The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory uncertainties if these products are ultimately classified as swaps rather than futures, a matter 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.' These 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.
Both parties await a federal court decision, which could substantially influence how the US approaches the rapidly growing arena of perpetual futures. One significant consequence, according to Duffy, is how the Internal Revenue Service (IRS) will ultimately tax these contracts. The dispute arises from whether perpetual futures should be legally treated as futures or swaps.
Duffy argued 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 how the CFTC categorizes them as futures. Unlike traditional futures, perpetual contracts never expire; instead, traders periodically exchange funding payments to keep the derivative's price close to the underlying asset's price.
Duffy contended that these recurring payment exchanges satisfy the statutory definition of a swap under US law. Duffy views the main problem with this mismatched designation as the potential tax implications.
If perpetual contracts qualify as futures, many institutional traders could receive 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. If these contracts are classified as swaps, they will be taxed under 'ordinary' taxation. Given that perpetual futures are newer innovations, 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. Legal experts, however, consider the issue more complex. Rustin Diehl, a tax attorney, stated, 'The challenge here is that textually, by 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.' The definition of swaps is extremely broad, leaving considerable room for interpretation regarding its application to new financial products like perpetual futures.
Jason Gottlieb, partner and chair of Morrison Cohen's digital assets practice, noted, 'Basically, the statutory definition of swaps is so broad as to encompass… anything.' The outcome will depend on how the court interprets it, particularly after the Supreme Court's 2024 Loper Bright decision, which eliminated the longstanding 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 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.' 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 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 courts provide greater clarity, Duffy noted that large institutions could face uncertainty over how to report trades involving perpetual futures, posing significant risks.