Finding John Doe: IRS Steps up Enforcement Efforts to Take the Anonymity Out of Virtual Currency

By on April 21, 2021

The Internal Revenue Service (IRS) is stepping up its virtual currency enforcement, and taxpayers who have engaged in a cryptocurrency transaction should immediately assess any potential tax implications as the IRS has recently issued two John Doe summonses to popular exchanges. These are the first it has issued in about three years, sending a very clear signal that the IRS is ready to tackle what it believes to be a continuing noncompliance. A US Federal District Court in Massachusetts upheld the summons issued to Circle Internet Financial Inc., including the popular cryptocurrency exchange Poloniex, while a US Federal Court for the Northern District of California required the government to submit a response explaining its need for the information requested in its summons to Kraken. (See: In re Tax Liability of John Does, No. 21-cv-2201, ECF No. 8 (N.D. Cal. Mar. 31, 2021)).

Filed on April 14, 2021, the government’s response provided numerous examples of how the data received in the Coinbase summons required additional requests in order for the exchange to locate actual taxpayers. The response argued that the need for multiple follow-ups defeated the purpose of the summons. It also described how information in Kraken’s possession, such as accountholder telephone numbers and email addresses, will facilitate the IRS’s ability to utilize relevant cryptocurrency platform data in its possession that was received from other sources relating to foreign-based cryptocurrency exchanges. Noting the potential for abuse by an accountholder, the response provided an example of an individual falsifying their identity as the basis for its need for complete account history in order to catch these issues. In addition, the response stated, “[m]atching the IP addresses for Kraken users to IP addresses and other data points in the IRS’s information will allow the IRS to link substantive account information from multiple sources for a single individual taxpayer and make a more accurate initial determination of whether that individual is in compliance with the internal revenue laws.”

It remains to be seen how the court will react to the government’s response. What is clear, though, from the response and the accompanying affidavit is that the IRS has made significant progress in its analysis of this data and its ability to follow leads. As a result, now is the time for individuals involved in these transactions to consult a tax professional to determine if they have any tax liability or potential exposure, including criminal exposure. After the Coinbase summons, the IRS issued 10,000 letters to taxpayers regarding virtual currency transactions. In the wake of these summonses, and potentially others, it is only a matter of time before the IRS reaches out to thousands of other taxpayers.

It is also clear that the enforcement arm of the IRS is working very closely with its counterparts around the world. The need for email addresses and phone numbers mentioned above to use foreign data certainly drives this point home. Even more so, as a precursor of things to come, in its response, the government stated:

The IRS has historically relied heavily upon correspondence information obtained through John Doe summonses when conducting investigations directed at tax noncompliance in the offshore area. Because offshore tax evasion often involves an offshore entity (e.g., a corporation, trust or foundation) or multiple entities, these entities typically are controlled through nominee directors and/or trustees and are used to conceal the taxpayers’ beneficial ownership of offshore—and sometimes domestic—accounts and assets. Foreign corporations/offshore foundations with nominee officers and directors are often used to conceal beneficial ownership…To properly examine taxpayers operating offshore, the IRS needed to obtain correspondence to identify the true beneficial owner—the individual who was making decisions and benefiting from the offshore funds. (Id.)

Just as with offshore tax avoidance, individuals have begun using cryptocurrency as a digital avenue to move money and avoid taxes because of its pseudonymous aspects. However, because of the verification requirements that Kraken has implemented, the IRS believes it can wait to obtain correspondence that may be relevant to its investigation until a later time. If the IRS receives the other summoned information discussed so far, it should be able to issue a follow-up summons to Kraken for the subject individual for correspondence. So, the IRS has removed this request from the revised proposed summons.

Practice Point: More details about these recent events can be found in our article, “Prepare for Global Collaboration in Crypto Tax Enforcement.” The IRS is gathering information at an accelerated pace and is going to use it. The Tax Man is coming…

Carlos F. Ortiz
Carlos F. Ortiz is a member of the Litigation and White Collar Defense teams and his work has a particular emphasis on white collar defense and investigations. He uses his prominent 15-year background as a high-level federal prosecutor to assist clients with matters relating to the Foreign Corrupt Practices Act (FCPA), high-risk tax controversies, offshore tax issues, anti-money laundering, e-commerce fraud, healthcare fraud, as well as allegations of fraud against government agencies and financial institutions. Over his career in private practice he has secured the declination of criminal charges for corporate and individual clients. On several occasions he has prevented the referral of charges for the target of criminal tax investigations.

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