Cryptocurrency Trusts: A Way Around State Tax Problems? Tax Expert Rob Wood Explains
Cryptocurrency carries with it some special tax problems. Transfers of crypto can involve taxation issues for both the recipient and the transferor. In addition to the issues with federal taxation of gains on crypto holdings, state tax laws can also cause problems. There may be a way to avoid some of the state tax problems by the use of a cryptocurrency trust. Tax lawyer Rob Wood discusses the use of crypto trusts in this report. He also wrote about them in his Forbes article “Bitcoin Trusts Avoid Taxes, Including $10,000 SALT Deduction Cap.”
Wood explains that there may be a way to avoid some state tax issues by transferring crypto to a special kind of trust. The crypto trust is something that you might use if you live in a high tax state—California, perhaps. The trust would pay taxes, but not in your state, and the high state tax rate would not apply. Crypto trusts are typically set up in Nevada, Delaware, or Wyoming for this purpose. The idea is to create a trust such that the grantor is not viewed as the owner. Rather, the trust and the trustee would be in a low-tax (or no-tax) state, and the grantor would not be taxed on gains associated with the trust assets.
The challenge is setting up the trust in another state without having to move to that state. Wood says it can be done. It’s important to understand that the IRS treats cryptocurrency as property. It lives where its owner lives—in California, for purposes of this example. Thus, when it is sold, both the IRS and California will tax any gain in value. If the owner moves to Nevada and does things right, any subsequent sale would be free from state income taxation as Nevada has no such tax and California would have no claim on the asset. Wood points out that the move from California to Nevada (in this example) would have to be done correctly in order to eliminate the California tax. For example, there may be timing issues that affect the taxability of the crypto under California law.
An alternative to moving is the setting up of the crypto trust in Nevada with the use of a Nevada trustee. If the set-up is done correctly, the crypto will be free from California income taxation. Wood says that “the jury is still out” on how crypto trusts will work in the future. California has not yet changed its law to attack the validity of these trusts. Wood suggests that California will make a move to attack these trusts at some future date.
Someone who is considering the use of a crypto trust should get some tax advice before attempting this solution. Using the trust could be risky if not done with solid tax advice.
Robert W. Wood is the Managing Partner of Wood LLP, San Francisco. Often listed among the best tax lawyers in America, Wood has broad experience in corporate, partnership and individual tax matters. Concerning the tax treatment of litigation settlements and judgments, he is perhaps the preeminent tax lawyer in the United States. He is also an authority on merger and acquisition tax matters, tax opinions, offshore account and entity disclosures, and many types of tax controversies. The Legal Broadcast Network is a featured network of Sequence Media Group.