BitcoinIn a recent speech, the Under Secretary of Treasury’s Office of Terrorism and Financial Intelligence (TFI) warned of the growing threats to the U.S. financial system posed by virtual currencies. Addressing the Securities Industry and Financial Markets Association’s Anti-Money Laundering & Financial Crimes Conference, Sigal Mandelker spoke broadly of the U.S. government’s efforts to combat money laundering, terrorist financing, narcotics trafficking, corruption, and other types of illicit finance and national security threats.

In her speech, Under Secretary Mandelker specifically focused on ways in which criminals and other illicit actors are now using virtual currencies:

Kleptocrats and criminals are also attempting to find new ways around our controls to exploit the financial system. In recent years, we’ve seen terrorist groups, criminal organizations, and even rogue regimes like Venezuela experiment with and use digital and virtual currencies to hide their ill-gotten gains and finance their illicit activities. Recently, for example, Venezuela announced plans to create the “petro” digital currency to try and sidestep our powerful sanctions, which the United States imposed on the regime for its vicious assault on human rights and the rule of law.

Likewise, law enforcement authorities recently arrested a woman in New York who used Bitcoin to launder fraud proceeds before wiring the money to ISIS.

In TFI, we closely track technological innovations involving virtual currency and are aggressively targeting rogue actors attempting to use it for illicit purposes. Critical to our efforts is the regulatory framework and enforcement authorities we have in place that govern the use of virtual currency. Through FinCEN, Treasury regulates virtual currency exchangers as money transmitters and requires them to abide by Bank Secrecy Act obligations. We also use our strong enforcement powers to target those who fail to live up to their responsibilities.

Virtual currency businesses are subject to comprehensive, routine AML/CFT examinations, just like financial institutions in the securities and futures markets. We work in partnership with the IRS to examine virtual currency exchangers under our regulations for money transmitters. We also work in partnership with the SEC and CFTC to ensure that these businesses and those in your sector dealing in virtual currency appropriately address their AML/CFT BSA responsibilities.

We are also encouraging our international partners to strengthen their virtual currency frameworks. The lack of AML/CFT regulation of virtual currency providers worldwide greatly exacerbates virtual currency’s illicit financing risks. Currently, we are one of the only major countries in the world, along with Japan and Australia, that regulate these activities for AML/CFT purposes. But we need many more countries to follow suit, and have made this a priority in our international outreach, including through the Financial Action Task Force.

North Korea, Hizballah, Iran, and emerging technologies used by illicit actors are just a few examples of the many threats we face. They reinforce the importance of the international community coming together to combat bad actors and protect financial systems, markets, and institutions from abuse.

Under Secretary Mandelker also spoke about the critically important role of anti-money laundering compliance in the financial industry, and warned that “companies and individuals who do not adhere to our laws face stiff penalties,” noting that “[a]ggressive enforcement gives teeth to our powerful economic authorities.” She further explained that the financial industry must carefully study, and learn from, the enforcement actions taken by FinCEN and other Treasury departments:

Each of our actions, whether by FinCEN, OFAC, or other departments, provides an opportunity for the private sector to gain better insight into our compliance and enforcement priorities, and each action tells a story about our expectations and where that particular company fell short.

She then described FinCEN’s well-publicized enforcement action against BTC-e, a foreign virtual currency exchanger:

In the last year we have pursued actions against a number of non-U.S. companies and individuals for violating U.S. laws related to economic sanctions and money laundering, sending the very powerful message that we are intent on using our authorities no matter where in the world the illicit activity is taking place.

For example, FinCEN recently assessed a $110 million fine against BTC-e, an Internet-based virtual currency exchanger located outside the United States which did substantial business in our country. BTC-e exchanges fiat currency, as well as convertible currencies like Bitcoin and Ethereum, at one point serving approximately 700,000 customers across the world and associated with bitcoin wallets that have received over 9.4 million bitcoins.

Customers located within the United States used BTC-e to conduct tens of thousands of transactions worth hundreds of millions of dollars in virtual currencies, including between customers located in the U.S.

