On Friday, Coinbase, the largest U.S.-based Bitcoin exchange, notified approximately 13,000 of its customers that it would be turning over their account information to the Internal Revenue Service within 21 days. This follows the decision by a federal court in November to uphold a “John Doe” summons issued by the IRS seeking such data from Coinbase due to concerns about tax non-compliance by Coinbase customers. In the Court’s ruling, Coinbase was ordered to hand over the following information for certain of its customers during the 2013-2015 time period: taxpayer ID, name, date of birth, address, and historical transaction records. As a result of this development, Individuals who are not tax-compliant with respect to their Coinbase holdings may need to take immediate remedial action to mitigate their potential civil and/or criminal exposure.
“John Doe” Summons to Coinbase
A “John Doe” summons is an information-gathering tool that is being used with increasing frequency by the IRS to obtain information and records about a class of unidentified taxpayers if the IRS has a reasonable belief that such taxpayers are engaged in conduct violating U.S. tax laws. Because the identities of the targeted taxpayers are unknown, the summons is denoted with a “John Doe” moniker. Expressly authorized by the Internal Revenue Code, a John Doe summons must first be approved by a federal judge before it can be served. The IRS sought to serve a summons on Coinbase because of its concern that the anonymous nature of virtual currencies like Bitcoin may allow users to engage in tax evasion and other illegal conduct:
Virtual currency, as generally defined, is a digital representation of value that functions in the same manner as a country’s traditional currency. There are nearly a thousand virtual currencies, but the most widely known and largest is bitcoin. Because transactions in virtual currencies can be difficult to trace and have an inherently pseudo-anonymous aspect, taxpayers may be using them to hide taxable income from the IRS.
In late 2016, a federal judge authorized the IRS to serve a “John Doe” summons on Coinbase seeking information about U.S. taxpayers who conducted transactions in virtual currency during 2013, 2014, and 2015. In court documents, the Justice Department stated that Coinbase was the fourth largest exchanger globally of Bitcoin and the largest exchanger in the United States. The Justice Department further stated that Coinbase offered buy/sell trading functionality in 32 countries, maintaining over 4.9 million wallets with wallet services available in 190 countries, serving 3.2 million customers, with $2.5 billion exchanged in Bitcoin. According to the IRS, only 2,500 taxpayers reported transactions in Bitcoin on their U.S. income tax returns during the three years in question, as compared to nearly 500,000 U.S. customers reported by Coinbase during the same period. Coinbase vigorously resisted the “John Doe” summons, and the matter has been in litigation for a full year before the court ruled in November that Coinbase had to comply.
Coinbase Customer Notification
Here is the text of the letter sent by Coinbase to its customers:
Subject: An important message from Coinbase
In December 2016, the Internal Revenue Service issued a summons demanding that Coinbase produce a wide range of records relating to approximately 500,000 Coinbase customers. Coinbase fought this summons in court in an effort to protect its customers, and the industry as a whole, from unwarranted intrusions from the government.
After a long process, the court issued an order that represents a partial, but still significant, victory for Coinbase and its customers: the order requires Coinbase to produce only certain limited categories of information from the accounts of approximately 13,000 customers.
We are writing to let you know that the above-described court order requires us to produce information specific to your account.
If you have concerns about this, we encourage you to seek legal advice from an attorney promptly. Coinbase expects to produce the information covered by the court’s order within 21 days.
For your reference, the court’s judgment can be found here. The case was filed in the United States District Court for the Northern District of California, Case No. 17-cv-01431-JSC.
In addition, we also want you to know that because Coinbase received a summons on December 8, 2016, and more than six months passed before our challenges to the summons were resolved by the court, the period of limitations under sections 6501 and 6531 of the Internal Revenue Code (title 26 of the U.S. Code) were suspended beginning as of June 8, 2017 and continuing through the final resolution of Coinbase’s response to the summons. This may be relevant to the tax returns that you have filed for the 2013, 2014, and 2015 calendar years. If you have questions about your tax liability for those years, we strongly encourage you to consult with your tax advisor.
The Coinbase Team
Once it receives the summoned data from Coinbase, the IRS will cross-check tax returns filed by the individuals in question to determine if they properly reported their Bitcoin trading gains and losses. Individuals who have not properly reported their Bitcoin holdings will likely be contacted by the IRS, and the nature of that contact will be dictated by the magnitude of each individual’s tax non-compliance. For Coinbase customers with a relatively small number of unreported transactions, the IRS may simply send a “soft” letter advising them to file amended tax returns. Coinbase users with a greater number of unreported transactions may be selected for audit and face penalties for not properly reporting Bitcoin transactions. The most egregious examples of non-compliance may well face criminal investigation by the IRS, if there is evidence those customers deliberately intended to evade their tax obligations by trading in Bitcoin. As we previously reported, the IRS-Criminal Investigation Division is ramping up its scrutiny of cryptocurrency transactions, assembling a specialized team of criminal investigators to build criminal tax evasion cases involving users of Bitcoin and other cryptocurrencies.
Immediate Action May Be Necessary for Affected Coinbase Customers
For individuals whose Coinbase account information is about to be released to the IRS, immediate action may be necessary. While the IRS has not yet announced whether it will unveil a voluntary disclosure program for crytopcurrency (similar to the popular and well-publicized Offshore Voluntary Disclosure Program for foreign bank accounts), the IRS continues to maintain a traditional voluntary disclosure program pursuant to which individuals can mitigate potential criminal exposure by promptly self-disclosing their non-compliance. As with the OVDP, time is of the essence because the IRS can deny a voluntary disclosure application if the IRS already knows of the taxpayer’s non-compliance, such as through information received as a result of a “John Doe” summons. In the context of the OVDP, the IRS has published a specific FAQ addressing this very point:
Once the Service or the Department of Justice obtains information under a John Doe summons, treaty request, or other similar action that provides evidence of a specific taxpayer’s noncompliance with the tax laws or Title 31 reporting requirements, that particular taxpayer will become ineligible for OVDP and Criminal Investigation’s Voluntary Disclosure Practice. For this reason, a taxpayer concerned that a party subject to a John Doe summons, treaty request, or similar action will provide information about him to the Service should apply to make a voluntary disclosure as soon as possible.
The IRS can be expected to apply the same principle to taxpayers whose data is turned over by Coinbase. As a result, taxpayers with Coinbase accounts who wish to make a voluntary disclosure would be well-advised to do so before Coinbase hands over their account information to the IRS.
Impact on Statute of Limitations
Coinbase’s letter to its customers contains an important warning regarding suspension the statute of limitations. The Internal Revenue Code imposes strict time limits for the IRS to audit a tax return or to file criminal charges regarding a filed return. Ordinarily, the IRS has three years to commence a civil audit of a tax return (subject to certain exceptions), and six years to bring criminal charges. Because Coinbase filed a legal challenge to the “John Doe” summons served by the IRS, and more than six months passed before that challenge was resolved by the court, the applicable statutes of limitation were suspended for at least six months. This means that the IRS has additional time to audit or investigate the 13,000 taxpayers whose data is being turned over to the IRS.
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