As cryptocurrency and digital assets become increasingly prevalent in the portfolios of high-net-worth individuals and families, traditional wealth management and estate planning practices are facing unprecedented challenges. The unique characteristics of digital assets—from custody complexities to regulatory uncertainties—require sophisticated legal and tax strategies that go far beyond conventional financial planning approaches.

In this illuminating Q&A, Michael S. Arlein, chair of trusts and estates at Patterson Belknap Webb & Tyler LLP, draws on his extensive experience advising wealthy families and crypto entrepreneurs to address the most pressing issues facing practitioners today. Michael brings a unique perspective to the intersection of digital asset law and traditional estate planning practice.

These insights explore the practical realities of securing and transferring crypto wealth across generations, maximizing tax benefits for blockchain startups and their investors through QSBS planning, and structuring sophisticated trust arrangements that can effectively manage digital asset investments while meeting fiduciary obligations. Michael's responses reflect the evolving nature of this practice area, where traditional legal frameworks must adapt to accommodate assets that exist purely in digital form and the complex custody, valuation, and governance challenges they present.

For estate planning attorneys, wealth managers, and affluent families navigating the digital asset landscape, these perspectives offer essential guidance on structuring, protecting, and transferring crypto wealth in an increasingly complex regulatory environment.

Question 1: Estate Planning for Digital Assets and Crypto Holdings

As chair of trusts and estates at a firm that launched an FTX Task Force, you're uniquely positioned to address the intersection of traditional estate planning with digital assets. What are the key challenges high-net-worth individuals face when incorporating cryptocurrency and digital assets into their estate plans? How should families structure their digital asset holdings to ensure proper succession planning while maintaining privacy and security, and what practical steps should executors take to identify and manage crypto assets after death?

The biggest challenge is that typically crypto is not like other financial assets where custody is held at a bank.  There’s no “account statement,” and keys/seed phrases are the asset. High net worth individuals who hold crypto should be sure to prepare detailed instructions for their family members and executor about where crypto is held and how to access it.  For significant holdings, consider implementing multisig with roles split among (i) a family member, (ii) a professional fiduciary/co-trustee, and (iii) a lawyer or accountant.  After death, the executor will need to secure custody of the crypto, safeguard it, and arrange a valuation for tax purposes.

Question 2: QSBS Tax Benefits and Crypto/Blockchain Companies

Given your expertise in QSBS (Qualified Small Business Stock) tax planning and the growing number of blockchain and crypto startups, how are you advising entrepreneurs and investors in the digital asset space to maximize Section 1202 benefits? What specific structuring considerations should crypto startups and their early investors consider to preserve QSBS eligibility, and how do recent regulatory developments in the crypto space affect these tax planning strategies?

QSBS applies to stock of a domestic C-corporation, acquired at original issuance, when aggregate gross assets ≤ $50M at issuance (now $75M), and held >5 years (now starting at 3 years).   Crypto companies are sometimes organized as foundations or offshore companies where QSBS would not apply.  In addition, QSBS does not apply to certain business activities – e.g. financial services, banking/financing/investing and brokerage services – which may exclude certain crypto companies.   Keep in mind that compensation or fundraising in tokens/warrants for tokens doesn’t create QSBS, only corporate stock.

Question 3: Trust Structures for Digital Asset Investment and Management

With the increasing institutional adoption of cryptocurrency and the emergence of digital asset investment vehicles, how are sophisticated trust structures evolving to accommodate crypto investments for wealthy families? What governance frameworks and investment committee structures do you recommend for family trusts looking to include digital assets in their portfolios, and how should trustees approach their fiduciary duties when managing volatile and rapidly evolving crypto assets?

Custody is also a challenge for gifting crypto to accomplish tax planning objectives.  The donor of a gift typically must give up control, which leads to security concerns and structuring issues.  Directed trusts (permitted in certain states like Delaware and Nevada) and LLCs can be helpful in navigating these issues.  If there will be a large concentration of volatile crypto, it is also important to set up a trust in a jurisdiction that allows rules mandating diversification and prudent investing to be waived by the settlor.  

Want to contribute to our Q&A series? If you're a legal expert in the web3/AI space and would like to share your expertise by joining our Q&A series, please reach out to hi@databirdjournal.com