TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Saturday, April 1, 2017

WSJ:  IRS Crackdown On Bitcoin Exchange Fuels Privacy Worries

Bitcoin IRSWall Street Journal, IRS Crackdown on Bitcoin Exchange Fuels Privacy Worries:

The federal government is ramping up pressure on a leading digital-currency company to turn over a vast amount of its customer records as part of a tax-evasion probe, an effort that is raising privacy alarms.

The IRS is focusing on Coinbase, a popular exchange and “wallet” service for bitcoin, which has surged in value over the past year as a kind of digital alternative to gold.

Some consumers use bitcoin as a potentially faster, cheaper and more secure way to shop and transfer funds online. Its growing adoption, and perceived anonymity, has made the IRS more concerned about people using digital currency to evade paying taxes.

Coinbase claims it has more than 6.2 million customers and has helped exchange more than $6 billion worth of digital currency across 33 countries.

After getting court approval, the IRS in December served a so-called John Doe summons to Coinbase that demanded transaction and user profile records and other information on all of the company’s U.S. customers from 2013 to 2015, a request covering hundreds of thousands or more account holders. The Justice Department, representing the IRS, petitioned a federal court this month for an order enforcing the summons.

Coinbase, which is based in San Francisco, has refused to hand over the records and has asked the government to drastically narrow its scope and focus. The company says its general practice “is to cooperate with properly targeted law-enforcement inquiries.” But it says the IRS summons is “indiscriminate and over broad” and has vowed to fight it unless it is scaled back.

The breadth of the IRS’s request, and the implications for digital consumer privacy, is troubling to bitcoin advocates and Silicon Valley. ...

Getting a valid John Doe summons requires the IRS to show “a reasonable basis for believing that such person or group or class of persons may fail or may have failed to comply” with the tax law.

That is a relatively low bar for the IRS, said Jeremy Temkin, a white-collar defense lawyer in New York City. Partly for that reason, said Mr. Temkin, challenges to IRS summonses are rarely successful.

“Does it make sense that people would use virtual currency to evade taxes? Yes,” said Mr. Temkin. “Does it make sense that there are other legitimate reasons why people would use a virtual currency? Yes.”

The IRS has suggested in court papers that a review of tax-return data shows a suspiciously small number of filers reporting virtual currency-related transactions. ...

One complication is that the IRS treats bitcoin as property, rather than currency. The property classification has its advantages for investors by treating bitcoin like stocks, a capital asset subject to a more favorable long-term capital gains rate. For bitcoin consumers, though, the downside is a ton of paperwork. Even the smallest transactions using bitcoin to pay for goods or services are technically taxable events, whose gains or losses must be individually tabulated. That is in contrast to more streamlined rules regarding foreign-currency holdings.

Coinbase says it could potentially send customers a 1099-B, the form issued by brokers summarizing proceeds from stock transactions. But using the tax form for bitcoin is problematic, the company says, because there is no way at the moment to track every bitcoin purchase and sale.

The Treasury Inspector General for Tax Administration, the bureau responsible for overseeing the IRS, offered the example of the complexity of properly reporting the purchase of a cup of coffee using bitcoin as payment.

In a report last year, the watchdog bureau said “further guidance is needed to help taxpayers voluntarily comply with their tax obligations.” The IRS told the inspector general that an overhaul of “reporting documents to capture virtual currency amounts is not a priority at this time.”

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