Crypto, or cryptocurrency, is a digital currency that is designed to be used over the internet. Although it has "currency" in its name, the Internal Revenue Service (IRS) takes the position that, for federal tax purposes, cryptocurrency is not treated as currency at all; instead, it is categorized as property and taxed according to the general tax principles applicable to property transactions. (Internal Revenue Service Notice 2014-2, https://bit.ly/3kbucaX).

Therefore, the use of cryptocurrency to make a purchase, such as a cup of fresh brewed coffee from your favorite chain, may trigger capital gain to the extent that the fair market value of the cryptocurrency exceeds the original cost basis of such cryptocurrency at the time you purchase your coffee.

Bitcoin — although frequently used as a synonym for crypto — is just one of over thousands of types of cryptocurrencies. What makes Bitcoin or other types of cryptocurrencies so unique is the blockchain technologies that they use, which all operate in a decentralized market without the backing of a central banking agency. According to Coinbase, a cryptocurrency exchange platform, "[a]t its most basic, a blockchain is a list of transactions that anyone can view and verify." (https://bit.ly/3KhlzpS).

The site goes on to say that the technology creates a digital accounting ledger that contains a written record of every electronic transfer of crypto between parties. With the use of blockchain technology, crypto users have an elevated sense of privacy and security since personal information such as name, address or social security number is not required.

Crypto, as an asset class, is widely accepted to be extremely volatile. Volatility, or the measure of how much the price of any particular asset or investment has moved up or down over time, is a natural part of market activity, according to Coinbase. (https://bit.ly/38pvYmn). Generally speaking, the more volatile an asset is, the riskier the investment — and the greater potential it has to offer higher returns or larger losses over shorter periods of time. The volatility of crypto is increased due to its small total market size, regulatory obstacles and positive and negative news coverage.

Currently, each individual may make taxable gifts of up to $12,060,000 (excluding certain gifts to spouses and charities and the application of annual exclusion gifts) before incurring a federal gift tax. A traditional gift of assets in trust or outright to a child or other individual works well for most asset classes. However, the volatility of crypto poses a risk with traditional planning in that, if the value of a particular type of crypto falls substantially in value, the donor may unnecessarily lose all or a portion of the gift exemption used.

A grantor retained annuity trust (GRAT) works well in this volatile environment since it does not rely upon or use any of the donor's gift exemption.

The planning objective of a GRAT is to remove the post-transfer appreciation of an asset or assets in excess of the statutory assumed rate of return (which is set at the IRS 7520 Rate, which changes monthly, and is currently 2.2% for April 2022) from the donor's gross estate at no transfer-tax cost.

The donor (often called the "grantor") creates an irrevocable trust in the form of a GRAT and transfers to the trust a fixed amount of cryptocurrency.

The GRAT pays the grantor annual annuity payments over the trust term with a present value equal to the value of the property transferred to the trust. The annuity payment structure (often referred to as a "zeroed out" trust) results in no taxable gift on creation of the trust.

Since GRATs are ignored for federal income tax purposes, payments back to the grantor in kind do not result in gain recognition. In addition, at any point, the grantor can substitute other property of equivalent value (ideally property with less volatility) to "lock in" gain incurred as a result of a crypto investment. Such an exchange is also not a taxable event.

GRATs tend to perform better in shifting value to the next generation with shorter terms in lieu of longer terms, where gains and losses may offset each other over a longer investment period. GRAT terms can be as short as two years.

There are a number of possible outcomes depending on the following factors:

•If the rate of appreciation of trust assets exceeds the statutory rate of return utilized to calculate the annuity payments (again, currently 2.2% for April 2022), then at the end of the trust term all remaining trust assets will pass with no gift tax consequences to the grantor's designated beneficiaries (e.g., a trust for the benefit of one's spouse, children, other family members and friends).

•If the rate of appreciation of trust assets is equal to or less than the statutory rate, then all trust assets are returned to the grantor, and no tax savings are realized.

•If the grantor were to pass away before all required annuity payments are made, all or a portion of the assets held in the GRAT could be included in the grantor's gross estate for both federal and state estate tax purposes. Older clients may wish to use a shorter GRAT term to minimize this mortality risk.

The availability of GRATs may be limited in the future. The Biden administration has advanced the "Greenbook" proposals (General Explanations of the Administration's Fiscal Year 2023 Revenue Proposals, Dept. of the Treasury, March 2022) as a potential revenue raiser that would make GRATs less attractive by preventing taxpayers from structuring GRATs in the manner discussed above.

The proposal would restrict the use of GRATs by requiring (1) a 10-year minimum term, (2) a taxable gift upon formation, and (3) recognition of gain or loss in assets acquired by the grantor in an exchange. Thus, there is a potential time sensitivity for individuals wishing to fund GRATs with crypto while utilizing their gift exemptions for other purposes.

Buying and selling cryptocurrency requires the opening of an account with an online exchange and creating a crypto wallet (akin to a bank account), which is often tied to a cellphone for security purposes. In GRAT planning, you might need three separate online accounts to effectuate the planning: (1) one for the grantor, (2) one for the GRAT and (3) one for the remainder beneficiaries.

To simplify the initial funding and ongoing administration of a GRAT, it is often useful for the grantor to first create a single-member limited liability company (LLC) and fund it with cash. Then, the LLC can use the cash and open an account to acquire cryptocurrency in the name of the LLC. Once an LLC is funded with cryptocurrency, the grantor can create the GRAT and fund it with 100% of the membership interest of the LLC.

When annual annuity payments are required to be made to the grantor, the GRAT can simply assign back a certain percentage of the membership instead of transferring the crypto itself. When the GRAT term ends, the GRAT can transfer the balance of the membership interest to the remainder beneficiaries without the need to open another online account for the cryptocurrency. Thus, utilizing the LLC as a part of the GRAT planning process insures the need for only one online account.

As crypto continues to dominate the wealth among millennials, traditional planning may not be the best fit for such a volatile asset class. In the attempt to capture the post-transfer appreciation in excess of the statutory assumed rate, a grantor of a GRAT should be confident that planning with crypto is a perfect match.