Is The IRS Justified In Demanding Information On Millions Of Bitcoin Users?

These are the show notes for the Unchained podcast. Listen to my whole interview with Daniel and Jeff here or on Google Play, iTunes, Stitcher or TuneIn Radio.

Since its beginnings eight years ago, bitcoin was seen as a way to spend digital money while enjoying many of the features of cash, including, to some extent, privacy.

A new attempt by the Internal Revenue Service to collect data on a large group of bitcoin users — customers of Coinbase, the most popular cryptocurrency exchange in the United States — threatens that privacy, but the players involved aren’t giving up without a fight.

In November, the IRS, with approval from a federal court, served a subpoena to Coinbase, requesting information on its users from January 1, 2013 to December 31, 2015. The purported reason? To catch individuals using cryptocurrency to evade taxes.

This so-called John Doe summons, which doesn’t target an individual, but a group or class of people, would affect millions of Coinbase customers.

The company initially responded, “In its current form, we will oppose the government’s petition in court,” and chief executive officer Brian Armstrong has since published a Medium post calling the subpoena “overly broad” and saying it “unfairly punishes Coinbase,” which, as I described in my magazine feature on the company, has a track record of prioritizing compliance and working with regulators and law enforcement. Armstrong then proposed an alternate solution: that the company file 1099-B reports, which brokerage firms use to report customers’ gains and losses.

Jeff Berns, managing partner at Berns Weiss LLP and cofounder of its virtual currency practice group,  and Global Tax Advisors’ Daniel Winters, an accountant specializing in cryptocurrency, have a lively discussion about the case — and make bets in how they think it will turn out — in the latest episode of my podcast, Unchained (Google Play, iTunes, Stitcher, TuneIn Radio).

Jeff Berns, managing partner at Berns Weiss LLP, and Daniel Winters, tax accountant at Global Tax Advisors (courtesy of Jeff Berns and Daniel Winters)

“This is unprecedented. I’ve never seen a fishing expedition come like this from the IRS,” says Berns, who is also gotten personally involved in the case. In order to represent the interests of Coinbase’s users, he filed a motion to intervene asking the court to stop the procedure.

He says the subpoena’s strategy is to “ask for everything and eventually, they’ll find something” — to get records on a couple million people in order to find a few customers and companies who did use bitcoin to evade taxes.

Comparing the amount of information requested in the case to that required for a criminal proceeding, he says, “They want every scrap of email. Every scrap of transaction history. They want to know the devices that accessed your account and how. They want the password that access your account and, as I read it, access to the virtual currency. I don’t know how many people understand that. Once you have private keys, it’s the password that controls your virtual currency, [the money] can be sent out anywhere and never recovered again.”

Tune in to the episode to find out why Berns called the IRS’s response to his motion to intervene “fantastical” and why he says it shows that the agency has requested more information than it needs.

Winters believes that the John Doe summons indicates that the IRS has “a fundamental misunderstanding of bitcoin and blockchain technology.” Noting that bitcoin is a legitimate way to transfer value and do business — Coinbase alone processes payments for more than 45,000 merchants — Winters says, “With this really broad John Doe summons to Coinbase, it seems their only focus is that bitcoin can be used for tax evasion and money laundering.”

However, Winters and Berns say that there have been previous John Doe summons that were justified. For instance, in a John Doe summons served to UBS, the IRS had obtained a statement from a former UBS banker that the bank assisted U.S. clients in hiding assets offshore. UBS eventually turned over information on its U.S. account holders.

However, the John Doe summons on Coinbase is built on shakier ground, says Winters. The IRS only has evidence of three entities having broken the law — only one of which is an individual — and the Coinbase connection is simply that the two businesses had Coinbase accounts.

“It’s a huge difference of degree,” says Winters. The John Doe summons on UBS had “evidence of criminal activity on a broad scale,” he says, referring to the statement by the former UBS employee. In contrast, the summons to Coinbase is more “we know that three users broke the law, and therefore we’re now going to treat the other 99.99% of users as criminals,” he says.

Tune in to this energetic discussion (Google Play, iTunes, Stitcher, TuneIn Radio, web) to find out what Winters and Berns say would be a more appropriate kind of request from the IRS, why the IRS chose Coinbase out of all the cryptocurrency exchanges, and what fundamental mistake Berns says the IRS made long before even issuing this summons.

Plus, as it’s tax time, in this episode, Winters describes how users can best track their bitcoin transactions for tax reporting purposes.

These are the show notes for the Unchained podcast. Listen to my whole interview with Jeff and Daniel here or on Google Play, iTunes, Stitcher or TuneIn Radio.

Laura Shin hosts the Unchained podcast (Google Play, iTunes, Stitcher, TuneIn) and wrote The Millennial Game Plan. Disclosure: I own some bitcoin and ether.