Estate Planning For Digital Currencies
By: Morris Law Group - May 28, 2015
Bitcoin is technically a form of "cryptocurrrency," meaning that parties can exchange value anonymously, quickly, and without the intervention of a third-party intermediary, such as a bank, which also means there are no transactions costs.
The digital currency Bitcoin has been in the news quite a bit recently, and just about one year ago, on March 25, 2014, The Internal Revenue Service classified Bitcoin as property for U.S. tax purposes. That means anyone buying or selling Bitcoin will need to report either gains or losses on the transactions, and anyone who receives Bitcoin as payment for goods and services will have to report those receipts as gross income.
It's difficult to know if the government's official acknowledgment of Bitcoin may lead to it becoming more of mainstream investment (some argue the opposite, since lack of regulation was an attractive feature of the digital currency), but at the minimum, government regulation signals that Bitcoin has reached a tipping point in terms of popularity.
How Does Bitcoin Work?
Each owner of Bitcoin is issued a "wallet" that functions much like a bank account. The wallet contains the authentication information needed for each Bitcoin owner to send and receive the currency. Wallets can be online (i.e. hosted by a third-party in the cloud), they can be software based (i.e. hosted on your own computer), or they can even be offline (e.g. on a CD, USB storage device, or even on a piece of paper similar to a stock certificate that can be uploaded to the Bitcoin network by scanning a barcode).
Every wallet has a public address and a private authentication key. The only information that needs to be given in order for someone to receive money is the public address, but to send money, the private authentication key is also required to "sign" the transaction. All transactions are posted on a public network that acts as a sort of ledger pertaining to all Bitcoin. Private authentication keys are never visible or accessible to other users, though they are verified through the network.
Unique Estate Planning Challenges
The decentralized and anonymous nature of Bitcoin creates unique challenges for estate planning purposes. These assets cannot be owned by a trust, there is no way to make pay-on-death designations, and there is no mechanism in place for joint ownership. Only persons with access to a wallet and the associated private key will have access to the assets. Without an adequate plan in place to transfer bitcoins after death, there is a risk of permanently losing the bitcoins with no hope of ever recovering them.
Several options exist for the effective transfer of Bitcoin assets. The first is simply to incorporate detailed instructions for beneficiaries or trustees on how to access a wallet in a letter of instruction. This is a preferable method for anyone with only a single Bitcoin wallet, but in the case of someone with multiple wallets and any combination of online and offline wallets, instructions would need to be very detailed. The downside to this form of planning is that if the instructions fall into the wrong hands, all of the Bitcoin assets could be compromised with no recourse.
An alternative method is to make copies of wallets and either give those copies to trusted beneficiaries and/or store them in safe locations that will surely be accessed upon death (e.g. a safety deposit box, which would be a good place to store a letter of wishes too). Of course, giving a copy of the wallet directly to a trusted beneficiary gives that person immediate access to your bitcoins, and it could make it difficult for contingent beneficiaries to ever gain access to the assets.
Another option is to create a multiple-signature wallet that would require at least two authentication keys in order for bitcoins to be transferred. With this type of planning, an individual could create three authentication keys and give one to a beneficiary and another to a trustee. Upon the individual's passing, the beneficiary and trustee would together be able to access and distribute the bitcoins. Of course, this method too relies on a high degree of trust.
We can't predict whether or not virtual currencies like Bitcoin are going to become mainstream. They certainly have some desirable attributes, and some notable investors have taken sizable stakes in currencies like Bitcoin (e.g. the Winklevoss twins of Facebook fame), but the future remains uncertain.
What is certain is that if you own intangible assets like digital currencies, then you need to be proactive in your approach to planning how you intend to make those assets part of estate plan. This includes all virtual assets that may have value to you (e.g. email accounts, social media accounts, etc.).
The Morris Law Group is committed to making sure that all your assets, whether physical or intangible, become part of your enduring legacy, and if you have questions about how to approach this or any other subject related to creating an effective and comprehensive estate planning solution, we invite you to contact us.
** Disclaimer Required by IRS Circular 230** Unless otherwise expressly approved in advance by the undersigned, any discussion of federal tax matters herein is not intended and cannot be used 1) to avoid penalties under the Federal tax laws, or 2) to promote, market or recommend to another party any transaction or tax-related matter addressed.