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Can an LLC Hold Cryptocurrency? How to Structure It

LegalGPS : Dec. 1, 2024

12:03

With the rise of cryptocurrency, more businesses are exploring how they can incorporate digital assets into their operations. One common question is whether an LLC can hold cryptocurrency, and if so, how to structure it effectively. In this blog, we'll explore how an LLC can own and manage cryptocurrency, and the key considerations to ensure compliance and efficiency.

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Can an LLC Hold Cryptocurrency?

The short answer is yes, an LLC can hold cryptocurrency. Many businesses are now using LLCs as a vehicle for investing in or managing crypto assets. The main advantage of doing so is the limited liability protection offered by the LLC structure, which helps separate personal assets from business liabilities, providing a layer of security for owners. However, there are important tax, legal, and operational aspects to consider when structuring an LLC to hold cryptocurrency.

Legal Ownership

When an LLC holds cryptocurrency, it becomes a business asset, and this distinction is essential for tax reporting and regulatory compliance. The LLC, rather than the individual members, owns the cryptocurrency. This means that any gains or losses resulting from trading or selling crypto must be reported by the LLC, not the individual members.

Take Action: Form an LLC specifically for crypto holdings if you want to separate liability and ensure legal protection.

Draft an operating agreement that includes provisions for buying, holding, and selling cryptocurrency.
Specify how decisions regarding crypto investments will be made among LLC members.
Consult with a legal expert to ensure your operating agreement aligns with relevant regulations and state laws.

Example: Suppose three partners decide to form an LLC to invest in cryptocurrency. By setting up the LLC, they ensure that any liabilities resulting from losses in the volatile crypto market do not affect their personal assets. Each member's role is defined in the operating agreement, which helps prevent disputes and protects each partner's interests.

Structuring an LLC for Crypto Investments

If you decide to set up an LLC to hold cryptocurrency, structuring it properly from the outset is crucial. This includes considering the operational structure, tax implications, and compliance requirements.

Creating an Operating Agreement

An LLC's operating agreement is a crucial document that outlines the roles and responsibilities of each member, as well as how profits, losses, and voting rights are managed. For an LLC holding cryptocurrency, it is important to address how crypto investments will be handled, how decisions will be made, and who will have control over wallet access.

Take Action: Draft an operating agreement that clearly defines how crypto assets are managed.

Establish who will have the authority to execute trades or transactions.
Include provisions for maintaining private keys and multi-signature wallets to protect company assets.
Outline how profits or losses from crypto trading will be distributed among members.

Example: If one member of the LLC has more experience with cryptocurrency trading, the operating agreement could specify that this individual will have the authority to make trades, while other members must approve any transactions over a certain threshold. This helps balance expertise with shared control.

Wallet and Security Considerations

Holding cryptocurrency means managing digital wallets and security keys. For LLCs, it’s essential to decide who will have access to the wallets and how the security of the private keys will be maintained. Consider implementing a multi-signature wallet, where multiple members must approve transactions, to enhance security and reduce risk.

Take Action: Set up a secure wallet system that fits your LLC's needs.

Use a multi-signature wallet that requires approval from multiple members for any transaction.
Develop internal policies to specify who manages wallet access and how private keys are stored.
Consider using a custodial service if your LLC holds significant amounts of cryptocurrency, to add an extra layer of security.

Example: A four-member LLC decides to use a multi-signature wallet requiring three out of four members to approve any transaction. This ensures that no single member can move funds without consensus, which helps mitigate the risk of theft or misuse.

Tax Implications of Holding Cryptocurrency in an LLC

Cryptocurrency is generally treated as property by tax authorities, which means that holding, buying, or selling crypto has specific tax consequences. For an LLC, it’s important to understand how these rules apply and to keep detailed records of all crypto transactions.

Tax Treatment

In a typical LLC, profits and losses "pass through" to individual members, meaning that the members report income on their personal tax returns. This is also true for crypto transactions, which means each time the LLC buys or sells crypto, the gains or losses must be calculated and reported. It’s crucial to maintain accurate records to ensure compliance and to prepare for potential audits.

Take Action: Set up a reliable system to track your LLC's crypto transactions.

Use specialized crypto accounting software, such as CoinTracker or TaxBit, that can integrate with your wallets and exchanges.
Establish a regular schedule for updating your records, ideally monthly or quarterly, to ensure your books are always up-to-date.
Work with a CPA who understands cryptocurrency taxation to prepare your tax filings and ensure compliance.

