CME’s Duffy warns an overlooked tax risk looms over U.S. perpetual futures

U.S. approval of perpetual futures contracts could expose traders to unexpected tax and regulatory uncertainty if the products are ultimately determined to be swaps rather than futures, an issue that has received little public attention, according to CME Group Chairman and CEO Terry Duffy.

“There’s a consequence that nobody’s talking about,” Duffy said in an interview with CoinDesk. “There’s ambiguity right there, from a tax perspective, for all U.S. participants now.”

The 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 U.S. Both sides await a federal court decision, and the outcome could significantly influence how the U.S. approaches the rapidly growing arena of perpetual futures. One consequence, according to Duffy, is how the Internal Revenue Service (IRS) ultimately taxes these contracts.

The dispute stems from whether perpetual futures should legally be treated as futures or swaps.

Duffy said that perps should fall under the legal definition of swaps, instead of how the CFTC categorizes them as futures, because of 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 keep the derivative’s price close to that of the underlying asset. Duffy argued that those recurring payment exchanges satisfy the statutory definition of a swap under U.S. 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.

What Duffy sees as the main problem 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 U.S. 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 the perps are newer innovations, the IRS has not issued guidance specifically addressing the tax treatment of perpetual futures.

So if the 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.

Legal experts, however, said that the issue is much more complex than that.

“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 and an Emeritus Fellow at Georgetown Law’s Institute for International Economic Law and professor of business law at Weber State University. “It’s really a substance-over-form question … function versus text.”

Adding to the uncertainty, legal experts say that the definition of swaps is extremely broad.

“Basically, the statutory definition of swaps is so broad as to encompass … anything,” Jason Gottlieb, partner and chair of Morrison Cohen’s digital assets practice, told CoinDesk. He added that the breadth of the statutory language leaves considerable room for interpretation regarding its application to new financial products such as perpetual futures.

What it will come down to is how the court interprets it.

That’s because the Supreme Court’s 2024 Loper Bright decision eliminated the longstanding Chevron doctrine; federal courts now give less deference to agencies’ interpretations of ambiguous statutes, meaning judges could play a larger role in deciding how existing derivatives laws apply to novel crypto products.

And it’s likely to be a long, drawn-out process.

“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.

Also, rather than immediately deciding whether the products should be classified as swaps or futures, a federal judge is likely to first examine whether the regulator reasonably considered public comments and sufficiently explained its decision before approving these contracts, Diehl said.

“I think the judge is going to focus on the Administrative Procedure Act, and kind of look at the question of did the CFTC really exercise independent judgment? Were they thorough? Were they reasoned? Did they express their reasoning?” he said.

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, Diehl said.

“I think people are going to want to maybe check with the IRS and see how they should report these,” said Diehl. “They [IRS] generally do agree with the CFTC’s definitions of commodities historically, but there’s been many times when the IRS doesn’t just agree with a taxpayer submitting their tax position based on CFTC rules.”

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.

Read more: Inside the CME and CFTC’s battle over onchain perpetual futures