The best question might not be whether you can use Bitcoin as part of a larger asset protection plan, but whether you should.
First things first: hiding money with intent to defraud a creditor or avoid taxes could render you civilly liable and is illegal in some jurisdictions like California.
There are, of course, variations in laws from state to state, but if your plan is to convert a lot of cash into Bitcoin and secret it away in anticipation of litigation, future legal troubles, or taxes there is no doubt that this is fraud and you could personally be subject to serious legal troubles under state federal law, with serious penalties resulting, including the transfer itself being voidable and you potentially serving prison time. So don’t do it.
In fact, as of November 28, 2017, the U.S. Senate Judiciary Committee has held hearings on a bill that aims to seriously criminalize the intentional concealment of ownership or control of a financial account. The bill amends the definition of a “financial account” and “financial institution” to include digital currencies and digital exchanges, including Bitcoin and other cryptocurrencies. Indeed, under the proposed amendments to U.S. Code §5312, a person who has knowingly concealed, falsified or misrepresented a material fact concerning the ownership or control of an account from or to a financial institution (or assets held in an account with a financial institution) would be potentially subject to a maximum of 10 years imprisonment or a fine up to $1,000,000, or both. (“SEC. 13. PREPAID ACCESS DEVICES, DIGITAL CURRENCIES, OR OTHER SIMILAR INSTRUMENTS.(a) In General.—Section 5312(a) of title 31, United States Code, is amended—(1) in paragraph (2)(K)—(A) by inserting “prepaid access devices, digital currency,” after “money orders,”; and (B) by inserting before the semicolon at the end the following: “, or any digital exchanger or tumbler of digital currency. . . .”).
You could, however, lawfully transfer Bitcoin to a foreign trustee or entity to hold and protect if you have no reason to suspect impending legal issues for protection from future creditors. The jury is out on whether doing so with Bitcoin or other cryptocurrencies is a good idea at this point in time. I think that if Bitcoin became more heavily relied upon long-term, we might see more stable prices, but until then, dollar bills invested abroad or in other foreign currencies appear less volatile.
Cryptocurrencies like Bitcoin have the potential to legally and safely keep assets away from many U.S. courts and out of creditors’ reach, not because they exist entirely on a decentralized digital ledger known as the blockchain or “Bitcoin protocol,” but only in the same way that you might transfer money to a foreign LLC or trustee in the Bahamas.
1. Bitcoin Technology, the Blockchain, and Bitcoin Protocol
Bitcoin transactions are executed on the blockchain via a system involving two types of keys. Keys are simply unique random sequences of numbers and letters and the keys to a transaction include both address keys and a secret key. Anyone viewing the blockchain can see that a transaction exists, but only the secret key can be used to access the contents of a certain transaction from one address to another. A secret key remains under the owner’s control and provides the ability to transfer the Bitcoin to another public address.
The blockchain ledger itself is updated to reflect a transfer of ownership in Bitcoin with the right to control the Bitcoin granted to the holder of the secret key. The holder corresponds to the address in the blockchain ledger, thus, the transferee of a secret key is the holder and owner of Bitcoin.
The blockchain is especially useful as an evidentiary tool because particular amounts of Bitcoin transferred in one transaction can be tracked from transferee to transferee based on the public key. This is especially important as we will see because proving the timing of a transfer is key to establishing its validity as part of a comprehensive asset protection plan, and will ultimately make a large difference depending on if Bitcoin is treated as property (or currency.
Anyone with the secret key can effectuate a transfer of Bitcoin to another address. Keys are often kept on a computers or mobile devices, but can also be stored on detached storage devices (such as a USB drives), a sheet of paper in a safe (referred to as “cold storage”), with a provider on the internet (such as Coinbase), or even memorized.
Bitcoin is touted by estate and financial planners and those seeking to protect their assets for the future because the technology serves evidentiary, protective and administrative functions.
If someone transferring Bitcoin overseas, for example, is worried about a malicious trustee (or co-trustees, co-managers, trust protectors, or members of a board of directors), they can require multiple secret keys so that multiple people are required to access the Bitcoin.
