Key Takeaways
- • The IRS has launched formal scrutiny of a $7.22 billion crypto ETF tax strategy involving in-kind redemptions, questioning whether funds are exploiting provisions to sidestep the 90% gross income test required for regulated investment companies (RICs) to maintain favorable tax treatment.
- • Treasury and the IRS identified digital assets as a priority area where fund managers may be stretching tax provisions beyond their intended purpose, with the notice specifically targeting structures that use in-kind transactions to exclude gains from commodities or digital assets held directly or through grantor trusts from income calculations.
- • The regulatory action directly challenges the tax efficiency benefits that the SEC endorsed just one year prior when it approved in-kind creations and redemptions for spot crypto exchange-traded products, positioning the agencies on a collision course over crypto ETF structuring.
- • Treasury Secretary Scott Bessent framed the escalation as part of a broader crackdown on "transactions designed to dodge taxes or exploit our federal tax code," signaling political commitment to closing perceived loopholes in crypto investment vehicles.
- • The 90% income test requires RICs to derive at least 90% of annual gross income from qualifying sources including dividends, interest, and gains from stocks, securities, and certain currencies—categories that have traditionally excluded digital assets and commodities.
Summary
The Internal Revenue Service has escalated enforcement scrutiny against crypto-linked exchange-traded funds employing in-kind redemption strategies to circumvent federal tax requirements. According to disclosures from the Treasury Department and IRS in late September 2026, regulators are examining whether approximately $7.22 billion in crypto ETF assets have been structured to improperly exclude digital asset gains from the 90% gross income test that governs regulated investment companies (RICs)—the vehicle category encompassing most U.S. ETF products.
The specific concern centers on how fund managers utilize in-kind redemption mechanics to manipulate the income calculation underpinning RIC tax qualification. To maintain favorable tax treatment, RICs must derive at least 90% of annual gross income from qualifying sources: dividends, interest, and capital gains from stocks, securities, and certain currencies. The Treasury alleges that some ETFs are arguing they can legally exclude gains from commodities and digital assets—held either directly or through grantor trust structures—from this calculation entirely, thereby preserving RIC status while generating substantial unrealized tax obligations downstream.
The regulatory action represents a sharp reversal from the Securities and Exchange Commission's decision just one year prior to approve in-kind creation and redemption mechanisms for spot crypto exchange-traded products. The SEC authorized this structural change specifically to reduce costs and minimize price slippage for retail and institutional investors, aligning crypto ETFs with the tax-efficient mechanics long employed by traditional commodity funds. The IRS notice now suggests that certain funds have weaponized this SEC-blessed mechanism to achieve tax outcomes that regulators contend bear little relationship to underlying portfolio economics.
Treasury Secretary Scott Bessent publicly characterized the initiative as part of a coordinated federal effort to eliminate tax-motivated investment structures, stating the agencies were "serious about cracking down on transactions designed to dodge taxes or exploit our federal tax code." Notably, the IRS stopped short of challenging conventional in-kind redemptions themselves, instead targeting the specific use case where funds employ these transactions primarily for tax avoidance rather than operational efficiency. The notice seeks public comment on novel investment fund strategies, indicating that formal rulemaking or enforcement guidance may follow. This escalation places significant uncertainty over the tax advantages that drove substantial capital inflows into crypto ETF products over the preceding twelve months.
The specific concern centers on how fund managers utilize in-kind redemption mechanics to manipulate the income calculation underpinning RIC tax qualification. To maintain favorable tax treatment, RICs must derive at least 90% of annual gross income from qualifying sources: dividends, interest, and capital gains from stocks, securities, and certain currencies. The Treasury alleges that some ETFs are arguing they can legally exclude gains from commodities and digital assets—held either directly or through grantor trust structures—from this calculation entirely, thereby preserving RIC status while generating substantial unrealized tax obligations downstream.
The regulatory action represents a sharp reversal from the Securities and Exchange Commission's decision just one year prior to approve in-kind creation and redemption mechanisms for spot crypto exchange-traded products. The SEC authorized this structural change specifically to reduce costs and minimize price slippage for retail and institutional investors, aligning crypto ETFs with the tax-efficient mechanics long employed by traditional commodity funds. The IRS notice now suggests that certain funds have weaponized this SEC-blessed mechanism to achieve tax outcomes that regulators contend bear little relationship to underlying portfolio economics.
Treasury Secretary Scott Bessent publicly characterized the initiative as part of a coordinated federal effort to eliminate tax-motivated investment structures, stating the agencies were "serious about cracking down on transactions designed to dodge taxes or exploit our federal tax code." Notably, the IRS stopped short of challenging conventional in-kind redemptions themselves, instead targeting the specific use case where funds employ these transactions primarily for tax avoidance rather than operational efficiency. The notice seeks public comment on novel investment fund strategies, indicating that formal rulemaking or enforcement guidance may follow. This escalation places significant uncertainty over the tax advantages that drove substantial capital inflows into crypto ETF products over the preceding twelve months.
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