On The Case

The taxman cometh for crypto traders: Judge okays IRS demand for Circle records

(Reuters) - The U.S. Internal Revenue Service believes thousands of taxpayers are not telling the government about their income and investment gains from cryptocurrency transactions. If you are one of those thousands, and if you use the Boston-based digital currency platform Circle Internet Financial, now might be the time to think about filing an amended tax return.

On Friday, U.S. District Judge Richard Stearns of Boston issued an ex parte order allowing the IRS to serve a John Doe summons on Circle for the financial records of a wide swath of customers – anyone in the U.S. who had an account at Circle (or any of its predecessors or affiliates) and engaged in cryptocurrency transactions worth $20,000 in any one year between 2016 and 2020. The summons demands account registration records, money laundering reports, account funding and activity records.

The IRS did not estimate in its petition or accompanying memo how many Circle customers might be subject to the John Doe summons. But according to the IRS memo, after the government won a 2017 decision enforcing similar demands for information from the digital currency exchange Coinbase, the IRS sent notification letters to more than 10,000 taxpayers, advising them to file amended returns and pay back taxes.

The IRS said those Coinbase notifications have resulted in nearly $25 million in revised assessments against taxpayers. (Coinbase has said in court filings that the IRS summons, which was limited to information from 2013 to 2015, covered more than 14,000 customer accounts.)

A spokesman for Circle said in an email response to my query that the company is reviewing the order and expects “to work collaboratively with the IRS in responding.” The summons does not allege that Circle itself did anything wrong.

The IRS obtained the ex parte order granting access to Circle customer data just a day after filing its petition before Stearns, the Boston judge. Circle was not involved in briefing the issue.

That’s similar to what happened back in 2016, when the IRS initially obtained an ex parte order directing Coinbase to make its customers’ records available. Coinbase put up a fight, going to court to oppose enforcement of the John Doe summons for its customers’ records. The IRS slightly narrowed the scope of its demands, and though Coinbase counsel from Goodwin Procter and Frost Brown Todd argued against enforcement of the narrowed summons, U.S. Magistrate Judge Jacqueline Scott Corley of San Francisco ended up siding with the government.

I specifically asked Circle’s spokesman in a follow-up email if the company will oppose enforcement of the John Doe summons. He did not respond. The information that the IRS is demanding from Circle – data on customers who have engaged in digital currency transactions of $20,000 in a single year – parallels the government’s narrowed summons in the Coinbase case.

The IRS told Stearns that it has good reason to believe Circle customers are not reporting all of their tax liability from crypto income, including currency mining and investment. In general, the IRS brief said, the Coinbase John Doe summons indicated that virtual currency account holders are engaged in widespread underreporting of taxable income and investment gains. And that problem is exacerbated, the IRS said, by companies like Circle, which do not provide tax authorities with information about their customers’ transactions.

It’s a good bet that Circle won’t be the last crypto platform to be hit with a John Doe summons. In the Justice Department announcement of Stearns’ order, IRS Commissioner Chuck Rettig called the John Doe summons for Circle customer information a “clear message” to virtual currency account holders and “a step to enable the IRS to uncover those who are failing to properly report their virtual currency transactions.”

The IRS said in last week’s Circle brief that it knows tax avoiders are taking advantage of cryptocurrency transactions because those deals are “difficult to trace, with many having an inherent pseudo-anonymous aspect.” These John Doe summons served on crypto exchanges seem to be the government’s idea of a flashlight.

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