From an evidentiary standpoint, all transactions in Bitcoin are recorded and date-stamped on the blockchain, which provides proof and transparency to prevent claims of fraudulent conveyances and threats of contempt orders.
As for as making trust administration and asset protection more transparent and efficient, Bitcoin and its blockchain make administration of the funds easier to divide amongst multiple beneficiaries/transferees and the technology itself may one day allows the Bitcoin to self-execute contracts and automatically rename trustees, for example.
According to asset protection attorney Eric Boughman, effectively using Bitcoin in legitimate asset protection may simply involve the transfer of a private key to an offshore trustee (or manager) like transfer of cash or other property to an off-shore trustee or LLC. This is because properly selected offshore trustees are unlikely to become subject to the jurisdiction of a court where a defendant may be sued, just like an off-shore trust or use of a foreign LLC.
The blockchain is decentralized. This means that Bitcoin is not subject to any central authority (such as a bank or other financial institution) that might be legally compelled to provide a court with access or control over assets in its possession. And without the complete private key, no court or legal authority can manipulate ownership of a blockchain asset.
Thus, absent the jurisdiction of a court in the United States, there is no power to require an off-shore transferee to turn over the assets. (Although leading asset protection attorney Eric Boughman cautions that, “Some U.S. states may find the concept of self-settled trusts anathema to public policy and thus choose to ignore the trust and treat the grantor/beneficiary as the de facto owner of trust assets.” These courts typically treat offshore LLCs and self-settled trusts in a similar manner.)
The borderless and quasi-anonymous nature of digital currencies inevitably leads to a discussion of using Bitcoin for asset protection. The assumption by some is that, with anonymity, ownership of cryptocurrencies could be an effective and efficient means to hide wealth from debtors and courts alike.
2. Legitimate v. Fraudulent Asset Protection
There is a large difference between legitimate asset protection and defrauding creditors. Implementation of a legitimate asset protection plan must begin before the debtor anticipates creditor action or litigation. (See The Myth Of Using Cryptocurrencies For Asset Protection).
Legitimate asset protection involves planning before you have any issues to protect against unknown future claims. Debtors seeking protection after they have already defaulted on a debt, been sued or are facing divorce cannot transfer their assets to frustrate payment of their creditors or else face potential liability. Such transfers may be unwound by courts as “fraudulent transfers” and are even illegal in some jurisdictions like California. (See generally, the Uniform Voidable Transactions Act; see also Ca. Pen. Code Sec. 154, 155(a), & 155.5.)
Transparency is key
According to Boughman, a key yet often overlooked element of effective and legitimate asset protection is transparency. If a debtor is subject to having a judgment taken against them, they will be required to disclose details about assets, including bank accounts, investments, real and personal property ownership, and other transfers of assets at an oral examination to enforce the judgment. Bitcoin, Boughman argues, can be an effective method to record a transfer in time to escape a claim of a fraudulent conveyance to frustrate creditors.
Debtors, after all, may be summoned to court for an oral examination to divulge their financial records, and are usually asked about expenses and transfers of cash or other property. Failing to divulge the requested information and to reveal any cash-to-Bitcoin conversions is at once fraud, perjury, and a serious no-no.
Digital currency ownership is subject to complete disclosure, and the inquiry would not be limited to a current snapshot. An effective creditor’s lawyer will look at account histories and scrutinize transfers made during and immediately before a lawsuit to sniff out fraudulent transfers. Because subsequent Bitcoin transactions for the same particular Bitcoin leave a trail of information, creditors and the court will also be able to track those transfers and sniff out fraud.
Transferees must also be careful because they could also potentially get hit with a Contempt Order for the fraudulent conveyance in certain cases. That is to say, when the Bitcoin is no longer in a debtor’s hands, the transferee might become entangled in costly litigation with dogged creditors seeking to unwind and void the transfer of Bitcoin (if the transfer was indeed to defraud a creditor).
Could Bitcoin and other digital currencies be useful in asset protection?
“Sure,” says attorney Eric Boughman, but “like cash hidden under a mattress, failure to disclose such ownership may constitute perjury and subject a debtor to contempt proceedings.”