Yet BTC-e never registered as a money transmitter, even after FinCEN made clear through published advisories and other guidance that such exchangers were legally required to do so.

The company lacked basic controls to prevent the use of its services for illicit purposes.

As a result, they emerged as one of the principal means by which cyber criminals around the world laundered the proceeds of their illicit activity, facilitating crimes such as computer hacking and ransomware, fraud, identity theft, tax refund schemes, public corruption and drug trafficking.

In light of BTC-e’s failure to fulfill its AML obligations, Treasury took action both against the company and Russian national Alexander Vinnik, who directed and supervised BTC-e’s operations and finances.

We imposed a $12 million penalty on Vinnik and the Justice Department indicted him on 21 counts.

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In Rajagopalan v. Commissioner, Judge Holmes confronted what he called the Chai ghoul.  See Rajagopalan v. Commissioner, Docket No. 21394-11, Order, Dec. 20, 2017.  In Chai v. Commissioner, the Second Circuit held that the section 6751(b)(1) written approval requirement “requires written approval of the initial penalty determination no later than the date the IRS issues the notice of deficiency (or files an answer or amended answer) asserting such penalty.”  Chai v. Commissioner, 851 F.3d 190 (2d Cir. 2017), aff’g in part, rev’g in part 109 T.C.M. 1206.  The Tax Court agreed with the Second Circuit’s holding in Chai soon after it was released.  See Graev v. Commissioner, 149 T.C. __ (Dec. 20, 2017).

These decisions prompted the Commissioner to ask the court to reopen the record in Rajagopalan (and in a number of other cases) so that he could introduce penalty-approval forms to show he complied with section 6751(b)(1) for the 20% accuracy-related penalties.  Trial and briefing in Rajagopalan took place long before Chai and Graev, and the Commissioner did not introduce evidence that he complied with section 6751 at trial.

In support of his motion, the Commissioner submitted an IRS supervisor’s declaration to authenticate the penalty-approval forms and to show how the supervisor approved the penalty determination.  The forms also listed the applicable IRS examiner.  In her declaration, the supervisor stated that she was the examiner’s immediate supervisor and that she signed the forms approving the examiner’s penalty determination.

As a general rule, the Tax Court has broad discretion to reopen the record.  But its discretion is not unlimited.  The court will not reopen the record to admit evidence that is merely cumulative or impeaching.  Instead, the evidence must be material and likely to change the outcome of the case.  Butler v. Commissioner, 114 T.C. 276, 287 (2000), abrogated on other grounds by Porter v. Commissioner, 132 T.C. 203 (2009).  The court must also weigh the Commissioner’s diligence against the possibility of prejudice to the petitioners.  Prejudice here turns on whether the submission of evidence after trial prevents the petitioners from questioning the evidence as they could have during trial.

Judge Holmes found that the penalty-approval forms met the first requirement, and would have actually been admissible at trial under the business-records exception to the hearsay rule.  Judge Holmes was also unconvinced that the petitioners would be prejudiced by the court’s decision to reopen the record.  The petitioner’s main argument was that they should have been “entitled to question” the supervisor and examiner to confirm that the penalties “were properly asserted and whether [the Commissioner] complied with Code section 6751(b).”  But it was unclear how the petitioners would have benefited from cross-examination.  Judge Holmes pointed out that the penalty-approval forms either did or did not answer those questions, and would have been admitted under the business-records exception regardless.

As a result, Judge Holmes granted the Commissioner’s motion to reopen the record.  Despite the court’s decision to admit the penalty-approval forms, Chai continues to present the Commissioner with major challenges as he seeks to assert penalties in cases tried before Chai.

In United States v. Stein, the Eleventh Circuit recently decided a novel – but critical – issue for taxpayers.  It held that an affidavit that satisfies Rule 56 of the Federal Rules of Civil Procedure (the summary judgment rule) may create an issue of material fact precluding summary judgment, even if it is self-serving and uncorroborated.  The case centered around an IRS assessment.  IRS assessments are entitled to a presumption of correctness, which can be a difficult burden for taxpayers to overcome.

