In a petition filed November 17, 2016, with the U.S. District Court for the Northern District of California, the U.S. Department of Justice (DOJ) asked the court for a John Doe summons to be issued on Bitcoin exchanger Coinbase Inc.
The John Doe summons would require Coinbase Inc., the largest bitcoin exchanger in the U.S., to provide the DOJ with information related to all bitcoin transactions it processed between 2013 and 2015. The DOJ would then share the information received with the Internal Revenue Service to be matched against filed tax returns. The IRS would be looking for bitcoin transactions that have the potential for successful criminal investigation and prosecution.
A John Doe summons is Under Internal Revenue Code Sections 7609 (c)(3) and 7609 (f), a John Doe summons is a summons that does not identify the person with respect to whose liability the summons is issued. The Internal Revenue Code authorizes the Service to issue a John Doe summons pursuant to an investigation of a specific, unidentified person or ascertainable group or class of persons. With a normal summons, the IRS seeks information about a specific taxpayer whose identity is known. In contrast, a John Doe summons allows the IRS to get the names and requested information and documents concerning all taxpayers in a certain group. A John Doe summons can be a useful tool when trying to obtain information like a list of investors in a certain tax shelter, owners of cryptocurrency accounts, or account holders at a financial institution.
The IRS has previously stated a position that virtual currency transactions, such as Bitcoin, are property on which gain can be realized. In Notice 2014-21, the IRS stated that it would tax digital money such as bitcoin like property, not currency. The IRS also believes bitcoin transactions provide an opportunity for tax evasion. In fact, according to the IRS, the potential for tax evasion is enhanced via bitcoin transactions, “because there is no third-party reporting of virtual currency transactions for tax purposes … and the likelihood of under-reporting is significant.”
Anyone engaging in Bitcoin transactions, particularly those transactions utilizing the exchange services of Coinbase Inc. during the 2013 to 2015 time-frame, should take note of the DOJ summons.
After more than a year, when the case was initially filed, which attempted to prevent the IRS from gaining access to the transaction records of Coinbase users, a California federal court has ordered that the digital currency exchange turn over the accounts of some of its users. In the John Doe Summons issued to Coin Base, the IRS maintained that it was necessary for Coinbase to turn over the identifying records of its customers in order to better determine the tax compliance risks posed by virtual currencies. Initially, the IRS requested the records of virtually all U.S. customers between those time frames, which Coinbase estimates includes over 500,000 customers a bid to force it to hand over customer financial records.
However, in a partial victory for the digital currency exchange, the IRS significantly reduced this figure to 14,355 customers. According to the court order, for each of the more than 14,000 accounts who received more than $20,000 through its accounts, Coinbase is to provide the IRS with the user’s name, birth date, address, and taxpayer ID. Additionally, the tax agency requests the records of all account activity and any associated account statements.
According to the Court, the order was justified based on the discrepancy that there are more Coinbase users trading bitcoin than reporting gains on their tax returns. In March, it was reported by the IRS in a filing as part of the Coinbase summons case, that fewer than 1,000 U.S. citizens report their bitcoin earnings each year. At the time, an investigation by the agency found that in 2013, 807 people reported a transaction on Form 8949; in 2014 that figure was 893; and in 2015, that fell to 802.
How would using Retirement Funds to Purchase Cryptos Protect Me from IRS Attack?
When the IRS issues a John Doe summons, it is generally concerned that a group of taxpayers are avoiding reporting or paying taxes based on a certain activity. The IRS is clearly concerned that a significant number of cryptocurrency investors that used non-retirement funds to invest in cryptocurrencies are not accurately reporting their gains from an income tax standpoint. However, if retirement funds are being used to invest in cryptocurrencies, no tax would be triggered on any type of cryptocurrency transaction, irrespective of whether the transaction is a short-term or long-term capital gain. Thus, even if your Self-Directed IRA LLC or 401(k) Plan received an inquiry from the IRS due to a John Doe summons issued to a cryptocurrency exchange where you have opened an account, the fact that your account was opened in the name of an LLC wholly owned by a retirement account or in the name of the 401(k) Plan will help you move through any potential IRS inquiry quickly and smoothly since no tax would be subject to reporting.
The IRS John Doe Summons tool provides it with sweeping powers that will ultimately allow them to target most of the major cryptocurrency exchanges in order to collect taxpayer account information. The same tactic was used successfully the IRS against U.S. taxpayers with foreign bank accounts some years ago. Since no tax is due when a retirement account purchases cryptocurrencies, navigating any IRS inquiry as a result of their John Doe summons powers should be quite effortless for retirement account holders.