The IRS has signaled a major enforcement shift in early 2026, targeting crypto ETFs that allegedly use redemption strategies to evade federal income limits. By utilizing specific internal accounting methods during the redemption process, these funds have reportedly avoided distributing taxable gains to investors, a practice the IRS now deems a potential violation of Internal Revenue Code requirements for Regulated Investment Companies (RICs). Spot Bitcoin (BTC) and Ethereum (ETH) ETFs are the primary focus of this scrutiny as the agency seeks to close loopholes that treat crypto assets differently than traditional equities.
This regulatory move follows a period of rapid growth for spot crypto products where tax efficiency was a primary selling point. The IRS argues that while traditional equity ETFs use in-kind redemptions to manage tax liabilities, the specific volatile nature of crypto assets and the way these funds structure trades to wash away capital gains has crossed a legal line. The agency is particularly concerned that these funds are failing to meet the 'gross income test,' which requires that at least 90% of a fund's income come from specific qualifying sources, a benchmark that becomes difficult to maintain if certain crypto-related gains are improperly shielded.
The implications for US investors are significant. If a crypto ETF is found to be in violation of these rules, it could lose its status as a pass-through entity for tax purposes. This would result in the fund being taxed at the corporate level, severely diminishing net returns for shareholders and potentially triggering sell-offs as the 'tax-advantage' of the ETF wrapper evaporates. For the broader market, this creates a cloud of uncertainty over the institutional products that have driven liquidity over the past year.
Readers should monitor upcoming IRS guidance expected in the second quarter of 2026, which will likely define which redemption practices are considered 'abusive.' Major asset managers may be forced to restructure their fund operations or issue unexpected tax distributions to shareholders to remain compliant. As the 2026 tax season progresses, the clarity of these rulings will determine the long-term viability of current spot crypto ETF structures in the United States.