In 2015, the government sued Estelle Stein for outstanding tax assessments, late penalties, and interest for the 1996 and 1999-2002 tax years.  The government moved for summary judgment and tried to show that Ms. Stein had outstanding tax assessments by submitting her federal tax returns, account transcripts, and an affidavit from an IRS officer.  Ms. Stein responded with her own affidavit, stating that, “to the best of [her] recollection,” she had paid the taxes and penalties at issue.  Her affidavit also explained that she used an accounting firm to file the tax returns, that she remembered paying the taxes and penalties due, but that she did not have bank statements showing these payments.

The district court granted summary judgment for the government because, it explained, Ms. Stein did not produce any evidence documenting payments.  An Eleventh Circuit panel affirmed based on Mays v. United States, 763 F.2d 1295 (11th Cir. 1985).  In Mays, the court affirmed summary judgment for the government, holding that a taxpayer in a refund suit must not only show the government’s assessment is wrong, but also establish the “correct amount of the refund due.”  Mays further held that the taxpayer’s claim “must be substantiated by something other than tax returns, uncorroborated oral testimony, or self-serving statements.”

The Eleventh Circuit sitting en banc in Stein, however, disagreed and overruled Mays “to the extent it holds or suggests that self-serving and uncorroborated statements in a taxpayer’s affidavit cannot create an issue of material fact with respect to the correctness of the government’s assessment.”  Under Rule 56(a), summary judgment may be granted only when “there is no genuine dispute as to any material fact” and the moving party is “entitled to judgment as a matter of law.”  The Eleventh Circuit further held that nothing in the Federal Rules of Civil Procedure prohibit an affidavit from being self-serving.

Stein is a significant win for taxpayers, and it may make it easier for taxpayers to overcome the presumption of correctness that IRS assessments have enjoyed.

BitcoinThe Internal Revenue Service has assembled a specialized team of criminal investigators to build criminal tax evasion cases involving users of Bitcoin and other cryptocurrencies, according to a Bloomberg article entitled “IRS Cops Are Scouring Crypto Accounts to Build Tax Evasion Cases.” In that article, David Voreacos writes that IRS Special Agents are pivoting from investigating taxpayers with secret offshore bank accounts to taxpayers with cryptocurrency accounts. Don Fort, chief of the IRS Criminal Investigation Division (IRS-CI), is quoted as saying that “It’s possible to use Bitcoin and other cryptocurrencies in the same fashion as foreign bank accounts to facilitate tax evasion.”

Last fall, IRS-CI announced that it was creating a new international tax enforcement group to focus on investigating and building criminal cases involving cross-border activity. According to the Bloomberg article, a newly-assembled team of 10 special agents in that group are now focusing not only on international crimes but also potential tax evasion using cryptocurrency.

As we have previously reported (here, here, and here), other federal agencies are tightening the regulatory framework surrounding cryptocurrencies and are launching vigorous enforcement campaigns to crackdown on fraud. Both the Securities and Exchange Commission and Commodity Futures Trading Commission have formed specialized enforcement groups to focus on cryptocurrency fraud, and have issued stern warnings to investors and consumers about the risks of cryptocurrency investments.

Last fall, the Internal Revenue Service has prevailed in its long-running dispute with Coinbase, the largest U.S.-based Bitcoin exchange, with a federal judge ordering Coinbase to comply with a “John Doe” summons seeking customer information. In an opinion issued on November 28, 2017, the court in San Francisco found that the government’s narrowed request for information on Coinbase’s customers served the legitimate purpose of investigating whether Bitcoin users properly reported gains or losses on their income tax returns. The Court also found that the customer records sought by the government were relevant because they can be used by the IRS to determine whether a particular Coinbase customer is tax compliant. Coinbase must now hand over to the IRS records for accounts that had at least one transaction of at least $20,000 value during the period 2013 to 2015. According to Coinbase, this will require it to divulge trading records regarding nearly 9 million transactions conducted by over 14,000 customers.

