Treasury Scrutinizes Tax Strategy Used by Crypto ETFs

The US Treasury Department and Internal Revenue Service (IRS) are scrutinizing a tax strategy used by some crypto-linked exchange-traded funds (ETFs). The strategy, which involves using in-kind redemptions to avoid taxable gains, is being reviewed for compliance with the tax code. According to Treasury Secretary Scott Bessent, 'we're serious about cracking down on transactions designed to dodge taxes or exploit our federal tax code.'

The IRS has identified a rule governing regulated investment companies (RICs), which include many US ETFs, as an area of concern. To preserve their favorable tax treatment, RICs must derive at least 90% of their annual gross income from qualifying sources. Treasury is questioning whether some ETFs can exclude gains from assets outside those categories when determining whether they passed the RIC income test.

The notice applies to RICs that obtain digital-asset exposure directly or through vehicles such as grantor trusts and then use redemptions to remove appreciated positions whose gains could complicate the 90% test. Treasury has left itself several options for what comes next, including regulations, revenue rulings, or other guidance.