IRS Targeting Cryptocurrency Platforms to Obtain Taxpayer Information

The Internal Revenue Service (IRS) continues to ramp up its efforts to identify taxpayers that have failed to properly report cryptocurrency transactions...

The Internal Revenue Service (IRS) continues to ramp up its efforts to identify taxpayers that have failed to properly report cryptocurrency transactions. On May 5, 2021, a California federal court authorized the IRS to serve a John Doe summons on Payward Ventures Inc., and Subsidiaries d/b/a Kraken (Kraken) seeking information about U.S. taxpayers who conducted at least the equivalent of $20,000 in transactions in cryptocurrency during the years 2016 to 2020. 

“There is no excuse for taxpayers continuing to fail to report the income earned and taxes due from virtual currency transactions,” IRS Commissioner Chuck Rettig said in a press statement. “This John Doe summons is part of our effort to uncover those who are trying to skirt reporting and avoid paying their fair share.”

Tax Treatment of Cryptocurrency Transactions

As discussed in greater detail in a prior article, the IRS is increasingly targeting taxpayers who have conducted cryptocurrency transactions and may have failed to report associated taxable income. As set forth in IRS Notice 2014-21, virtual currencies that can be converted into traditional currency are property for tax purposes, and a taxpayer can have a gain or loss on the sale or exchange of a virtual currency, depending on the taxpayer’s cost to purchase the virtual currency (i.e., the taxpayer’s tax basis).

IRS Issuing Summons to Cryptocurrency Platforms

The recent order issued by the Northern District of California grants the IRS permission to serve a “John Doe” summons on Kraken. Through this type of summons, the IRS is not alleging that Kraken has engaged in any wrongdoing in connection with its digital currency exchange business; instead, the agency is seeking information related to its users.

As set forth in the summons, the information being sought relates to the IRS’s “investigation of an ascertainable group or class of persons” that the IRS has reasonable basis to believe “may have failed to comply with internal revenue laws.” According to the copy of the summons filed with the petition, the IRS directed Kraken to produce records identifying the U.S. taxpayers who transacted $20,000 worth of crypto or more on Kraken from 2016 to 2020, along with other documents relating to their cryptocurrency transactions.

In court documents supporting the summons, the IRS noted that cryptocurrency transactions are difficult to trace, particularly in the absence of third-party reporting to the IRS. The IRS also argued that, given its anonymity, cryptocurrency is attractive to taxpayers who may be looking to hide taxable income.

Kraken users aren’t the only ones the IRS is targeting. On April 1, 2021, a Massachusetts federal court granted an order authorizing the IRS to serve a similar John Doe summons on Circle, a digital currency exchange headquartered in Boston. Back in 2017, the IRS sought similar records from Coinbase. While the digital currency exchange challenged the summons, the court ultimately authorized a narrower version.  Coinbase was ordered to produce documents for accounts with at least the equivalent of $20,000 in any one transaction type (buy, sell, send, or receive) in any one-year period between 2013 and 2015.

After it obtained the user information, the IRS sent notification letters to more than 10,000 taxpayers, advising them to amend their returns and pay back taxes. According to the IRS, its actions resulted in nearly $25 million in revised assessments against taxpayers. The summons also prompted Coinbase to be more proactive, and it began sending annual 1099-Ks for users engaging in at least $20,000 worth of trades or 200 transactions. For the 2020 tax year, the platform switched to sending a1099-MISC form to users who earned at least $600 in crypto through rewards or staking.

Next Steps for Taxpayers

Kraken and Circle likely won’t be the last crypto platforms to receive a John Doe summons. Given the heightened scrutiny by the IRS, taxpayers should keep detailed records documenting receipts, sales, exchanges, or other dispositions of virtual currency and the fair market value of the virtual currency. If you have potential outstanding tax liability, it is imperative to consult with a tax attorney experienced in cryptocurrency as soon as possible.

If you have questions, please contact us

If you have any questions or if you would like to discuss the matter further, please contact me, Jeff Pittard, or the Scarinci Hollenbeck attorney with whom you work, at 201-896-4100.