In November of 2017, Coinbase, Inc. (“Coinbase”), a company that facilitates digital currency transactions, was ordered to comply with an IRS summons demanding specific Coinbase client identifying information and transaction data for Coinbase accounts “with at least the equivalent of $20,000 in any one transactions type” in any year during the period of 2013-2015. Approximately 14,000 Coinbase clients will be affected. The federal district court ruled that the summons, as narrowed in its decision, “serves the IRS’s legitimate purpose of investigating Coinbase account holders who may not have paid federal taxes on their virtual currency profits.”
The Battle Over the “John Doe” Summons
The decision ended Coinbase’s year-long resistance to the initial “John Doe” administrative summons issued by the IRS in November of 2016. The IRS employs this type of summons, recognized under IRC §7609(f) and (h)(2), when the IRS has knowledge or suspicion of questionable transactions, but lacks knowledge of the participant’s identity or the transaction results. This initial IRS summons was comprehensive and sought “information regarding United States persons who, at any time during the period January 1, 2013, through December 31, 2015, conducted transactions in a convertible virtual currency as defined in IRS Notice 2014-21.” The IRS argued that the Coinbase summons was necessary because the IRS had evidence of Coinbase clients’ noncompliance and underreporting; however, due to the pseudo-anonymity inherent in virtual currency transactions, the IRS was unable to identify participants and transaction results without more information.
Coinbase refused to comply. The IRS eventually narrowed its demand to ask only for information pertaining to accounts “with at least the equivalent of $20,000 in any one transaction type” in any year during the period of 2013-2015.
United States Magistrate Judge Jacqueline Scott Corley considered the narrowed summons and specifically noted that:
“Coinbase itself admits that the Narrowed Summons requests information regarding 8.9 million Coinbase transactions and 14,355 Coinbase account holders. That only 800 to 900 taxpayers reported gains related to Bitcoin in each of the relevant years and that more than 14,000 Coinbase users have either bought, sold, sent or received at least $20,000 worth of bitcoin in a given year suggests that many Coinbase users may not be reporting their Bitcoin gains. The IRS has a legitimate interest in investigating these taxpayers.”
Judge Corley further narrowed the summons, however, preventing the IRS from acquiring:
1.) Records of Know-Your-Customer diligence,
2.) Agreements or instructions granting a third-party access, control, or transaction approval authority, and
3.) 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.
What Happens Now?
In February of 2018, Coinbase notified its customers that it will be complying with the order. Once the IRS receives the data, it will begin investigating whether the identified individuals’ returns properly account for the virtual currency transactions. Anyone who didn’t properly report these transactions will likely be contacted by the IRS. Depending on the extent of non-compliance, such individuals may face anything from direction to amend a return to outright audit and penalties. It is even possible that some will attract IRS criminal investigation-if the IRS has evidence that the individuals willfully intended to evade tax obligations.
Individuals in this situation should act immediately. They may want to consider the IRS’s traditional voluntary disclosure program and disclose any non-compliance promptly. Such self-disclosure may mitigate criminal exposure-but it needs to occur before the IRS discovers the non-compliance through the information received from the summons. Once the IRS knows of the non-compliance, voluntary disclosure application may be denied.
If you need assistance with issues involving virtual currency transactions, please contact Frost & Associates, LLC today at 410-497-5974.
 United States v. Coinbase, Inc., No. 17-cv-01431-JSC, 2017 BL 426697, 2017 ILRC 3091 (N.D. Cal. Nov. 28, 2017), Court Opinion.