Notwithstanding all of this enforcement activity, early data from federal tax filing season (which began January 29, 2018) suggests that cryptocurrency investors may not be properly reporting gains/losses on their 2017 federal income tax returns. Reuters reported yesterday on preliminary tax filing data from online tax service Credit Karma:

Less than 100 people out of the 250,000 individuals who have already filed federal taxes this year through company Credit Karma reported a cryptocurrency transaction to U.S. tax authorities, the company said on Tuesday.

This is despite nearly 57 percent of the 2000 Americans surveyed by the credit score startup and research firm Qualtrics last month saying they had realized some gains from cryptocurrencies, according to a Credit Karma study.

Roughly the same percentage said they had never reported cryptocurrency gains to the Internal Revenue Service, while nearly half of those polled said they understood how owning cryptocurrencies affected their taxes, the study said.

The IRS considers cryptocurrencies such as bitcoin as property for federal tax purposes, meaning any profits or losses from the sale or exchange of the virtual coins should generally be reported as capital gains or losses.

Trading of cryptocurrencies, digital tokens whose value is not backed by central banks and hard assets, surged in 2017 amid a rally in their price. A single bitcoin is worth more than $8000, compared with $1000 a year ago.

Despite the surge it remains unclear how many Americans hold cryptocurrencies as these are bought and sold on online platforms, sometimes anonymously or using pseudonyms. US-based cryptocurrency exchange Coinbase says it has 10 million users, although it is unclear how many of these are in the U.S.

Jagjit Chawla, general manager for Credit Karma Tax said the company was not too surprised that few people had reported cryptocurrency gains as Americans with more complex tax situations tend to file closer to the deadline.

“However, given the popularity of bitcoin and cryptocurrencies in 2017, we’d expect more people to be reporting,” Chawla said in a statement.

Credit Karma entered the online tax filing market last year, and about 1 million individuals filed their tax returns using Credit Karma’s product.

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The Supreme Court recently granted certiorari in South Dakota v. Wayfair Inc., a case that could dramatically change how sales taxes apply to online retail activity. Under the Supreme Court’s current precedent in Quill Corp. v. North Dakota, online retailers need not collect sales taxes unless they have a physical presence in a state. But Quill was decided in 1992, when most remote sales were via phone or mail order. If the Supreme Court overturns Quill, online retailers may face significant new tax liabilities in numerous jurisdictions. States, on the other hand, see Wayfair as an opportunity to significantly increase their tax revenues. It is estimated that state and local governments could have collected around $13 billion more in 2017 had they been allowed to require online retailers to collect sales taxes, even with no physical presence. South Dakota made it clear that the law at issue in Wayfair is designed to test the Quill standard.

The Supreme Court will hear oral arguments this spring. Stay tuned for updates as the parties submit their briefs.

Our colleagues Joshua Horn, Ernest E. Badway, and Benjamin H. McCoy have published an article about the recent release by the Securities and Exchange Commission’s Office of Compliance Inspections and Examinations of its 2018 examination priorities, an annual report outlining the areas of the securities industry its examiners will target. This year, the priorities are organized into five broad areas:

  • Compliance and risks in critical market infrastructure
  • Retail investors
  • FINRA and MSRB
  • Cybersecurity
  • Anti-money laundering programs

The priorities also deal with recent hot-button developments in cryptocurrency and initial coin offerings, which we have written about previously (see prior coverage herehere, and here) . Firms should review the 2018 priorities and ensure that internal controls and practices are updated to effectively handle priority risks. You can read their article here.

