Largest US Bitcoin Exchange Is “Extremely Concerned” With IRS Crackdown Targeting its Users

Last Thursday we reported that in a startling development seeking to breach the privacy veil of users of America’s largest bitcoin exchange, the IRS filed court papers seeking a judicial order to serve a so-called “John Doe” summons on the San Francisco-based Bitcoin platform Coinbase.

The government’s request is part of a bitcoin tax-evasion probe, and seeks to identify all Coinbase users in the U.S. who “conducted transactions in a convertible virtual currency” from 2013 to 2015.

IRS is targeting transaction records of Coinbase users: case is 16-cv-06658, U.S. District Court, Northern District of California

— zerohedge (@zerohedge) November 17, 2016

What makes a “John Doe” unique, is that it represents a special “shotgun” form of summons to look for tax evaders that allows the IRS to obtain information about all taxpayers in a group or class of people, even if the agency doesn’t know their identities. The IRS has deployed the tactic in its recent crackdown on undeclared offshore accounts.

In other words, the US government’s crackdown on local bitcoin users has begun.

In the court filing, the WSJ reports that  Justice Department attorneys wrote that an IRS agent had “identified and interviewed three taxpayers who had used virtual currencies as a means of evading taxes” and that two of these taxpayers were corporate entities that “had wallet accounts at Coinbase and attempted to conceal bitcoin transactions as technology expenses on their tax returns.”

According to Forbes’ tax blogger Kelly Phillips Erb, in his declaration to the court in support of the summons, IRS Senior Revenue Agent David Utzke noted that his investigations included two taxpayers with annual revenues in the millions who “admitted disguising the amount they spent purchasing the bitcoins as deductions for technology expenses on their tax returns.” Those corporate taxpayers had wallet accounts at Coinbase. Unlike other kinds of financial transactions, there is currently no third-party information which requires separate reporting for bitcoin (think of third-party reporting like the forms 1099 issued by your bank). This, says IRS, means that the “likelihood of underreporting is significant.”

The likelihood of underreporting combined with the anonymity of virtual currency means that the IRS needs more data to complete its investigation. It also explains why the “John Doe” summons is so broad.

Meanwhile, Coinbase – not to mention its VC bakers – was “extremely troubled” by the development. It posted the following statement on its website:

Our customers may be aware that the U.S. government filed a civil petition yesterday in federal court seeking disclosure of all Coinbase U.S. customers’ records over a three year period. The government has not alleged any wrongdoing on the part of Coinbase and its petition is predicated on sweeping statements that taxpayers may use virtual currency to evade taxes.

Although Coinbase’s general practice is to cooperate with properly targeted law enforcement inquiries, we are extremely concerned with the indiscriminate breadth of the government’s request. Our customers’ privacy rights are important to us and our legal team is in the process of examining the government’s petition. In its current form, we will oppose the government’s petition in court.

Additionally, Reuters reports that Coinbase cited concerns with the wide-ranging nature of the government’s request. “We want to work with law enforcement — that’s generally our policy,” the company’s head legal counsel, Juan Suarez, said Friday. “But we can’t tolerate sweeping fishing expeditions. We are very concerned about the financial privacy rights of our customers.”

Chris Padovano, a lawyer and the founder of Decentralized Legal, said he expects Coinbase to turn back the government’s request. Cited by Reuters, Padovano said that “there are two questions here. One is whether or not (the IRS has) reasonably identified a class of individuals and has a reasonable basis for believing that all U.S. customers for Coinbase from 2013-2015 may have failed to comply with laws based on these three users,” he said. “Two is whether the information sought by IRS is not available from any other reasonable source than Coinbase.”

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Good luck to Coinbase fighting the IRS: if America’s tax collector is intent on getting the identities of the biggest traders are in America’s largest bitcoin exchange, it will certainly succeed (especially if they happen to be conservatives).

It is still possible that a judge will overturn the request. Before it can serve such a summons, the IRS must first get court approval, which is why we expect the entire bitcoin community to follow the Northern District of California court fight closely as it will have profound implications not only for the tax-treatment of all future bitcoin transactions, whose biggest draw until this point at least, had been their relative anonymity.

It will also have vast chilling effects on the population of US bitcoin traders, and may ultimately lead to “business continuity” problems for Coinbase should its clients seek to withdraw their funds in bulk into an otherwise illiquid market, ahead of what may end up being the latest IRS witch hunt.