Republicans in Congress just sent a harsh rebuke to the Internal Revenue Service (IRS) suggesting the IRS has overstepped its boundaries by issuing a very broad “John Doe” summons to Coinbase seeking volumes of information on its customers’ digital currency accounts. Coinbase is the largest digital currency exchange firm in the US and the largest exchanger in the United States of bitcoin into US dollars. The John Doe summons (here) sought records of all US customers who bought virtual currency from Coinbase in the period 2013 to 2015. The summons would affect about half a million active Coinbase customers, 90 percent of whom had engaged in less than $10,000 in cumulative, gross transactions during the entire period requested.

IRS Called to Task – Not Everyone Using Bitcoin Evades Taxes and Where is Taxpayer Guidance?

In order to issue a John Doe summons, the IRS must first establish that the summons pertains to an ascertainable class of persons whose identity is unknown and with respect to whom the IRS has a “reasonable basis” for the belief that the individuals have failed to comply with tax laws. In its letter, the Chairman of the Committee on Senate Finance (Orrin Hatch), Chairman of the House Committee on Ways and Means (Kevin Brady) and Chairman of the House Committee on Ways and Means Oversight Subcommittee (Vern Buchanan) pointedly asked the IRS to justify its position that all Coinbase customer records are needed for the requested 3-year time-frame. In other words, the IRS is being reminded that not everyone using Bitcoin is a tax evader!

In addition, the letter took the IRS to task for issuing the John Doe summons to Coinbase before the IRS had even developed a comprehensive digital currency tax strategy. I believe the Chairmen authoring the letter gave the IRS a not-so-subtle hint. As I see it, the as-yet undeveloped tax strategy would educate the public on the uses and taxation of digital currency transactions. This strategy should be produced by the IRS before the agency starts issuing an overly broad John Doe summons on a subject matter the guidance for which it has barely addressed to date.

The only guidance provided by the IRS was issued in 2014 with Notice 2014-21. In that Notice IRS proclaimed that virtual currency is to be treated as “property” and not “currency” for US federal tax purposes. Even though virtual currency operates like “real” currency — i.e., the coin and paper money of the United States or of any other country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance — it did not have legal tender status in any jurisdiction until April 1, 2017 when Japan declared Bitcoin as a legal tender or payment method. The IRS Notice issued in 2014 relied on the fact that virtual currency was not regarded as legal tender in any jurisdiction. That has now changed with the recent Japanese pronouncement effective April 1st. Whether the IRS may view Bitcoin differently now (especially when used in transactions with Japan where it is legal tender) is an open question and the possible different treatment indeed raises other tax issues (e.g., foreign currency gains and losses). Evidently, the tax law cannot keep up with technological changes, putting taxpayers at great risk for simply not knowing how transactions should be treated for tax purposes. Is such a broad John Doe summons in any way justifiable under such circumstances?

Coinbase said it has not produced any records in response to the IRS summons, and stated it would continue to fight against its scope. Now, Coinbase has the added ammunition of this wonderful letter!

Going Forward

Taxpayers who are not in tax compliance due to virtual currency transactions with Coinbase or other virtual currency exchanges should not sit idly by. They should act relatively quickly to ascertain their own particular tax situation. Delays can bear on a taxpayer’s intent and can negatively impact a claim that tax noncompliance was a matter of a good faith misunderstanding of one’s tax obligations. The longer delays continue, the more difficult the case may become for a successful resolution.

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