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A vocal critic of the Internal Revenue Service’s passport revocation program, the National Taxpayer Advocate recently announced that she had issued hundreds of orders prohibiting the IRS from certifying taxpayers for passport denial or revocation. The IRS began implementing its passport denial/revocation program on January 22, 2018 (see prior coverage here, here, and here), pursuant to which the IRS will certify a taxpayer’s seriously delinquent tax debt (greater than $51,000) to the State Department. Upon receipt of such a certification, the State Department must deny any passport application, or renewal, filed by such taxpayer, and may even revoke a previously-issued passport. The passport law provides exceptions for taxpayers with current installment agreements, offers-in-compromise, or pending Collection Due Process hearings. The IRS has created additional administrative exceptions, such as for taxpayers whose debt has been declared “currently not collectible” status or taxpayers with pending applications for installment agreements or offer-in-compromise.

The National Taxpayer Advocate has previously written extensive criticism of the IRS passport program (here and here), focusing primarily on the program’s lack of prior notice to taxpayers and potential for violating constitutional due process rights of taxpayers. In her recent Annual Report to Congress, the National Taxpayer Advocate identified the IRS passport program as one of the “20 Most Serious Problems” encountered by taxpayers.

The National Taxpayer Advocate has repeatedly requested that the IRS exercise its discretion to exclude from the State Department passport certification process taxpayers who have requested assistance from the Taxpayer Advocate Service (TAS). When the IRS refused to do so, and rolled out its passport certification program in January without creating any exception for taxpayers with open TAS cases, the National Taxpayer Advocate cried foul:

Certifying taxpayers who are already actively working with TAS to resolve their debts violates the taxpayers’ right to a fair and just tax system and treats TAS taxpayers inconsistently from others who are trying to resolve their issues directly with the IRS. This, in essence, violates Congress’s purpose in establishing the Office of the Taxpayer Advocate.

The National Taxpayer Advocate then took steps to protect taxpayers with open TAS cases from certification. As of January 11, 2018, TAS identified nearly 800 taxpayers with assessed tax debts in excess of $51,000 who have an open TAS case and do not otherwise meet any exclusion from certification. On January 16, the National Taxpayer Advocate issued Taxpayer Assistance Orders (TAOs) for each of these taxpayers, ordering the IRS not to certify their debts to the State Department. By law, the IRS may not certify any of these taxpayers until the TAOs are rescinded or modified by the National Taxpayer Advocate, the IRS Commissioner, or the IRS Deputy Commissioner.

For taxpayers who have already been certified to the State Department prior to seeking assistance from TAS, the National Taxpayer Advocate has issued interim guidance to all TAS employees authorizing TAS to accept passport revocation cases from affected taxpayers even if such cases do not satisfy any TAS Case Criteria. Such cases will be accepted by TAS under Criteria 9, which authorizes TAS to accept cases when the National Taxpayer Advocate determines that a compelling public policy warrants assistance to an individual or group of taxpayers. In doing so, the National Taxpayer Advocate observed:

Given the imminent, irreparable harm that taxpayers may face by the loss of their passports and the right to travel internationally, there is clearly a compelling public policy for assisting any taxpayer subject to passport certification.

The National Taxpayer Advocate also made clear that she would continue to advocate for the IRS to exercise its discretion to exclude from passport certification all taxpayers with open TAS cases, and she committed that TAS would work diligently with already-certified taxpayers to resolve their tax liabilities and become decertified.

As we have previously written, the ability to cause passport revocation or denial provides the IRS with powerful leverage over individuals who are delinquent in their tax debts. Taxpayers who owe the IRS more than $51,000 and are concerned about the possibility of losing their passport must take immediate steps to address their outstanding tax liabilities, by either paying such debt in full or seeking to negotiate a collection alternative such as an installment agreement or offer-in-compromise.  In light of the recent actions undertaken by the National Taxpayer Advocate, affected taxpayers should also consider seeking TAS assistance in order to forestall potential adverse consequences with respect to their passports.

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BitcoinOver the course of the last two months, we have witnessed a flurry of enforcement activity with respect to initial coin offerings and virtual currency fraud schemes by the Securities and Exchange Commission and the Commodity Futures Trading Commission. The SEC continued that trend today with an announcement that it has obtained a court order halting an allegedly fraudulent ICO that targeted retail investors to fund what was claimed to be the world’s first “decentralized bank” offering its own cryptocurrency. The public sale in question began around December 26, 2017, and was originally scheduled to conclude on January 27, 2018, with distribution to investors on February 10, 2018.

