The approval of perpetual futures contracts in the US may lead to unforeseen tax and regulatory uncertainty for traders if these products are ultimately classified as swaps rather than futures, a concern that has received minimal public attention, as stated by CME Group Chairman and CEO Terry Duffy. In an interview with CoinDesk, Duffy mentioned, 'There's a consequence that nobody's talking about. There's ambiguity right there, from a tax perspective, for all US participants now.' These 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.

The outcome of this challenge could substantially influence the US approach to the rapidly growing arena of perpetual futures, with one potential consequence being how the Internal Revenue Service (IRS) taxes these contracts. The dispute arises from the question of whether perpetual futures should be legally treated as futures or swaps. Duffy argues that perpetual futures should fall under the legal definition of swaps due to the periodic funding payments exchanged between long and short positions, rather than being categorized as futures by the CFTC. 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 contends that these recurring payment exchanges satisfy the statutory definition of a swap under US law. The main issue with this mismatched designation, according to Duffy, is that if perpetual contracts qualify as futures, many institutional traders could receive a blended tax treatment under Section 1256 of the US tax code. However, if these contracts are classified as swaps, they will be taxed under 'ordinary' taxation, and the IRS has not provided guidance on the tax treatment of perpetual futures.

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. Duffy warned, '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.' However, legal experts say the issue is more complex, with Rustin Diehl, a tax attorney, stating, '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 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, as the Supreme Court's 2024 Loper Bright decision eliminated the Chevron doctrine, resulting in federal courts giving less deference to agencies' interpretations of ambiguous statutes.

This is likely to be a long, drawn-out process, 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.

Duffy emphasized that until regulators, tax authorities, or the courts provide greater clarity, large institutions could face uncertainty over how to report trades involving perpetual futures, saying, '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?'