The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory risks if these products are ultimately deemed to be swaps rather than futures, a concern that has garnered little public attention, as stated by CME Group Chairman and CEO Terry Duffy. In an interview with CoinDesk, Duffy noted, 'There's a consequence that nobody's talking about.
There's ambiguity right there, from a tax perspective, for all US participants now.' The comments come amidst CME's ongoing legal challenge against the Commodity Futures Trading Commission (CFTC) regarding the regulator's approval of perpetual futures contracts in the US. A federal court decision is pending, and its outcome could substantially influence how the US approaches the rapidly growing field of perpetual futures, including how the Internal Revenue Service (IRS) taxes these contracts.
The dispute revolves around whether perpetual futures should be legally categorized as futures or swaps. Duffy argues that perpetual futures should be classified as swaps due to the periodic funding payments exchanged between long and short positions, which, in his view, aligns with the statutory definition of a swap under US law. Unlike traditional futures, perpetual contracts do not expire; instead, traders periodically exchange funding payments to keep the derivative's price close to the underlying asset's price.
Duffy emphasized that these recurring payment exchanges meet the definition of a swap. The primary issue with this mismatched designation, according to Duffy, is that if perpetual contracts are considered futures, many institutional traders could receive a blended tax treatment under Section 1256 of the US tax code, where gains and losses are generally treated as 60% long-term and 40% short-term capital gains. However, if these contracts are classified as swaps, they would be subject to 'ordinary' taxation. Given that perpetual futures are a newer innovation, the IRS has not provided specific guidance on their tax treatment.
If regulators or courts ultimately conclude that perpetual contracts are swaps rather than futures, market participants who have been treating them as futures for tax purposes could face uncertainty about how to report these positions to the IRS. Legal experts, however, consider the issue more complex. Rustin Diehl, a tax attorney, noted, 'The challenge here is that textually, by the structure, perpetual futures look a lot like a swap, but economically they perform a lot like futures. It's really a substance-over-form question … function versus text.' Jason Gottlieb, a partner at Morrison Cohen, added that the statutory definition of swaps is extremely broad, leaving considerable room for interpretation regarding its application to new financial products like perpetual futures.
The outcome will depend on the court's interpretation. The Supreme Court's 2024 Loper Bright decision, which eliminated the Chevron doctrine, means federal courts now give less deference to agencies' interpretations of ambiguous statutes, potentially leading to a larger role for judges in deciding how existing derivatives laws apply to novel crypto products. This process is likely to be long and drawn out, with Gottlieb predicting, 'My view is that there’s going to be a lot of litigation about it, and the Supreme Court has told courts that if there is ambiguity in the statute, they can ignore the CFTC and read the statute for themselves.' Instead of immediately deciding whether the products should be classified as swaps or futures, a federal judge is likely to first examine whether the regulator reasonably considered public comments and sufficiently explained its decision before approving these contracts.
Even if the litigation ultimately clarifies the classification of perpetual contracts, tax treatment may still require separate guidance from the IRS, which is not obligated to adopt the CFTC's interpretation of financial instruments. Until regulators, tax authorities, or the courts provide greater clarity, Duffy warned that large institutions could face uncertainty over how to report trades involving perpetual futures, potentially leading to significant tax implications.