According to the SEC’s complaint, filed in federal district court in Dallas on January 25 and unsealed late yesterday, Dallas-based AriseBank used social media, a celebrity endorsement, and other tactics to raise what it claims to be $600 million of its $1 billion goal in just two months. AriseBank and its two co-founders allegedly offered and sold unregistered investments in their “AriseCoin” cryptocurrency by depicting AriseBank as a first-of-its-kind decentralized bank offering a variety of consumer-facing banking products and services using more than 700 different virtual currencies.  AriseBank’s sales pitch claimed that it developed an algorithmic trading application that automatically trades in various cryptocurrencies.

The SEC alleges that AriseBank falsely stated that it purchased an FDIC-insured bank which enabled it to offer customers FDIC-insured accounts and that it also offered customers the ability to obtain an AriseBank-branded VISA card to spend any of the 700-plus cryptocurrencies.  AriseBank also allegedly omitted to disclose the criminal background of key executives.

The district court approved an emergency asset freeze over AriseBank and its two co-founders, and appointed a receiver over AriseBank, including over its digital assets.  The court-appointed receiver was able to immediately secure various cryptocurrencies held by AriseBank including Bitcoin, Litecoin, Bitshares, Dogecoin, and BitUSD.  The SEC seeks preliminary and permanent injunctions, disgorgement of ill-gotten gains plus interest and penalties, and bars against the individuals to prohibit them from serving as officers or directors of a public company or offering digital securities again in the future.

Today’s announcement from the SEC is the latest foray in an aggressive federal crackdown on virtual currency scams that has been underway since last fall. Both the SEC and CFTC have created specialized units to focus on virtual currency issues. The SEC’s Cyber Unit was created in September 2017 to focus the Enforcement Division’s cyber-related expertise on misconduct involving distributed ledger technology and initial coin offerings, the spread of false information through electronic and social media, hacking, and threats to trading platforms. The CFTC has created a Virtual Currency Task Force to focus on virtual currency fraud schemes.

The SEC’s Cyber Unit filed its first-ever suit to halt an ICO scam in early December (coverage here). Shortly thereafter, the SEC announced that it had obtained a cease-and-desist order to halt a California company’s ICO (coverage here).

Earlier this month, the CFTC weighed in, announcing the filing of two enforcement actions to combat alleged virtual currency fraud schemes (coverage here). The next day, the CFTC and SEC issued a joint statement reaffirming their agencies’ commitment to continuing to address violations and to bringing legal actions to stop and prevent fraud in the offer and sale of digital instruments. Most recently, the CFTC filed suit on January 24 to halt an alleged virtual currency scam involving a currency called My Big Coin (coverage here).

In addition to these enforcement actions, the SEC and CFTC have published guidance warning consumers and investors as to the perils of ICOs and virtual currency schemes. The SEC’s Office of Investor Education and Advocacy issued an Investor Alert in August 2017. In December 2017, the CFTC launched its Virtual Currency Resource Web Page and published a Customer Advisory to inform the public of possible risks associated with investing or speculating in virtual currencies.

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The Internal Revenue Service said today that it successfully started accepting and processing 2017 federal individual income tax returns. More than 155 million returns are expected to be filed this year.

The filing deadline to submit 2017 tax returns is Tuesday, April 17, 2018, rather than the traditional April 15 date. In 2018, April 15 falls on a Sunday, and this would usually move the filing deadline to the following Monday – April 16. However, Emancipation Day – a legal holiday in the District of Columbia – will be observed on that Monday, which pushes the nation’s filing deadline to Tuesday, April 17, 2017. Under the tax law, legal holidays in the District of Columbia affect the filing deadline across the nation. Taxpayers requesting an extension will have until Monday, Oct. 15, 2018, to file.

The IRS expects more than 70 percent of taxpayers to get tax refunds this year. Last year, nearly 112 million refunds were issued, with an average refund of $2,895.

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