Example: Imagine an LLC that actively trades Bitcoin and Ethereum. Each time a trade is made, the transaction details, including the date, value, and resulting gain or loss, must be recorded. Using crypto accounting software helps automate this process, reducing errors and ensuring that the LLC remains compliant.

Deductible Expenses

If your LLC is actively trading or mining cryptocurrency, certain expenses related to those activities may be deductible. This can include transaction fees, mining hardware, and electricity costs, among other things. Identifying and tracking these expenses can reduce your overall tax burden.

Take Action: Keep detailed records of deductible expenses related to crypto activities.

Track all transaction fees, software subscriptions, and hardware purchases.
Consult with a tax professional to ensure you are maximizing eligible deductions while staying compliant.

Example: An LLC that mines cryptocurrency might incur significant electricity costs. By keeping detailed records of electricity bills and allocating the portion used for mining, the LLC can claim these costs as a business expense, thereby reducing taxable income.

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Compliance and Regulatory Considerations

Cryptocurrency is still a relatively new and evolving asset class, and regulations are constantly changing. It's important for LLCs holding crypto to stay informed about regulatory requirements, such as anti-money laundering (AML) regulations and know-your-customer (KYC) obligations.

State and Federal Regulations

Depending on your jurisdiction, there may be specific regulations that apply to businesses holding cryptocurrency. For example, some states require companies engaging in crypto-related activities to obtain money transmitter licenses. Federal regulations, such as those enforced by the IRS and the Financial Crimes Enforcement Network (FinCEN), also need to be considered.

Take Action: Ensure your LLC complies with all applicable regulations.

Review your state’s specific requirements for cryptocurrency businesses.
Consider consulting a legal expert to help navigate federal regulations.
Develop internal policies to ensure compliance with KYC/AML standards if applicable.

Example: A crypto-focused LLC based in New York might need to comply with the state's BitLicense requirements, which include strict reporting and operational standards. Consulting with a legal expert familiar with these requirements helps ensure the LLC can operate without legal issues.

AML and KYC Compliance

If your LLC is engaging in transactions that may trigger AML or KYC requirements, it's important to establish protocols to verify the identity of clients and monitor suspicious activities. Failing to comply with these regulations could result in fines or even the dissolution of your business.

Take Action: Develop a compliance framework to manage KYC and AML requirements.

Use third-party tools that can verify user identities and screen for suspicious activity.
Train your team on recognizing signs of fraud or money laundering and establish procedures for reporting suspicious activity.
Periodically review your compliance policies to align with changes in regulations.

Example: If an LLC provides crypto payment processing for clients, it may need to verify the identity of each client to comply with AML laws. By using third-party KYC tools, the LLC can automate this process, reducing manual workload and ensuring compliance.

Practical Considerations for Crypto Management

Beyond tax and compliance issues, there are practical considerations when an LLC holds cryptocurrency, such as liquidity management and risk mitigation.

Managing Volatility

Cryptocurrency is inherently volatile, and this volatility can affect an LLC's financial health. If the value of the cryptocurrency held by the LLC drops significantly, it could impact the company's overall financial stability. Developing a strategy to manage this risk is crucial.

Take Action: Create a strategy to manage crypto volatility.

Set guidelines for how much of the LLC’s assets can be held in cryptocurrency versus fiat to reduce risk exposure.
Consider using stablecoins as a way to mitigate volatility while still participating in the crypto market.
Establish clear policies for selling assets if the value drops below a predetermined threshold.

Example: An LLC that holds 50% of its assets in Bitcoin decides to hedge against volatility by converting 20% of its holdings into a stablecoin like USDC. This helps protect the company’s financial position during times of high volatility in the crypto market.

Banking and Access to Services

Many traditional banks are still hesitant to work with crypto businesses, making it challenging for an LLC holding crypto to access banking services. Finding a bank or financial institution that is crypto-friendly can help ensure your LLC has access to the services it needs.

Take Action: Find a banking partner that supports crypto-related businesses.

Research and create a list of banks or credit unions that are known to work with crypto businesses.
Be prepared to provide detailed documentation about your LLC’s activities, including AML/KYC policies and risk mitigation strategies.
Consider alternative options, such as fintech companies that offer crypto-friendly banking solutions.

Example: An LLC that actively trades cryptocurrency might work with a fintech company like Mercury, which offers banking services specifically tailored for startups, including those dealing in digital assets. This helps the LLC avoid the challenges of working with traditional banks that may not support crypto.

Do I need a business lawyer?

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