COURT ORDERS ENFORCEMENT OF SUMMONS FOR CRYPTO DATA

Digital Currency Trading Information is NOT Private

In case you continue to believe that your digital currency trades are private, consider this. A United States District Court in California, on June 30, 2023, ordered the enforcement of an IRS summons that was issued against Payward Ventures, Inc., an online cryptocurrency exchange platform that does business as Kraken. See: United States v. Payward Ventures, Inc., Case No. 23-mc-80029-JCS (Dist Ct. ND Cal. 2023). Note, we discuss summonses in more detail in the next article.

Kraken offers digital current exchange services to investors buying and selling cryptocurrency. Its clients are located in the U.S., as well as in over 190 countries across the world. To open an account, users must provide: (a) their name and identification documents to confirm their identity, (b) a physical address, (c) proof of residence, and (d) for U.S. clients, a taxpayer ID number. They may also be required to provide a photo and complete a “Know-Your-Customer Questionnaire” which, among other things, asks questions about the applicant’s occupation, source of income, and intended use of the account.

Once established, secured login procedures involve a two-factor authentication for login that includes an email address, one’s full name and date of birth, phone number, and physical address. Once established, one can trade in unlimited amounts through the Kraken account. In addition to buying and selling cryptocurrency, a client can trade on margin, earn additional cryptocurrency by participating in blockchain activity, trade in options, and engage in over-the-counter trading.

Cryptocurrency has been on the IRS’s radar since 2014, when the agency issued IRS Notice 2014-21. That ruling deemed cryptocurrency to be “property,” and thus it is to be treated no differently than, say, a share of stock or an automobile. Plus, the number of crypto investors has skyrocketed since 2010. Given that fact, along with the wealth of information held by Kraken regarding the identity and trading activities of its U.S. clients, it should come as no surprise that the company caught the attention of the IRS.

To learn the names, addresses and other identifying information of Kraken’s U.S. clients, the IRS issued a “John Doe” summons on the company in 2021, under the authority of Code § 7609(f). That section allows the IRS to issue a summons to a third-party recordkeeper “which does not identify the person with respect to whose liability the summons is issued.” Rather, such a summons can seek information from the third party that identifies individuals within an “ascertainable group or class of persons.” See: Code § 7609(f)(1)-(3). In this case, the IRS sought the identity of U.S. citizens.

A “John Doe” summons is, in a very real sense, a broad dragnet the IRS casts. It was cast with the expectation of discovering the names of citizens who may have failed to pay taxes on their crypto activity. Indeed, in Payward Ventures, the IRS listed six specific ways that that trading in crypto can relate to tax compliance. They are:

• Wages, salary, or other income paid to an employee with virtual currency is reportable by the employee as ordinary income and subject to employment taxes paid by the employer.

• Virtual currency received by a self-employed individual in exchange for goods or services is reportable as ordinary income and is subject to self-employment tax. This would include a person who “mines” virtual currency as a trade or business.

• Virtual currency received in exchange for goods or services by a business is reportable as ordinary income.

• Gain on the exchange of virtual currency for other property is generally reportable. It is considered capital gain income if the virtual currency was held as a capital asset. It is considered ordinary income if the virtual currency was held for sale to customers in a trade or business (such as a broker’s sales activities).

• Gain on the sale of property held as a capital asset in exchange for virtual currency is reportable as a capital gain.

• Payments made in virtual currency are subject to information reporting requirements to the same extent as payments made in fiat currency or instruments denominated in fiat currency. Payward Ventures, Id. Pg 6.

The long-time, controlling precedent for determining whether courts will enforce an IRS summons seeking data, whether from an individual citizen or from third parties (including through the use of a “John Doe” summons), is the Supreme Court case of United States v. Powell, 379 U.S. 48 (1964). That case states that in order for the court to enforce an summons, the IRS must establish that the summons is issued “in good faith” by showing that the summons: (1) is issued for a legitimate purpose; (2) seeks information relevant to that purpose; (3) seeks information that is not already in the IRS’s possession; and (4) satisfies all of the administrative steps set forth in the Internal Revenue Code.” United States v. Powell, 379 U.S. 48, 57–58 (1964)). “[T]his showing need only be minimal . . . because the statute must be read broadly in order to ensure that the enforcement powers of the IRS are not unduly restricted.” Liberty Fin. Servs. v. United States, 778 F.2d 1390, 1392 (9th Cir. 1985) (citing United States v. Balanced Financial Management, Inc., 769 F.2d 1440, 1443 (10th Cir.1985)). These same rules apply to “John Doe” summons. United States v. Samuels, Kramer & Co., 712 F.2d 1342, 1346 (9th Cir. 1983).

Once the IRS makes a prima facie case that the Powell factors are met, the taxpayer bears a “heavy” burden to show an abuse of process or lack of good faith on the part of the IRS. United States v. LaSalle Nat’l Bank, 437 U.S. 298, 316 (1978). “‘The taxpayer must allege specific facts and evidence to support [their] allegations of bad faith or improper purpose.’” Id. (quoting United States v. Jose, 131 F.3d 1325, 1328 (9th Cir. 1997)). Where such evidence is presented, the court must then “scrutinize” the summons “to determine whether it seeks information relevant to a legitimate investigative purpose, and the court may choose either to refuse enforcement or narrow the scope of the summons.” United States v. Goldman, 637 F.2d 664, 668 (9th Cir. 1980) (citing United States v. Bisceglia, 420 U.S. 141, 146 (1975)).

Only in extremely rare cases do the courts deny enforcement of summonses. And such was not the case here. The court ordered the enforcement of the summons issued against Payward Ventures for the release of information on Kraken account holders “with any combination of accounts having at least the equivalent of $20,000 in value of transactions (regardless of type) in cryptocurrency in any one year, for the period January 1, 2016 through December 31, 2020.” Payward Ventures, Id, pg 50.

Specifically, the following information was ordered to be released to the IRS:

1. Name (including full name, any pseudonym, or any user ID),
2. Date of birth,
3. Taxpayer Identification Number,
4. Physical address,
5. Telephone number,
6. Email address,
7. Detailed and specific transaction activity, and
8. All records showing deposits, withdrawals, and transfers in any manner.

Do not make the mistake of believing that cryptocurrency account information and trading activity is either, (a) tax-free, or (b) totally private and unavailable to the government. Indeed, Payward Ventures is not the first case in which the IRS was granted the keys to the private filing cabinets of crypto trading companies. In 2017, a U.S. District Court in California ordered the enforcement of a summons similar to that issued against Payward Ventures. That summons was issued against Coinbase, Inc., the pioneer in crypto trading. See: United States v. Coinbase, Inc., No. 17-cv-01431-JSC, 2017 WL 5890052 (N.D. Cal. Nov. 28, 2017).

If you trade in crypto in any way, shape or form, you need to be aware of the tax consequences of your transactions. Seek competent counsel to accurately report those transactions and pay the correct tax on any gain or profit.

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