Largest U.S. Bitcoin Exchange Ordered to Share Client Information with the IRS
November 7, 2018
In a recent decision, a California court ordered the largest bitcoin exchange in the U.S. to hand certain customer information over to the IRS to facilitate the IRS’ investigation into underreporting of virtual income gains.
Coinbase is a San Francisco based exchange dealing in cryptocurrency. Between 2013 and 2015, Coinbase maintained more than 4.9 million bitcoin wallets in 190 countries, serving 3.2 million customers and exchanging $2.5 billion.
Believing that virtual currency gains were being unreported, in 2016, the U.S. government filed a petition for an order permitting the IRS to serve a John Doe administrative summons on Coinbase, requesting “information regarding United States persons, who, at any time during the period January 1, 2013, through December 31, 2015, conducted transactions in a convertible currency as defined in IRS Notice 2014-21”. Nine categories of documents were requested, including:
- Complete user profiles;
- Know-your-customer due diligence;
- Documents regarding third party access;
- Transaction logs;
- Records of payments processed;
- Correspondence between Coinbase and Coinbase users;
- Account or invoice statements;
- Records of payments; and
- Exception records produced by Coinbase’s AML system.
This initial request was subsequently narrowed eight months later to encompass only those Coinbase users who “bought, sold, sent, or received at least $20,000” worth of cryptocurrency in a year.
Coinbase initially refused to comply, and the United States petitioned the court to enforce the John Doe summons.
The IRS may issue a summons for “ascertaining the correctness of any return, making a return where none has been made, determining the liability of any person for any internal revenue tax or…collecting any such liability”.
In order to obtain a court order enforcing a summons, the IRS must first establish “good faith” by showing that the summons:
- Is issued for a legitimate purpose;
- Seeks information relevant to that purpose;
- Seeks information that is not already in the IRS’ possession; and
- Satisfies all of the administrative steps set forth in the Internal Revenue Code.
Once the government has met its burden in establishing these elements (known as Powell factors), and the respondent wishes to challenge the enforcement of the summons, he or she has a “heavy” burden of showing either abuse of power or a lack of good faith on the part of the IRS.
Where a summons is challenged by a respondent, it will be scrutinized by the court to determine whether it seeks information relevant to a legitimate investigative purpose. In such an instance, the court may choose to either refuse enforcement or narrow the scope of the summons.
The court found that there was no dispute that the third and fourth Powell factors were satisfied, but had to determine whether the summons 1) served a legitimate purpose and 2) sought relevant information.
The court found that the amended summons served the 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 summonsed years.”
The court went on to say that Coinbase is the largest U.S. exchange of bitcoin into dollars with $6 billion in transactions while only 800 to 900 taxpayers a year have electronically filed returns with a property description related to bitcoin between 2013 and 2015. This discrepancy creates a inference that more Coinbase users are trading bitcoin than reporting gains on their tax returns. The IRS has a legitimate interest in investigating these taxpayers.
The court agreed with the government’s argument that obtaining a Coinbase account holder’s identity and transaction records would permit the government to investigate whether that account holder had taxable gains that were not properly declared. However, the court noted that the government’s request for numerous categories of documents was broader than necessary.
The court found that the following documents as requested were relevant:
- Taxpayer ID number;
- Date of birth;
- Transaction history.
All other documents, including know-your-customer diligence and correspondence between Coinbase and the user were not necessary to achieve the government’s legitimate purpose at this stage (but could become relevant at a later stage).
Abuse of Process
Since the government met its burden in establishing the Powell factors, it was up to Coinbase to show either abuse of process or lack of good faith as a means of challenging enforcement of the summons.
Coinbase argued that the government committed an abuse of process because it sought to enforce a summons that “lack[ed] a proper investigative purpose” and requested “production of a vast array of documents relating to 14,000 accounts without any proper foundation.”
The court, however, found that the Government had met its burden of showing that the narrowed summons served the legitimate investigative purpose of enforcing tax laws against those who profit from trading in virtual currency. In addition, the court found that the information that was ordered to be produced was relevant and no more than necessary for the government to serve that purpose.
Coinbase therefore failed to meet its burden to “allege specific facts and evidence to support [its] allegations of bad faith or improper purpose”.
The court therefore granted the petition to enforce the summons.
if you have questions about how investing in Bitcoin or other emerging currencies will affect your current tax plan contact Feigenbaum Law. We are leaders in the field of tax law, and offer services to clients in the US, Canada and around the world. Contact us to learn more about how we can help or call us at (905) 695-1269 or toll-free at (877) 275-4792.