The Internal Revenue Service is conducting an “ongoing, extensive investigation involving substantial IRS resources” into cryptocurrency holders. As part of that investigation, the IRS is serving “John Doe” summons on various cryptocurrency companies, seeking court orders to require cryptocurrency exchanges to turn over account holder’s names and other key identifying information. On May 5, 2021, the United States District Court for the Northern District of California ordered Kracken to turn over key account information for its users, including (1) Name, (2) Taxpayer ID Number; (3) Date of birth; (4) Physical address; (5) Telephone number; and (6) Email address. For cryptocurrency investors who have unreported crypto – whether in an account with Kraken or anywhere else – the IRS is looking for you.
The IRS first filed a petition for leave to serve a John Doe summons, which would have required Kraken to provide specific account holder information to the IRS, on March 30, 2021. Rather than granting the petition, the Court issued an Order to Show Cause, requiring the IRS to explain why the petition, which requested a vast array of information, should not be denied for the failure to meet the “narrowly tailored” requirement of the statute authorizing such summonses. (You can read more about that here). The IRS responded by both reducing the scope of information requested and by explaining that when it comes to cryptocurrency, a lot of information is needed to determine whether or not a taxpayer is skirting the rules.
The IRS explained to the court that more than just a taxpayer’s name, address, date of birth, and taxpayer identification number are needed to determine whether there is a tax compliance issue. The extensive information is needed because the IRS is aware of account holders whose information was handed over in the Coinbase case that used “aliases, false addresses, or post office boxes, fictitious entity names, or other means to disguise their true identities, and taxpayers who created false identities are more likely to evade their taxes.” (emphasis added). In fact, in response to the Coinbase John Doe summons, over 170 account holders used a pseudonym instead of their legal name to set up an account. Driving home its point that it needs more than just account holder names and taxpayer identification numbers, the IRS explained to the court that “more than 750 [Coinbase account holder] taxpayers remain unknown to the IRS. These still-unidentified taxpayers had cryptocurrency proceeds that exceeded $100,000,000 that the IRS cannot examine because the limited identity information it received precludes a positive identification.” Put differently, from the Coinbase John Doe Summons alone, the IRS is still seeking names of 750 account holders who realized over $100,000,000 in proceeds and the IRS cannot identify them without additional information.
It is no wonder, then, that the IRS launched Operation Hidden Treasure to identify and pursue crypto account holders who have not reported and paid taxes on their crypto gains. And in asking the court in Kraken to allow access to specific account holder information, including a history of changes to the user’s profiles, the IRS has demonstrated its ability to learn from past mistakes and nimbly make adjustments. After reviewing the IRS’s response to the Order to Show Cause, the Court granted the modified petition. IRS Commissioner Charles Rettig applauded the ruling, noting, “There is no excuse for taxpayers continuing to fail to report the income earned and taxes due from virtual currency transactions. This John Doe summons is part of our effort to uncover those who are trying to skirt reporting and avoid paying their fair share.”
Importantly, the Court leaves open the possibility that further challenges to the summons may be brought. “Any further disputes as to the scope of the summons would benefit from adversarial briefing.” But the IRS now has the leave of court required to serve the John Doe summons. The statute that authorizes the summons process provides “any person who is entitled to a notice of a summons … shall have the right to begin a proceeding to quash such summons” within twenty days of service. A motion to quash is typically filed by a taxpayer whose information is being sought by a summons. In this case, it isn’t clear whether Kraken will notify its account holders when it has been served and the twenty-day clock to file a motion – for Kraken and for its account holders – begins. Even more uncertain is whether a motion to quash would yield any measurable result in narrowing the account information to be turned over.
What’s Next For Crypto Tax Enforcement?
The Coinbase and Kraken John Doe summons are by no means the end of the line for IRS enforcement. On April 1, 2021, the United States District Court for the District of Massachusetts granted a similar petition for a John Doe Summons to issue providing account information from Circle Internet Financial, formerly Poloniex LLC. The IRS has used John Doe summons very effectively before, most famously leading to the disclosure of tens of thousands of previously unreported foreign financial accounts and collection billions of unpaid federal income taxes. The first Swiss bank to receive a John Doe summons was UBS, but they were by no means the last. Crypto investors who have not reported all income earned should take no comfort if they haven’t yet heard from the IRS, or if they are at another exchange that isn’t named in this article. Operation Hidden Treasure isn’t aimed at identifying Coinbase account holders or Kraken account holders. It is aimed at identifying all crypto investors who are United States taxpayers, determining whether tax obligations have been met, and pursuing those who have failed to meet those obligations.
In my prior article on Operation Hidden Treasure, I urged readers who have undisclosed crypto to call a lawyer instead of confessing their “sins” to an accountant. There’s a good reason for this, and don’t just take my word for it. Tax litigator Anson Asbury explains why its best – for your and for your accountant – to take the approach of calling counsel if you are worried about past mistakes. “If you’ve made incomplete disclosures for prior years, and your accountant doesn’t know about it, she is not the person you want to tell for a number of reasons. You do not want to put her in the position where she is tempted to mislead an inquiring revenue agent about your disclosures (because she does not want to admit that the previously filed return she prepared was not accurate). That only puts both of you in jeopardy if the inconsistency is uncovered.” In addition, notes Asbury, “You also do not want to share any information with her that you do not want disclosed.” Accountants can and often are called to testify about what their clients did and did not tell them, and may not keep communications confidential in IRS civil or criminal examinations. “Finally,” says Asbury, “you want to preserve your accountant as a witness. She may be your best defense for reasonable cause. She cannot be a witness for you if she knows incriminating details that would have to be disclosed under oath.” Honestly is always the best policy when it comes to the current year’s return, but past sins should only be “confessed” to a lawyer.