Abstract
The Internal Revenue Service (IRS or “Service”) has some of the most powerful tools to collect information relating to U.S. taxpayers. One of these tools was recently tested in United States v. Coinbase, Inc., where the United States petitioned to enforce an IRS summons served on Coinbase, Inc. (“Coinbase”), a virtual currency platform based out of San Francisco.
In November of 2016, the IRS served a “John Doe” administrative summons on Coinbase to collect, among other things, information on U.S. persons who conducted transactions in a virtual currency using a Coinbase account, wallet, or vault registration. Coinbase is an exchange that deals in convertible virtual currency, operating a virtual currency wallet and exchange business. In May of 2017, Does 1, 2, and 3 moved to intervene and quash the IRS summons, whose records were subject to the original IRS summons because they are: (1) U.S. citizens; (2) registered users of Coinbase; and (3) conducted transactions in a convertible virtual currency using Coinbase during the period January 1, 2013 through December 31, 2015. Following the motion, the IRS filed a notice narrowing the original summons to those users with at least the equivalent of $20,000 in any one transaction (buy, sell, send, or receive) in any one year during the 2013 through 2015 period. In addition, the IRS limited the summons to those users whose identities were unknown to the IRS because Coinbase did not file a Form 1099-K. After the amendment to the original summons by the IRS, the records of Does 1 and 2 were no longer covered by the summons. The parties stipulated that Doe 4 would be substituted on the motion to intervene. Doe 3's motion was denied.
The court found that Doe 4 had a right to intervene to protect its interest. In granting the motion the court found the IRS did not act in good faith in issuing a summons with such broad scope. The court rejected the Service's argument that the vast amount of information it sought was to investigate the substantial gap between the number of transactions conducted using virtual currency and tax reporting. The court could not point to one explanation by the Service to show that the Service was entitled to the millions of documents it sought.
What the court focused on was the lack of basis for the Service's issuance of such a broad summons for information on hundreds of thousands of users. The IRS, in its investigation of virtual currency reporting, is seeking the information of every account holder because it suspects that the account holder did not properly report the transaction for U.S. income tax purposes. The court pointed out that the Service would be entitled to the bank statements of every U.S. taxpayer if the court relied on the reasoning presented in this particular case.
It is likely that other interested parties (account holders) with a protectable interest will file a motion to intervene to quash the summons. At the end, the Service may be entitled to a very limited amount of information under the summons to continue its investigation of U.S. taxpayers conducting transactions in virtual currency. The case is ongoing.
Note: In August of 2017, the IRS criminal investigation chief announced two new programs focusing on data investigations and international tax enforcement. The new programs will be made up of elite special agents who will have access to large amounts of data from IRS field offices, the Bank Secrecy Act, whistleblowers, the Offshore Voluntary Disclosure Program, the Panama Papers, and the Foreign Account Tax Compliance Act (FATCA). The elite agents will be tasked with analyzing the data to manipulate and use in efforts to investigate tax crimes. As demonstrated in the Coinbase summons, it appears that the IRS has adopted a model of gathering large amounts of data, and with the new programs in place it has the tools to make use of the data in various investigative efforts.