Another tool the IRS uses as part of its cryptocurrency initiative is the "John Doe Subpoena". In the past, the IRS used John Doe subpoenas to identify taxpayers who had failed to pay their tax obligations by serving credit card companies like American Express, MasterCard, and Visa, and payment services like PayPal.
Now the IRS is applying this tool to the exchange of cryptocurrencies. While a typical subpoena is issued when the IRS knows the name of the specific taxpayer, the IRS uses a John Doe subpoena to get the names of all taxpayers in a particular group. For example, a 2008 subpoena from John Doe was an important step in the search for US taxpayers with accounts with Swiss banks. Not only is a John Doe subpoena a potential cause for concern for taxpayers who may have cryptocurrency tax obligations, but it can also place a significant burden on the cryptocurrency exchange or any other party the IRS serves the subpoena.
A subpoena from John Doe must be approved by a federal district court judge. On April 1, 2021, a Massachusetts District federal court issued an order authorizing the IRS to serve a subpoena from John Doe at Circle Internet Financial Inc., a Boston-based digital money exchange company. The government was looking for information on U.S. taxpayers who conducted cryptocurrency transactions worth at least $ 20,000 between 2016 and 2020. The IRS asked Circle to provide records listing these US taxpayers along with other documents related to their cryptocurrency transactions.
According to the Justice Department, the government petition does not allege that Circle was guilty of any wrongdoing in connection with its digital currency exchange business. Rather, under the court order, the subpoena is seeking information related to the "investigation of an identifiable group or group of persons" by the IRS that the IRS can reasonably believe "may have violated a provision of internal tax law (.)"
The IRS is also empowered to issue John Doe subpoenas against Kraken, a California cryptocurrency exchange. The government is again asking about US taxpayers who have made transactions in cryptocurrency worth at least $ 20,000 between 2016 and 2020. The IRS has faced a more skeptical court there. On March 31, 2021, the federal court in the Northern District of California issued a reasoning order stating that the IRS likely had sufficient evidence to meet the law's requirements for issuing a John Doe subpoena the court had Concerns about the size of the application (which must be “tightly tailored” by law). On April 15, 2021, the IRS narrowed down their inquiries despite continuing to gather essential information from Kraken. The IRS does not claim that Kraken committed any wrongdoing.
The proposed subpoena will address broad categories of information such as "Complete User Preferences", "(a) All Other Know-Your-Customer Due Diligence Records" (KYC) and "(a) all correspondence between Kraken and the user or any other Person "queried third parties with access to the account that relates to the account", including similarly extensive inquiries. The court therefore asked the IRS to explain why the petition should not be rejected because it did not meet the law's “tightly tailored” requirement. In doing so, the IRS had to specifically address "why each category of information sought is closely tailored to the IRS 'investigative needs, including whether requests for more invasive and comprehensive categories of information could be deferred until the IRS reviewed the basics of account registration information and transaction histories." “In response to the Court's Issue Order Order, the IRS narrowed its request for KYC information to only seek the answers to the questions about employment, wealth, and source of wealth, and the IRS determined that it expected that these answers are only provided for a limited number of account holders referred to Kraken Pro-Level accounts.
As these two cases show, the IRS is looking for comprehensive information regarding those involved in cryptocurrency transactions, and third-party service providers will face high demands to produce such information. "Tools like the authorized John Doe subpoenas (in the Circle case) send a clear message to US taxpayers that the IRS is working to ensure they are fully compliant with the use of virtual currency," said IRS Commissioner Chuck Rettig. “The John Doe subpoena is a step the IRS can use to expose those who are not properly reporting their virtual currency transactions. We will enforce the law if we discover systemic violations or fraud. "
The extensive information the IRS is gathering as part of its cryptocurrency enforcement efforts is also likely to lead to a review of both the wider corporate community and individuals who may not be primarily involved in cryptocurrency transactions but who provide or provide services to cryptocurrency receive. and related reporting requirements. As with previous IRS enforcement initiatives, this may result in a focus on reporting and withholding tax obligations. Some of the issues that have arisen from previous similar IRS enforcement initiatives have been:
- Withholding payments to foreigners. Generally, a non-resident is subject to US tax of 30% on their US source income, subject to certain exceptions or reductions. Withholding tax refers to rules that require 30% withholding tax on payment of US withholding income and filing of required forms. Cryptocurrency payments are not exempt from these requirements, but their relative novelty has led some to overlook compliance issues.
- Foreign account and transaction reporting. U.S. citizens and residents with overseas accounts greater than $ 10,000 must report accounts on Form 114, Foreign Bank and Financial Account Report (FBAR). Currently, FinCEN has stated that a foreign virtual currency account is not reportable in the FBAR (unless it contains reportable assets in addition to virtual currency). However, FinCEN has announced its intention to change these regulations to require reporting of cryptocurrency. Separately, individuals with certain overseas financial assets greater than $ 50,000 must also report overseas accounts (and certain other overseas financial asset information) on Form 8938 (Statement of Foreign Financial Assets Declared). U.S. Individuals and Residents should be aware that (1) these rules may not be clear about the cryptocurrency, (2) the government has announced it will change the rules, (3) continue to have IRS positions in Regarding Reporting, Speculated Obligations and (4) Reporting for Foreign Assets can be complicated and subject US persons and residents to substantial penalties.
During the U.S. tax season, those doing business in cryptocurrency, whether as a trading tool or just to pay for goods or services, should receive appropriate tax advice. Typically, disclosing transactions to a qualified tax advisor and following legitimate advice can protect taxpayers from penalties (but not from the underlying tax liabilities). The IRS has shown it is taking steps to gather material information and will prosecute those who do not comply with the rules.
This column does not necessarily reflect the opinion of the Bureau of National Affairs, Inc. or its owners.
Information about the author
David Zaslowsky is a litigation partner in Baker McKenzie's New York office and the editor of the company's blockchain blog. Scott Frewing is a partner in the tax practice in Baker McKenzie's Palo Alto office. You can be reached at [email protected] or [email protected].
Bloomberg Tax Insights articles are written by seasoned practitioners, academics and policy makers to discuss developments and current issues in taxation. To make a contribution, please contact us at [email protected].