US Treasury Scrutinizes Crypto-Linked ETF Tax Strategy

The Internal Revenue Service (IRS) is scrutinizing a crypto-linked ETF tax strategy as part of its crackdown on structures designed to avoid taxable gains. Treasury Secretary Scott Bessent said the agencies are 'serious about cracking down on transactions designed to dodge taxes or exploit our federal tax code.' This move puts a fresh tax question over a crypto ETF market that has spent the past year adopting in-kind machinery.

At issue is a rule governing regulated investment companies (RICs), which include much of the US ETF industry. To preserve their favorable tax treatment, RICs generally must derive at least 90% of annual gross income from qualifying sources. Treasury said some ETFs argue they can keep gains from assets outside those categories out of the calculation altogether.

The notice specifically points to funds holding commodities or digital assets through a grantor trust. Instead of selling an appreciated position, the fund can use it to satisfy an in-kind redemption by an authorized participant. This could allow an ETF to limit the income subject to the 90% threshold regardless of its actual economic income.

Bessent was more categorical about prearranged transactions involving investors contributing appreciated securities to an ETF before quickly removing those assets through redemptions, allowing investors to emerge with a different portfolio without initially recognizing the embedded gain. The IRS said these arrangements can be recharacterized as taxable exchanges.