from hacking and may provide the safest means to protect it.
- Passwords: Crypto-currencies are traded on online platforms commonly known as exchanges. Investors that fail to secure their digital assets in hardware wallets (see below) typically have their crypto-currencies stored on default digital wallets provided by an exchange. It is important that the username, password, and security question information for exchanges be recorded to retrieve digital assets from exchange wallets.
- Two-Factor Authentication: Many crypto-currency exchanges also require that investors use two-factor authentication to authenticate their identity when accessing their account and transferring digital assets. Two-factor authentication is typically accomplished via a mobile application that provides a unique code to be entered into the exchange. Investors who use two-factor authentication should record their username, password, and security question information.
- Custody of Hardware Wallets
Once Bitcoin and other crypto-currencies are purchased on an exchange, they are automatically stored on that exchange’s default wallet where they can be accessed electronically by the investor. Digital wallets, especially those used by exchanges, are susceptible to hacking. Investors should transfer their digital assets to a hardware wallet. Hardware wallets can be purchased online and are, generally, encrypted flash drives that require a password to be accessed. Investors and their heirs may lose their digital assets if their hardware wallet is lost or damaged. Investors should record the password and other access information for their hardware wallets, and provide for custody of the information and the wallet itself in their will.
In 2017, New Jersey enacted the Uniform Fiduciary Access to Digital Assets Act (the “Act”). The Act generally enables individuals to appoint a fiduciary to manage their “digital assets”, broadly defined as electronic records. Under the Act, electronic records include account information for online exchanges. Unfortunately, while the Act authorizes a fiduciary to access a deceased investor’s exchange account, it fails to consider that the private key – the essential information to remove digital assets from a digital wallet – is not available to exchanges. Moreover, the Act’s limited applicability to electronic records may exclude its applicability to hardware wallets.
- Fiduciaries under Power of Attorney and Will
Under a well drafted Power of Attorney, an agent, appointed by the principal, is given the power to manage the principal’s assets and make investment decisions on behalf of the principal. Depending on how the document is drafted, the powers granted under the Power of Attorney can either be effective immediately upon execution or only effective upon the disability or incapacity of the principal. Having such a document avoids the necessity of asking the court to appoint someone as the principal’s guardian if he or she cannot manage his or her own affairs.
Among other things, the executor of an estate is tasked with distributing the property of the decedent in accordance with the decedent’s will.
In the context of Bitcoin and other crypto-currencies, it may be necessary for the agent under a Power of Attorney or the executor of an estate to have control over these assets. As such, it is critical that an owner of crypto-currency have a well drafted Power of Attorney and Will, specifically providing the agent with authority over the crypto-currency assets and the necessary information to access such assets.
- Estate Planning with Crypto-Currencies
The federal estate tax is based on the value of one’s assets less liabilities at one’s date of death and is imposed at a rate of 40%. One important exception that is critical to understanding how the federal estate tax works involves the estate and gift tax exemption. This exemption is the amount that one can transfer to anyone during one’s lifetime or at death without incurring a gift or estate tax. In 2018, the exemption is $11.18 and this amount will be indexed annually for inflation until 2026, when the exemption amount is scheduled to revert to $5.49 million, with an adjustment for inflation.
For wealthier owners of crypto-currency assets, implementing certain estate planning techniques in order to remove the value of these assets from his or her estate could be highly beneficial. One such technique would be the creation of a limited liability company (“LLC”), funding the LLC with crypto-currency assets, and then gifting most of the economic value of the LLC to a family trust.
The gift would use a portion of the owner’s federal gift tax exemptions and thus no federal gift tax would be due. Additionally, if the LLC is created with voting and non-voting membership interests and only the non-voting interests are transferred to the family trust, the value of the gift could be discounted for gift and estate tax purposes. Moreover, all future appreciation on the value of the LLC interests gifted would accrue outside of the transferor’s taxable estate.
Investors in crypto-currencies are at risk of losing their assets at death unless they plan ahead. Following these five factors and speaking to an estate planning attorney versed in crypto-currencies will help ensure that digital assets are effectively passed to heirs or beneficiaries.
As the law continues to evolve on these matters, please note that this article is current as of date and time of publication and may not reflect subsequent developments. The content and interpretation of the issues addressed herein is subject to change. Cole Schotz P.C. disclaims any and all liability with respect to actions taken or not taken based on any or all of the contents of this publication to the fullest extent permitted by law. This is for general informational purposes and does not constitute legal advice or create an attorney-client relationship. Do not act or refrain from acting upon the information contained in this publication without obtaining legal, financial and tax advice. For further information, please do not hesitate to reach out to your firm contact or to any of the attorneys listed in this publication.