IRS Aggressively Collects Taxes on Cryptocurrency Transactions – Part 2
Another tool the IRS uses as part of its cryptocurrency initiative is the “John Doe Summons”. In the past, the IRS used John Doe’s summons to identify taxpayers who had not paid their tax obligations by serving them on credit card companies such as American Express, MasterCard, and Visa, as well as on services payment methods such as PayPal.
Now the IRS is applying this tool to cryptocurrency exchanges. While a typical subpoena is issued when the IRS knows the name of the specific taxpayer, the IRS uses a John Doe subpoena to obtain the names of all taxpayers in a certain group. For example, a summons from John Doe in 2008 was a key step in the IRS to find US taxpayers with accounts in Swiss banks. A John Doe summons is not only a potential source of concern for taxpayers who may have cryptocurrency tax obligations, but it can also impose significant burdens on the cryptocurrency exchange or on a other party to which the IRS serves the summons.
A subpoena from John Doe must be approved by a federal district court judge, and on April 1, 2021, a federal court in the District of Massachusetts issued an order authorizing the IRS to serve a subpoena from John Doe on Circle Internet Financial Inc ., a digital business. bureau de change headquartered in Boston. The government sought information on U.S. taxpayers who made at least the equivalent of $ 20,000 in cryptocurrency transactions during the years 2016 to 2020. The IRS has asked Circle to produce records identifying these U.S. taxpayers. , as well as other documents relating to their cryptocurrency transactions.
According to the Department of Justice, the government’s petition does not allege that Circle has committed any wrongdoing in connection with its digital currency trading business. Rather, according to the court order, the subpoena seeks information relating to “the IRS’s investigation of a verifiable group or class of persons” that the IRS has reasonable grounds to believe “has may not comply with any provision of any internal tax legislation.[.]”
The IRS is simultaneously seeking to issue summons from John Doe against Kraken, a California cryptocurrency exchange. Once again, the government is questioning US taxpayers who made at least the equivalent of $ 20,000 in cryptocurrency transactions between 2016 and 2020. The IRS faced a more skeptical court there. low. On March 31, 2021, the Northern District of California Federal Court issued a show cause order in which it said the IRS likely had provided sufficient evidence to meet the legal requirements to issue a subpoena for John Doe, but the court had concerns about the scope of the claim (which the law requires to be “narrowly tailored”). On April 15, 2021, the IRS reduced its claims, although it continues to seek substantial information from Kraken. The IRS does not allege that Kraken engaged in any unlawful behavior.
The proposed summons looks for broad categories of information such as “full user preferences”, “[a]ny other Know-Your-Customer due diligence records, “(KYC) and”[a]Any correspondence between Kraken and the User or any third party having access to the account relating to the account ”, among other equally expansive requests. The court therefore asked the IRS to demonstrate the reasons why the petition should not be dismissed for failing to meet the “narrowly tailored” requirement of the law. In doing so, the IRS was required to specifically address “why each category of information sought is closely tailored to the investigative needs of the IRS, including whether requests for more invasive and all-encompassing categories of information might be.” deferred until the IRS has reviewed account registration information and transaction history. In response to the court’s show cause order, the IRS restricted its request for KYC information to only seek answers to questions about employment, net worth and source of wealth, and the IRS has observed that he expects these answers to be provided only for a limited number of account holders linked to Kraken “pro level” accounts.
As these two cases show, the IRS looks for general information about people engaged in cryptocurrency transactions, and third-party registrars will face onerous demands in producing this information. “Tools like summoning John Doe are allowed [in the Circle case] send the clear message to US taxpayers that the IRS is working to ensure they are fully compliant in their use of virtual currency, ”IRS Commissioner Chuck Rettig said. “John Doe’s summons is a step in enabling the IRS to uncover those who fail to properly report their virtual currency transactions. We will enforce the law in the event of systemic non-compliance or fraud. “
The general information collected by the IRS as part of its cryptocurrency enforcement efforts will likely lead to scrutiny from the broader community of businesses and individuals who may not be primarily engaged in transactions. cryptocurrency, but who provide or receive cryptocurrency services, and related reporting obligations. Like previous IRS enforcement initiatives, this may lead to a focus on reporting and withholding obligations. Some of the issues that have arisen as a result of previous similar IRS implementation initiatives include:
- Withholding from payments to foreign persons. Generally, a foreign person is subject to a US tax of 30% on their US source income, subject to certain exceptions or reductions. Withholding refers to rules that require a 30% withholding on a U.S. source income payment and filing of the required forms. Cryptocurrency payments are not exempt from these requirements, but its relative novelty has led some to overlook compliance concerns.
- Foreign account and transaction reporting. US citizens and residents who hold more than $ 10,000 in foreign accounts are required to report the accounts on Form 114, Report of Foreign Bank and Financial Accounts (FBAR). Currently, FinCEN has declared that a foreign account holding virtual currency cannot be declared to the FBAR (unless it holds reportable assets in addition to virtual currency), but FinCEN has declared its intention to change these regulations. to require the declaration of the cryptocurrency. In addition, those with certain foreign financial assets exceeding $ 50,000 must also report foreign accounts (and certain other foreign financial asset information) on Form 8938, Statement of Specified Foreign Financial Assets. US individuals and residents should be aware that (1) there is potential ambiguity in these rules applied to cryptocurrency, (2) the government has announced its intention to change the rules, (3) there has been ongoing speculation about the IRS ‘positions regarding reporting obligations, and (4) reporting foreign assets can be complicated and subject US individuals and residents to significant penalties.
With the tax season underway in the United States, those who transact in cryptocurrency, whether as a business vehicle or simply to pay for goods or services, should get proper tax advice. As a general rule, disclosing your transactions to a qualified tax advisor and taking legitimate advice can protect taxpayers from penalties (but not the underlying tax obligations). The IRS has shown that it is taking steps to gather substantial information and will prosecute those that do not follow the rules.
This column does not necessarily reflect the opinion of the Office of National Affairs, Inc. or its owners.
David Zaslowsky is a litigation partner in the New York office of Baker McKenzie and editor of the company’s blockchain blog. Scott Frewing is a partner in tax practice in the Palo Alto office of Baker McKenzie. They can be contacted at [email protected] and [email protected] , respectively.
Bloomberg Tax Insights articles are written by seasoned practitioners, academics, and policy experts who discuss current tax developments and issues. To contribute, please contact us at [email protected].