Ultimately, using cryptocurrencies with the intention of concealing ownership is not legitimate asset protection. It would be similar to burning all of your money to avoid paying creditors—you would not be absolved of your obligation to return the debt if the transfer was fraudulent. In the words of attorney Boughman, “It is simply lying and fraud, which can and should lead to harsh consequences.”
So how might you legitimately use Bitcoin for asset protection?
The intent, according to Boughman, should not be to hide assets and fly under the radar, but instead to document the occurrence and timing of transactions. In this manner, blockchain transactions might validate legitimate planning with defensible transparency from creditors. If you properly sent your Bitcoin to an off-shore transferee you could establish the proper timing (i.e., before the anticipation of litigation), because the blockchain is a public ledger that will establish when the transfer occurred. This is one way that Bitcoin serves a great evidentiary function for asset protection.
3. Currency or Other Property?
The law is unclear whether Bitcoin is a currency or other “property” (capital asset like a stock or commodity, in which case capital gains rules apply). The IRS and courts have categorized it differently on separate occasions.
A U.S. District Court, in an unpublished opinion, has suggested that, yes, Bitcoin is currency. (See SEC v. Shavers, 2014 U.S. Dist. LEXIS 130781.) How Bitcoin is ultimately classified has an effect on whether it passes encumbered with a creditor’s lien to a transferee or the transferee takes the Bitcoin outright without worrying about a court order requiring it to release the funds at a later date.
A transfer of currency to another is usually not encumbered by a creditor’s interest unless the transfer was intended to defraud the creditor. If the transfer was made with such intent, the assets would cease to be protected and might be subject to a levy or the transaction voidable as described above.
“Property,” as the IRS has characterized virtual currency, on the other hand, is presumed to pass encumbered with a creditor’s interest attached. If Bitcoin is ultimately treated as “property” rather than currency, this means that each subsequent transferee could be subject to the creditor’s lien on that property. This might make it difficult to return or liquidate the Bitcoin by re-transferring to an American transferee after a creditor has already attempted to collect those funds from a foreign transferee. This is because those Bitcoin assets would remain encumbered by the creditor no matter in whose hands they were placed.
Let’s say you transfer Bitcoin encumbered by a creditor’s lien to an off-shore trustee. If that transaction is treated as a transfer of currency (and it was not executed with the intent to defraud), then the transferee gets the Bitcoin outright without the creditor’s interest attached.
If, on the other hand, the courts and government ultimately decide to treat Bitcoin as other property, then it might be difficult to get that Bitcoin back into the U.S. economy free of the creditor’s lien. This is because if you transfer Bitcoin to a foreign trustee to hold, then the creditor’s lien passes with it, whether the transfer was fraudulent or not. If that trustee/transferee later attempts to transfer that same Bitcoin back to a person or entity subject to the judicial power of a United States court, it is possible that the creditor has a revived claim against the new second domestic owner, based on his earlier claim against the initial domestic owner.
In the end, the answer is yes. You can use Bitcoin as a store of wealth abroad as part of a legitimate asset protection plan. The potential for future technological developments and self-executing money is exciting, but not here yet.
While some scholars claim that Bitcoin’s price is bound to even out eventually, due to its current volatility, it does not yet appear to be a feasible alternative to other off-shore asset protection options. (Or even on-shore asset protection options. Hello Self-Settled Spendthrift Trusts.) On the other hand, the ease and cost-effectiveness of cryptocurrencies are to be desired over a traditional off-shore trust if you choose to go that route. I would not be surprised to see this become a burgeoning area of estate and financial planning in the coming years as Bitcoin, other cryptocurrencies, and peer-to-peer technologies, in general, become increasingly pervasive.
I am not a lawyer. This is not legal advice. I do not purport to be a substitute for the advice of counsel on any specific matter. For legal advice, you should consult with an attorney concerning your specific situation. For accounting advice, speak with an accountant.
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Author: Ryan Ullman
Ryan Ullman is an associate attorney at Spence | Brierley in Baltimore, Maryland, a boutique firm that assists its clients in all manner of civil litigation. He is particularly interested in technology, productivity, peak flow states, music, and the outdoors.