A PT Anniversary and Court Finds IRS Summons on Coinbase Suggests an Abuse of Process

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Today marks the 4th anniversary of Procedurally Taxing. Our first post, Welcome to Procedurally Taxing, discusses our goals for the blog. As I discussed in that initial post, we hoped to become a source for developments and to act as a filter to allow readers to hone in on some key issues relating to tax administration and tax procedure. When we started we had no idea how much work was involved in writing and editing. We also did not anticipate how much we would benefit from our readers, many of whom contact us, offer comments and become guest posters. So thanks to our readers for inspiring us to remain engaged.

Enough of the mush and on to some tax procedure.

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We have previously discussed the IRS issuance of a John Doe summons on Coinbase. The case has been proceeding and last week an order from a magistrate judge out of the Northern District in California held that an anonymous customer could intervene in the summons enforcement proceedings. This brief posts highlights some of those developments.

Coinbase is an exchange that deals in convertible virtual currency. It operates a bitcoin wallet. It is a big player in the virtual currency market. IRS has been concerned that parties using bitcoin are not complying with their tax obligations. Recall that in 2014 IRS issued Notice 2014-21, where IRS opined that virtual currencies are property for tax purposes, potentially triggering a gain or loss on sale or exchange of a virtual currency.

Flash forward a few years and IRS serves up its John Doe summons on Coinbase. The requested information was voluminous, including:

Account/wallet/vault registration records for each account/wallet/vault owned or controlled by the user during the period stated above including, but not limited to, complete user profile, history of changes to user profile from account inception, complete user preferences, complete user security settings and history (including confirmed devices and account activity), complete user payment methods, and any other information related to the funding sources for the account/wallet/vault, regardless of date.

At the recent ABA Tax Section meeting there was lots of talk about how the IRS summons was overbroad, potentially sweeping up small transactions and people whose information would likely be of no interest to the IRS.

Following service of the summons a number of parties, including Coinbase, sought to intervene to quash the summons. Coinbase also sought to narrow the scope of the summons.

This summer there was oral argument on the motions and IRS informed the court that it has narrowed the scope of the summons. The CA district court order on the motions describes that narrowing:

In particular, [IRS] now seeks information for users with at least the equivalent of $20,000 in any one transaction type (buy, sell, send or receive) in any one year during the 2013-2015 period. Further, the IRS does not seek records for users for which Coinbase filed Forms 1099-K during this period or for users whose identity is known to the IRS.

The order does a nice job laying out the procedures for IRS to get enforcement of a John Doe summons, highlighting that it (as with a generic third party or taxpayer summons) is not self-enforcing and also reviewing the special protections Congress set out in Section 7609(f) before the government can get records when it does not know the identity to whom the records belong.

As with any summons enforcement proceeding, the government has to show that it is issuing its summons in good faith and in pursuit of a Congressionally authorized purpose.

The interesting part of the recent order is the District Court considering whether one of the Coinbase customers has the right to intervene under the Federal Rules of Civil Procedure. There is a bit more to the issue than I describe but whether a party has a right to intervene in the absence of a privilege claim mostly turns on whether the IRS procedures amounted to an abuse of process.

In finding that there was an abuse, the court emphasized that the original summons was far too broad in relation to the government’s legitimate interest in seeking information that may pertain to potential evaders. It is worth honing in on the government’s position and the court’s rebuke:

As of 2014, Coinbase had one million users; thus, the IRS seeks broad data on likely hundreds of thousands of users. These records include complete user profiles including user payment methods, records of Coinbase’s due diligence on their customers, powers of attorney, complete user security settings and history (including confirmed devices and account activity), among other documents. The IRS offers no explanation as to how the IRS can legitimately use most of these millions of records on hundreds of thousands of users; instead, it claims that as long as it has submitted a declaration from an IRS agent that the IRS “is conducting an investigation to determine the identity and correct federal income tax liabilities of United States persons who conducted transactions in a virtual currency during 2013-2015” the Court must find that the Summons does not involve an abuse of process. It contends that “there seems to be a substantial gap between the number of people transacting in virtual currency (for which tax consequences might attach) and those that are reporting such transactions.”

