The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory challenges if these products are ultimately deemed to be swaps rather than futures. This issue, which has garnered little public attention, poses a significant ambiguity from a tax perspective for all US participants, according to CME Group Chairman and CEO Terry Duffy. In an interview with CoinDesk, Duffy highlighted the potential consequences, stating, '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 as CME continues its legal challenge against the Commodity Futures Trading Commission (CFTC) over the regulator's approval of perpetual futures contracts in the US.
A federal court decision is pending, and the outcome could substantially influence how the US approaches the rapidly growing arena of perpetual futures, including how the Internal Revenue Service (IRS) taxes these contracts. The dispute centers on whether perpetual futures should be legally treated as futures or swaps. Duffy argued that perpetual futures, also known as 'perps,' should fall under the legal definition of swaps due to the periodic funding payments exchanged between long and short positions, rather than how the CFTC categorizes them as futures. Unlike traditional futures, perpetual contracts never expire and instead involve periodic funding payments to keep the derivative's price close to that of the underlying asset.
Duffy contended that these recurring payment exchanges satisfy the statutory definition of a swap under US law, stating, 'When two parties exchange payments to each other, that is deemed a swap.' The main issue with this mismatched designation, according to Duffy, is that if perpetual contracts qualify as futures, many institutional traders could receive blended tax treatment under Section 1256 of the US tax code. This treatment generally classifies gains and losses as 60% long-term and 40% short-term capital gains. However, if these contracts are deemed swaps, they will be taxed under 'ordinary' taxation.
Given that perpetual futures are a newer innovation, the IRS has not issued 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. Duffy cautioned that this could lead to significant tax implications, saying, 'So if you file your tax return and this ruling comes back, where these products that you've been trading and filing government tax returns as 1256 contracts [futures], when it should be ordinary, I will be curious what the IRS has to say to you about how much they think you owe them because you didn't file your tax returns properly.' Legal experts, however, noted that the issue is more complex.
Rustin Diehl, a tax attorney and counselor at Allegis Law, stated, '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, partner and chair of Morrison Cohen's digital assets practice, added that the definition of swaps is extremely broad, leaving considerable room for interpretation regarding its application to new financial products such as perpetual futures. The outcome will depend on how the court interprets the law.
The Supreme Court's 2024 Loper Bright decision eliminated the longstanding Chevron doctrine, meaning federal courts now give less deference to agencies' interpretations of ambiguous statutes. This could lead to judges playing a larger role in deciding how existing derivatives laws apply to novel crypto products. The process is likely to be long and drawn out, with Gottlieb stating, '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.' A federal judge may first examine whether the regulator reasonably considered public comments and sufficiently explained its decision before approving these contracts, rather than immediately deciding whether the products should be classified as swaps or futures.
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. Diehl noted, 'I think people are going to want to maybe check with the IRS and see how they should report these.
They generally do agree with the CFTC's definitions of commodities historically, but there's been many times when the IRS doesn't just agree with a taxpayer submitting their tax position based on CFTC rules.' 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 and reputational risks.