UPDATE:  On August 15, 2022, Judge Otis D. Write II in the Central District of California entered an order approving service of the summons by the IRS on sFOX for account and transaction records.  The Department  of Justice entered a press release the following day with Commissioner Chuck Rettig quoted as saying “the John Doe Summons remains a highly valuable enforcement tool that the U.S. government will use again and again to catch tax cheats and this is yet one more example of that.”  Deputy Assistant Attorney General David A. Hubbert of the Department of Justice Tax Division was also quoted as well saying “taxpayers who transact with cryptocurrency should understand that income and gains from cryptocurrency transactions are taxable.”

The IRS knows it has a problem, in that it knows there are far more cryptocurrency transactions than are being reported on tax returns. The IRS may also get an $80 billion increase in funding for enforcement that will help solve that problem.  What can taxpayers and cryptocurrency service providers expect?  More John Doe Summonses.  If there was any doubt, the IRS filed two new John Doe Summons requests (here and here) this week on cryptocurrency service provider sFOX. sFOX is the full-service crypto prime dealer for institutional investors, providing brokerage services for digital assets. It’s also now a target for information by the IRS and the Department of Justice Tax Division.

John Doe Summonses

One of the most powerful tools in the IRS arsenal is the John Doe Summons. As a former Department of Justice Litigator, I myself used this tool multiple times, at the request of the IRS, to obtain information for various initiatives.  A normal IRS summons seeks information about a specific taxpayer whose identity is known; a John Doe summons involves taxpayers in a group the IRS cannot identify by name. At least, not yet. A John Doe summons allows the IRS to obtain the names of all taxpayers within a clearly defined group, so long as they receive judicial approval. This is exactly what happened with Coinbase, resulting in the release of information for 13,000 customers. The courts have also recently approved similar summonses for account holder information from Kraken and Circle.  The request to summons information enjoys a very low burden of proof (usually satisfied by a statement from and IRS Revenue Agent) and the approval process is done ex parte (i.e. only the government is involved with no opposing parties). The District Court Judge approving the summons for information from Kraken recognized that the interests of parties effected by the summons are unrepresented and specifically noted that “any further disputes as to the scope of the summons would benefit from the adversarial process.” The court also added that the permission to serve the summons was “without prejudice to any argument that Kraken or its users might raise in a motion to quash.” If the sFOX summons is approved, it and its users will be faced with the same choice.

The Taxpayer First Act changed Section 7609(f) of the Internal Revenue Code – the section governing John Doe Summonses.  Effective August 16, 2019, a John Doe Summons must be “narrowly tailored to information that pertains to the failure (or potential failure)” to comply with the Internal Revenue laws. The government’s interest is in a wide a net as possible to get as much information as possible to feed into its analytics and promote its current “Operation Hidden Treasure” initiative for finding unreported cryptocurrency.  sFOX and its customers interest in maintaining the privacy and confidentiality of its customers and transactions. Although there are legal costs involved, if the government continues to seek information without challenge the requests will only get broader and broader with each approved summons.  The government cited the approval of the Coinbase summons when seeking the Kraken summons and now cites the Kraken summons approval as support for approving the sFOX summons. The purpose of the Taxpayer First Act restrictions was to limit the intrusion into private financial information of taxpayers to only what is necessary. However, if nobody fights for that limitation it may be rendered meaningless.