Bored Apes at the IRS

The IRS is considering the tax treatment of NFTs.

Nonfungible tokens, or NFTs, are perhaps best known for their association with digital artwork such as the famous Bored Apes Yacht Club series. Yet they can be used in other ways, such as to certify ownership of a physical item. The IRS has announced that it plans to offer guidance on certain tax issues related to NFTs.

The concern is whether NFTs should be treated as “collectibles” as that term is defined in the tax law. Collectibles, including stamps, coins (with some exceptions), gems, works of art, and various other items, receive unfavorable tax treatment. A purchase of collectibles within a retirement account will be treated as a distribution from that account, often with painful consequences. The maximum tax rate applied to long-term capital gain is higher for collectibles than for other assets.

The IRS will provide detailed guidance after gathering more information. In the meantime it will use a “look-through analysis.” An NFT will be treated as a collectible if its associated right or asset is a collectible. For example, an NFT that certifies ownership of a gem would be considered a collectible because gems are collectibles. What about bored apes? “The Treasury Department and the IRS are considering the extent to which a digital file may constitute a ‘work of art’” and therefore a collectible.

The NFT market is highly speculative. Most advisors would consider them unsuitable as retirement investments, even apart from any tax problems. This IRS Notice warns that NFTs in an IRA or other retirement account may lead to disaster even without a decline in value.

ESG Investing: Excellent, Satisfactory, Good?

Retirement plan investment strategies can now include ESG investing considerations.

ESG investing is in the news. A political kerfuffle over its use in retirement plans has provoked President Biden’s first veto.

ESG investing refers to strategies based at least in part on factors in one or more of three broad areas: environmental, social and governance. Investors may consider how well a company handles environmental issues such as climate change, energy efficiency, and natural resource conservation. Social factors may include fair labor practices, product safety, and community relations. Shareholder rights, executive compensation, and transparency would fall under the governance umbrella.

A desire to align investments with personal values and beliefs is a motivating force behind ESG investing. Yet these factors can also be used to measure how well a company manages risks and opportunities in these areas. The effectiveness of ESG as a component of investment strategy has been studied extensively. A major review of these studies concluded that ESG has a positive impact on corporate financial performance. In short, ESG investing can be a sound investment tool.

Yet many conservative commentators and politicians see ESG investing as a way to promote progressive goals. The Trump administration in 2020 issued rules restricting the use of these principles in pension plan investments. Under Joe Biden, the Department of Labor removed that restriction. Republicans objected. Joined by one Democrat in the House and two in the Senate, they voted to block the new regulation. A Biden veto will keep the regulation in force.

The Wall Street Journal groused that the rule represents “the political exploitation of American retirement savings.” Yet the rule merely permits fiduciaries to consider the economic effects of ESG criteria in making investment decisions. It retains the core principle that the duties of prudence and loyalty require retirement plan fiduciaries to focus on relevant risk-return factors.

In any event, there is no denying that ESG investing has broad appeal. Aware of this, companies compete to improve their ESG ratings. Investment firms offer mutual funds built on these strategies, and screening tools their investors can use to build their own strategies. Like it or not, ESG investing is here to stay.