“The Times They Are A Changin’” – tax enforcement against cryptoexchanges is the new norm.


The United States Internal Revenue Service (IRS) has requested details on Coinbase’s users to identify any tax violations.

This action seems to have arisen as a result of US Treasury reprimanding the IRS for not taking sufficient action to ensure tax compliance of cryptocurrency users. Treasury made clear to the IRS that it has an “important enforcement tool at its disposal to address unlawful activities by those who use virtual currencies”.

The IRS and FinCEN have distinct roles under the Bank Secrecy Act. As said in this government report “FinCEN’s role is to oversee the administration of BSA by numerous agencies including IRS. IRS’s role is to (1) examine nonbank financial institutions (NBFI), such as money transmitters and check cashers, for compliance with BSA; (2) investigate potential criminal BSA violations; and (3) collect and store BSA reported data by all financial institutions.

It appears that previously the IRS’s emphasis in the area of cryptocurrency has been on non-tax violations. When US Treasury asked the Criminal Investigation department of the IRS about what they are investigating they stated that “most of the criminal cases involving virtual currency are related to narcotics and money laundering and provided us general information on five closed criminal investigation cases that involved virtual currency”.

The result of the US Treasury report is to encourage the IRS to be more proactive in tax violation enforcements.

FinCEN administers cryptocurrency exchanges (Exchanges) under the Bank Secrecy Act. As a result Exchanges are required to comply with transactional reporting provisions, customer due diligence and general record keeping. In addition, it is common for Exchanges to use cryptocurrency analytics tools to assess the provenance or outflow of cryptocurrency from an Exchange. Exchanges therefore hold significant customer data on users.

The IRS has taken the prompt from US Treasury that they should do more in the area of tax compliance and has started to target Exchanges to provide the above data on customers. This data will be useful for the IRS to determine any non-compliance with the US Tax Code.

The route that the IRS has taken – in the instance of Coinbase – is to commence a ‘John Doe’ summons. This procedure is laid out in the US Tax Code and permits the IRS to request information from a third party about a ‘class of persons’ who “may fail or may have failed to comply with any provision of any internal revenue law”.

In order for the IRS to be successful in its petition to the Californian court it has to prove, amongst other things, that there is a ‘reasonable basis’ that a group of persons have failed to comply with the US Tax Code and that the data is not “readily available from other sources”.

The IRS claims to have evidence of tax evasion using Coinbase accounts. The IRS refers to a few examples of persons who have been involved in using bitcoin to bring offshore income into the US without reporting. The IRS mentions a scheme where an offshore shell company was used to transfer USD to a bitcoin exchange and then convert the USD to bitcoin for withdrawal without reporting. The IRS then states that a few instances that they identified of tax underreporting or evasion involving persons with Coinbase accounts:  “Taxpayer 2 and Taxpayer 3 each had wallet accounts at bitcoin exchange Coinbase, Inc., the virtual currency exchanger the IRS seeks to summon in this case”. The IRS then points to general material in the public domain that the usage of cryptocurrency can be to avoid tax reporting: the IRS refers to a 2013 Huffington Post article where the article describes a business using bitcoin to avoid enforcement by the IRS.

Understandably, there may be a general concern that the IRS use of the John Doe summons may tantamount to a ‘fishing expedition’. More so, if you take a cynical view that the IRS may consider that – in general – cryptocurrency users may not be aware of how to comply with the tax code. In fact Nathaniel Popper wrote about the John Doe summons against Coinbase in the NY Times and he spoke to a tax professor in the University of California who according to Nathaniel said “that most Bitcoin users were probably not aware that they were supposed to record their losses and gains as taxable events every time they bought anything with their Bitcoins. “It may be the case that many people were not aware that what they were doing is taxable,” Mr. Marian said on Friday. “Are those the people the I.R.S. is looking for?”.

If there is general ignorance amongst cryptocurrency users of how to comply with the US Tax Code then the John Doe summons will create a potential pool of tax violations.

This wide sweep approach – if enforced retroactively – would be slightly surprising considering that the US Treasury itself admits that “more action is needed to educate tax players about virtual currency compliance” and recommended to the IRS that it “should take action to provide updated guidance”.

Without exploring the merits of this case further, what is certain at this stage is that tax enforcement policy has changed in the US and that we can expect to see more John Doe summons being sent to other Exchanges in the future. All cryptocurrency users should ensure that they have a suitable professional to support and audit their cryptocurrency activities to ensure their ongoing tax compliance.