Dec 11, 2017
An ongoing battle with Coinbase, Inc. (Coinbase), a virtual currency exchanger, where the Internal Revenue Service (IRS) has been attempting to access user records, through a “John Doe” summons, to investigate tax evasion by U.S. taxpayers has finally come to an end.
On November 28, 2017, the Northern District Court in San Francisco partly granted and partly denied the John Doe summons for Coinbase’s user information.
In order to decide on the summons, the District Court addressed whether the summons (1) served a legitimate purpose and (2) sought relevant information.
The Court sided with the IRS and stated that the summons served a legitimate purpose of investigating “the reporting gap between the number of virtual currency users Coinbase claims to have had during the summons period” and “U.S. bitcoin users reporting gains or losses to the IRS during the summoned years.” The discrepancy between users and reporting suggests that many Coinbase users may not be reporting their bitcoin gains and thus, failing to comply with federal tax law. As a result, the Court decided that there is a legitimate purpose of investigating noncompliance.
The IRS is authorized to seek information of even potential relevance to an ongoing investigation and its summons is a critical component to those investigative functions. Thus, the Government is not required to establish that the documents it seeks are actually relevant in any technical or evidentiary sense. The Court agreed that the Coinbase account holders’ identities and transaction records would assist in investigating compliance of taxable gain reporting. However, the summons cannot be broader than necessary to achieve its purpose.
Thus, the Court partly sided with Coinbase and stated that the Government is seeking information broader than necessary. In investigating whether the account holders had taxable gain, the correspondence between Coinbase and the user is not relevant if there was no gain to begin with. The John Doe summons requests information that goes beyond what is relevant to investigate mere compliance and the Court ensured that the IRS does not collect thousands of personal records unnecessarily.
Therefore, IRS was granted the enforcement of relevant documents as (1) the taxpayer ID; (2) name; (3) date of birth, (4) address; and (5) records of account activity including transaction logs or other records identifying the date, amount and type of transaction (purchase/sale/exchange), the post transaction balance, and the names of counterparties to the transaction. But only pertaining to accounts with at least the equivalent of $20,000 in any one transaction type (buy, sell, send, or receive) in any one year during the 2013-2015.
As for all other categories, the Court denied the IRS’s request for the additional user information as not relevant to their legitimate purpose.
Coinbase, Inc. is a virtual currency exchanger headquartered in San Francisco, California. A virtual currency exchanger functions much like an exchanger for traditional currency; except it can exchange virtual currency for traditional currency or vice versa. Additionally, a virtual currency is considered “convertible” if it has an equivalent value in traditional currency or acts as a substitute for traditional currency. (Defined in IRS Notice 2014-21).
As of today, Coinbase has served over 10 million customers in 32 countries with over $50 billion in digital currency exchanged. Although these numbers were lower for the 2013-2015 period for which the IRS is seeking information, based on the declaration of IRS agent David Utzke, a senior revenue agent in the Government’s offshore compliance initiatives program working on virtual currency matters, approximately 83 to 84 percent of taxpayers filed returns electronically and only 800 to 900 persons electronically filed Form 8949, reporting capital gain or loss from property that is “likely related to bitcoin” in each of the years 2013 through 2015.
In 2016, the IRS filed a petition for an order permitting to serve a “John Doe” administrative summons (Initial Summons) on Coinbase. This summons sought “information regarding United States person who at any time during the period January 1, 2013 through December 31, 2015 conducted transactions in a convertible virtual currency” (Case No. 16-cv-06658-JSC, Docket No 2-4) and it included nine categories of documents pertaining to user records. Although the Court granted the permission to serve, Coinbase refused to comply.
After eight months from filing the Initial Summons, the IRS filed a Notice of Narrowed Request for Enforcement where it sought information regarding accounts “with at least the equivalent of $20,000 in any one transaction type (buy, sell, send, or receive) in any one year during the 2013-2015 period.”
Although the Narrowed Summons did not include users who only bought and held bitcoin during the 2013-2015 period or for which Coinbase filed Forms 1099-K, the request did affect 8.9 million transactions and 14,355 account holders. Additionally, for these 14,355 users, the IRS requested: (a) account/wallet/vault registration records for each account/wallet/vault owned or controlled by the user during the period stated above limited to name, address, tax ID, date of birth, account opening records, copies of passport or driver’s license, all wallet addresses, and all public keys for all accounts/wallets/vaults; (b) records of Know-Your-Customer diligence; (c) agreements or instructions granting a third-party access, control, or transaction approval authority; (d) all records of account/wallet/vault activity including transaction logs or other records identifying the date, amount, and type of transaction (purchase/sale/exchange), the post transaction balance, the names or other identifiers of counterparties to the transaction; requests or instructions to send or receive bitcoin; and where counterparties transact through their own Coinbase accounts/wallets/vaults, all available information identifying the users of such accounts and their contact information; (e) correspondence between Coinbase and the user or any third party with access to the account/wallet/vault pertaining to the account/wallet/vault opening, closing or transaction activity; and (f) all periodic statements of account or invoices.
And nearly a year later, on November 28, 2017, the District Court further narrowed the IRS’s summons served on Coinbase.
Coinbase fought a fair fight to protect its users from unnecessary disclosure of information to the Government. Although the John Doe summons has some reach, it is still limited and will for now safeguard users who did not exceed the $20,000 threshold per transaction. Our expectation is that we will soon see the results of this investigation, including potential guidance on cryptocurrency.
In the meantime, CKR Law will continue to monitor developments surrounding this ruling. Should you have any questions or desire further insight, feel free to contact the Chair of our Tax Department, Mayer Nazarian at firstname.lastname@example.org or the Chair of our Blockchain Technology & Digital Currency Department, Alexandra Levin Kramer at email@example.com.
DISCLAIMER: This article is not intended to provide legal or tax advice, and no legal, tax, or business decision should be made based on its contents.