(emphasis added)

The order pushes back on the government’s perspective, claiming that it “proves too much”:

Under that reasoning the IRS could request bank records for every United States customer from every bank branch in the United States because it is well known that tax liabilities in general are under reported and such records might turn up tax liabilities. It is thus no surprise that the IRS cannot cite a single case that supports such broad discretion to obtain the records of every bank-account holding American. While the narrowed Summons may seek many fewer records, the parties agreed to have the Court decide the motion on the original record, and so it has.

The order is also interesting for its rebuke of the government’s position that a customer (unlike Coinbase itself) did not have a protected interest that would allow it to intervene. There is little law in this area, bit the court order distinguishes between enforcement and issuance proceedings. The court holds that a customer who learns of the John Doe summons through some other means can intervene in an enforcement proceeding but not on the issuance of the summons itself:

There is nothing in the John Doe summons procedure adopted by Congress to provide protections to those to whom the IRS could not give notice that suggests that when the John Doe nonetheless learns of a summons from other means the John Doe has no interest in challenging the enforcement of that summons. The government’s assertion that to do so would place an undue burden on the IRS’s legitimate use of John Doe summons makes no sense. All that is being addressed here is the proposed intervenor’s right to intervene in a proceeding that is already taking place. Moreover, as the IRS concedes, if it knew of the applicant’s identity, it would have to give the applicant notice and the applicant would have the opportunity to challenge enforcement. It is thus unsurprising that the one case to have discussed the issue, at least that the parties have cited, assumed that a subject of a John Doe summons could challenge its enforcement.

That the direct interests of the other parties are now involved in this proceeding is as the court implies a good development. Allowing information from customers to be directly introduced provides an opportunity for the court to be better informed. While the government has a clear view as to what it believes Coinbase customers are up to, the strong reaction to the IRS efforts and the IRS’s narrowing of the summons itself suggest that the IRS worldview may be a bit narrow.

Stay tuned, as the court will now likely address the merits of challenges to the summons itself.

Leslie Book About Leslie Book

Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

Comments

  1. Bryan Camp says:

    Hi all, o.k. I know this is going to be a silly question, but did the government argue that the Anti-Injunction Act (7421) prohibited the intervention of the John Doe? Also, I note that the right to intervene is explicitly given only to “persons entitled to notice of a summons under subsection (a)” (7609(b)). And that “subsection (a) shall not apply to any summons described in subsection (f)” (7609(c)(3)). So where does the intervenor get the right to intervene? Additionally, note that 7609(h) includes a specific grant of subject matter jurisdiction to the district court to “hear and determine any proceedings brought under subsection…(f).” As part of that grant of jurisdiction, 7609(h)(1) says “An order denying the petition shall be deemed a final order which may be appealed.” Arguably, that language appears to contemplate that ONLY the government would be appealing an adverse decision. If the decision is to enforce the summons, however, there is no party to take an appeal. Finally, allowing an John Doe to intervene creates an adverse party in what a proceeding that section 7609(h)(2) appears to require to be ex parte.

    Truly I am confused by this court’s opinion.

  2. Norman Diamond says:

    “Under that reasoning the IRS could request bank records for every United States customer from every bank branch in the United States because it is well known that tax liabilities in general are under reported and such records might turn up tax liabilities. It is thus no surprise that the IRS cannot cite a single case that supports such broad discretion to obtain the records of every bank-account holding American.”

    Wow, the court’s reasoning strikes a blow against FATCA too. That’s the law under which, together with strongarming from the US, the US gets bank records for every customer marked by US indicia from every bank branch outside the United States because it is well known that tax liabilities in general are under reported and such records might turn up tax liabilities. In 2011 the Taxpayer Advocate reported to Congress that thousands of honest taxpayers renounced US citizenship partly by being penalized for honesty, but those numbers are now dwarfed by those who have to renounce because of FATCA. Although I wouldn’t have standing in any court case on the FATCA issue, I have to hope for the benefit of the remaining nine million members of the US’s diaspora that this court’s reasoning will stand.

    By the way Coinbase doesn’t operate Bitcoin wallets and Bitcoin doesn’t operate Coinbase wallets.

  3. Norman Diamond says:

    I wrote:

    “By the way Coinbase doesn’t operate Bitcoin wallets and Bitcoin doesn’t operate Coinbase wallets.”

    Among my few comments to be accepted, just my luck that this was one.

    Coinbase does operate Bitcoin wallets, along with wallets for Ethereum and Litecoin.

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