The use of bitcoin by criminals has attracted the attention of financial regulators,[legislative bodies, law enforcement, and media. Criminal activities are primarily focused on darknet markets and theft, though officials in countries such as the United States also recognize that bitcoin can provide legitimate financial services.There are obviously some potential U.S. tax administration issues swirling around the use of bitcoin. The first is its secrecy. Untaxed funds can be dispersed -- laundered, if you will -- and then there is the separate subject of taxation of transactions in the bitcoin currency itself.
So, the IRS has made an opening move to peek behind the veil of bitcoin. The IRS filed papers seeking court approval to issue a John Doe Summons to the largest U.S. Bitcoin exchange firm. Dion Rabouin, REFILE-Bitcoin exchange processor likely to fight IRS summons -legal analyst (Reuters 11/20/16), here. The JDS seeks "the records of all customers who bought virtual currency from the company from 2013 to 2015, a lawyer familiar with the case said Sunday." The article reports that a lawyer familiar with the process and the expectations of the bitcoin customers believes that the firm will oppose the JDS.
UPDATE: ON 11/30/16, the magistrate judge authorized the issuance of the JDS. The DOJ Tax press release is titled "Court Authorizes Service of John Doe Summons Seeking the Identities of U.S. Taxpayers Who Have Used Virtual Currency (11/30/16), here. This announcement has links to the key documents, including the magistrate judge's order.
Another article is: Tyler Durden, Largest US Bitcoin Exchange Is "Extremely Concerned" With IRS Crackdown Targeting Its Users (ZeroHedge 11/21/16), here. Key excerpts:
What makes a “John Doe” unique, is that it represents a special "shotgun" form of summons to look for tax evaders that allows the IRS to obtain information about all taxpayers in a group or class of people, even if the agency doesn’t know their identities. The IRS has deployed the tactic in its recent crackdown on undeclared offshore accounts.
In other words, the US government's crackdown on local bitcoin users has begun.
In the court filing, the WSJ reports that Justice Department attorneys wrote that an IRS agent had “identified and interviewed three taxpayers who had used virtual currencies as a means of evading taxes” and that two of these taxpayers were corporate entities that “had wallet accounts at Coinbase and attempted to conceal bitcoin transactions as technology expenses on their tax returns.”
According to Forbes' tax blogger Kelly Phillips Erb, in his declaration to the court in support of the summons, IRS Senior Revenue Agent David Utzke noted that his investigations included two taxpayers with annual revenues in the millions who “admitted disguising the amount they spent purchasing the bitcoins as deductions for technology expenses on their tax returns.” Those corporate taxpayers had wallet accounts at Coinbase. Unlike other kinds of financial transactions, there is currently no third-party information which requires separate reporting for bitcoin (think of third-party reporting like the forms 1099 issued by your bank). This, says IRS, means that the “likelihood of underreporting is significant.”
The likelihood of underreporting combined with the anonymity of virtual currency means that the IRS needs more data to complete its investigation. It also explains why the “John Doe” summons is so broad.
Meanwhile, Coinbase - not to mention its VC bakers - was "extremely troubled" by the development. It posted the following statement on its website:
Our customers may be aware that the U.S. government filed a civil petition yesterday in federal court seeking disclosure of all Coinbase U.S. customers’ records over a three year period. The government has not alleged any wrongdoing on the part of Coinbase and its petition is predicated on sweeping statements that taxpayers may use virtual currency to evade taxes.
Although Coinbase’s general practice is to cooperate with properly targeted law enforcement inquiries, we are extremely concerned with the indiscriminate breadth of the government’s request. Our customers’ privacy rights are important to us and our legal team is in the process of examining the government’s petition. In its current form, we will oppose the government’s petition in court.
Additionally, Reuters reports that Coinbase cited concerns with the wide-ranging nature of the government's request. "We want to work with law enforcement — that's generally our policy," the company's head legal counsel, Juan Suarez, said Friday. "But we can't tolerate sweeping fishing expeditions. We are very concerned about the financial privacy rights of our customers."
Chris Padovano, a lawyer and the founder of Decentralized Legal, said he expects Coinbase to turn back the government's request. Cited by Reuters, Padovano said that "there are two questions here. One is whether or not (the IRS has) reasonably identified a class of individuals and has a reasonable basis for believing that all U.S. customers for Coinbase from 2013-2015 may have failed to comply with laws based on these three users," he said. "Two is whether the information sought by IRS is not available from any other reasonable source than Coinbase."Also, Les Book has has a good blog today: IRS Seeks Information via John Doe Summons Request on Bitcoin Users (Procedurally Taxing Blog 11/23/16), here.
In order to identify taxpayers who have may have underpaid taxes associated with transactions in virtual currency, the United States brings this ex parte proceeding under § 7609(f) and (h) of the Internal Revenue Code (26 U.S.C.) for leave to serve a John Doe summons on Coinbase. The John Doe summons seeks records relating to transactions in convertible virtual currency as defined in IRS Notice 2014-21. See Declaration of Senior Revenue Agent Davide Utzke in Support of Ex Parte Petition for Leave to Serve “John Doe” Summons (“Utzke Decl.”) Exhibit B. The John Does whose identities are sought by the summons are United States persons who, at any time during the period January 1, 2013, through December 31, 2015, conducted transactions in a convertible virtual currency. The issuance of the summons is warranted here because (i) the summons relates to an ascertainable group or class of persons; (ii) there is a reasonable basis for believing these U.S. taxpayers failed to comply with internal revenue laws; and (iii) information sufficient to establish these U.S. taxpayers’ identities is not readily available to the IRS from other sources.
(2) Suspension after 6 months of service of summons In the absence of the resolution of the summoned party’s response to the summons, the running of any period of limitations under section 6501 or under section 6531 with respect to any person with respect to whose liability the summons is issued (other than a person taking action as provided in subsection (b)) shall be suspended for the period—And, § 7609(i)(4) requires the summonsed party (Coinbase here) to
(A) beginning on the date which is 6 months after the service of such summons, and
(B) ending with the final resolution of such response.
(4) Notice of suspension of statute of limitations in the case of a John Doe summons
In the case of a summons described in subsection (f) with respect to which any period of limitations has been suspended under subsection (e)(2), the summoned party shall provide notice of such suspension to any person described in subsection (f).