The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory uncertainty if these products are ultimately deemed to be swaps rather than futures, a matter that has garnered limited public discussion, as stated by CME Group Chairman and CEO Terry Duffy. 'There's a consequence that nobody's talking about,' Duffy noted in an interview with CoinDesk. 'There's ambiguity right there, from a tax perspective, for all US participants now.' These comments come as CME continues its legal challenge against the Commodity Futures Trading Commission (CFTC) regarding the regulator's approval of perpetual futures contracts in the US. Both parties await a federal court decision, which could substantially influence the US approach to the rapidly expanding arena of perpetual futures.
One potential consequence, according to Duffy, involves how the Internal Revenue Service (IRS) ultimately taxes these contracts. The dispute originates from whether perpetual futures should be legally categorized as futures or swaps.
Duffy argues that perpetual futures should fall under the legal definition of swaps, rather than how the CFTC categorizes them as futures, due to the periodic funding payments exchanged between long and short positions. Unlike traditional futures, perpetual contracts never expire; instead, traders periodically exchange funding payments intended to maintain the derivative's price close to that of the underlying asset. Duffy asserts that these recurring payment exchanges satisfy the statutory definition of a swap under US law.
'When two parties exchange payments to each other, that is deemed a swap,' he said, referring to the funding-rate mechanism used by perpetual contracts. The primary issue Duffy sees with this mismatched designation is that if perpetual contracts qualify as futures, many institutional traders could receive the blended tax treatment available under Section 1256 of the US tax code.
Under this, gains and losses are generally treated as 60% long-term and 40% short-term capital gains. If those contracts fall under swaps, they will be taxed under 'ordinary' taxation. Given that perpetual futures are newer innovations, the IRS has not issued guidance specifically addressing the tax treatment of these contracts.
Thus, 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 those positions to the IRS. '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,' Duffy said. However, legal experts say the issue is more complex.
'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,' said Rustin Diehl, a tax attorney and counselor at Allegis Law. 'It's really a substance-over-form question … function versus text.' The definition of swaps is extremely broad, according to Jason Gottlieb, partner and chair of Morrison Cohen's digital assets practice. 'Basically, the statutory definition of swaps is so broad as to encompass … anything,' he said.
The outcome will depend on how the court interprets it, given the Supreme Court's 2024 Loper Bright decision, which eliminated the Chevron doctrine, resulting in federal courts giving less deference to agencies' interpretations of ambiguous statutes. This means judges could play 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 potential litigation.
'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,' Gottlieb said. A federal judge is likely to 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 whether perpetual contracts are swaps or futures, tax treatment may still require separate guidance from the IRS, which is not obligated to adopt the CFTC's interpretation of financial instruments. 'I think people are going to want to maybe check with the IRS and see how they should report these,' said Diehl.
Until regulators, tax authorities, or the courts provide greater clarity, Duffy said, large institutions could face uncertainty over how to report trades involving perpetual futures. 'How would you like to be running a very large public company that trades a lot and hedges a lot, and all of a sudden you're in the news for not paying proper taxes,' said Duffy.