Federal Regulators Target Crypto ETF Tax Strategies

The Internal Revenue Service (IRS) and the Treasury Department have launched a concentrated effort to scrutinize tax-saving strategies within the rapidly expanding crypto exchange-traded fund (ETF) market. Treasury Secretary Scott Bessent recently emphasized that federal agencies are prioritizing a crackdown on transactions designed to exploit the tax code, specifically targeting fund structures that may be stretching existing provisions to avoid taxable gains. This regulatory pivot introduces new legal uncertainties for fund managers who have recently adopted "in-kind" redemption models—a mechanism traditionally used by conventional ETFs to maintain tax efficiency.

Challenging the 90% Income Test

At the heart of the investigation is a rule governing Regulated Investment Companies (RICs), which requires these entities to derive at least 90% of their annual gross income from "qualifying sources" like dividends and interest. Because certain digital assets and commodities may not fall into these categories, some ETFs have allegedly used in-kind redemptions to satisfy investor withdrawals with appreciated crypto assets. By utilizing Section 852(b)(6) of the tax code, funds can distribute these assets without recognizing the embedded gain, subsequently arguing that these unrecognized gains should be excluded from the 90% income calculation entirely. Treasury officials expressed skepticism toward this interpretation, suggesting it allows funds to bypass income thresholds regardless of their actual economic performance.

Market Impact and Regulatory Risks

While major spot Bitcoin and Ethereum ETFs—such as those managed by BlackRock—typically operate as grantor trusts and are less affected by this specific RIC income test, the scrutiny poses a significant hurdle for the next generation of crypto products. This includes actively managed and multi-asset ETFs that incorporate digital assets into broader investment strategies. The Treasury has signaled that future guidance could be applied retroactively, meaning managers may face enforcement actions for past transactions. Consequently, fund sponsors may now need to reconsider their portfolio mechanics, provide more robust documentation of the economic purpose behind their trades, or seek additional legal safeguards before bringing new crypto-linked products to market.