IRS is on the lookout for data on cryptocurrency by way of John Doe Summonses

Taxpayers who have conducted cryptocurrency transactions should be aware that the Internal Revenue Service (“IRS”) requests customer records from cryptocurrency exchanges.

The Department of Justice (“DOJ”) recently filed petitions in the District of Massachusetts and the Northern District of California asking for the IRS to be served on John Doe subpoenas on two cryptocurrency exchanges.

A John Doe subpoena is an investigative tool used by the IRS to obtain information about unnamed taxpayers from third parties. A subpoena from John Doe is permitted under Section 7609 (f) of the Internal Revenue Code and enables the IRS to obtain the names, requested information and documents pertaining to all taxpayers of a particular group.

Although the two submissions from John Doe are nearly identical and the DOJ made similar arguments in support of both petitions, the two requests produced different results. The federal court for the Massachusetts District authorized the IRS to serve the subpoena on John Doe, while the federal court for the Northern District of California did not. Rather, the California court raised concerns about the scope of John Doe’s subpoena that the motion was too broad. The court issued an order to show why the petition to authorize service of John Doe’s subpoena should not be denied and asked the government to “specifically explain why each category of information sought is closely related to the investigative needs of the IRS tailored, including whether requests are made for more invasive and broader categories of information could be postponed until the IRS reviews basic account registration information and transaction histories. “

Both of John Doe’s subpoenas request information on U.S. taxpayers who have completed cryptocurrency transactions of at least $ 20,000 in any one year from 2016 to 2020. The documents sought by the IRS are account registration records, know-your-customer due diligence and account correspondence, anti-money laundering exception reports, records of account activity, and records of account funding.

The government used similar language in briefs filed in support of the two petitions, stating that the IRS is concerned that taxpayers are not properly reporting cryptocurrency transactions. The client records are expected to “aid the IRS ‘s ongoing investigations into the identification and correct income tax liability of US persons who have transacted cryptocurrency.” The government believes that in response to John Doe’s subpoena, the cryptocurrency exchanges may provide information about their customers’ currency transactions that the IRS can then use in conjunction with other publicly available information to verify that an individual has the internal tax laws complied with. “

Reporting requirement for cryptocurrency transactions

Pursuant to IRS Notice 2014-21, 2014-16 IRB 938, virtual currency, including cryptocurrency, is treated as property for federal tax purposes, and the general principles for real estate transactions apply to virtual currency transactions. A taxpayer who receives virtual currency for goods or services must include the fair value of the virtual currency at the time of receipt in their gross income. A taxpayer also realizes profits or losses from the sale or exchange of a virtual currency, including using a virtual currency to pay for a service and exchanging one virtual currency for another virtual currency. Ordinary income from the virtual currency is reported on Form 1040 (US Individual Income Tax Return). Sales and other virtual currency exchanges are reported on Form 8948, Sales and Other Disposals of Capital Assets, and Appendix D of Form 1040.

According to Revenue Ruling 2019-24, getting a new cryptocurrency after a hard fork also leads to taxable income. A hard fork occurs when a cryptocurrency in a distributed ledger undergoes a protocol change that breaks a single cryptocurrency into two parts: the pre-split blockchain, which continues to follow the old rules; and the post-split blockchain, which follows the updated rules. The IRS released a memorandum from the Chief Counsel’s office on March 22, 2021 clarifying that Bitcoin Cash received as a result of the Bitcoin fork dated August 1, 2017, is taxable income under Section 61.1 of the Internal Revenue Code Income is determined based on the market value of Bitcoin Cash on the day the taxpayer gained dominion and control over it. For example, if the taxpayer’s wallet does not support Bitcoin Cash until January 1, 2018, the income will be included in the taxpayer’s tax return for 2018 based on the value of Bitcoin Cash on January 1, 2018 (not August 1, 2017). The memorandum was written in response to a person who received Bitcoin Cash as a result of the hard bitcoin fork. However, it cannot be used or cited as a precedent.

For the 2020 tax year, the IRS added a virtual currency question to the first page of Form 1040. The question is, “At any point during 2020 have you received, sold, sent, exchanged, or otherwise acquired financial interests in any virtual currency?” On March 2, 2021, the IRS issued a FAQ guide to the new question stating, “If your only virtual currency transactions in 2020 were virtual currency purchases with real currency, you do not need to use Form 1040 answer with yes. However, taxpayers should be aware that frequently asked questions are not a legal authority. This means that the information cannot be used in support of a legal argument in a judicial proceeding or to facilitate sentence.

Use of John Doe Summonses

John Doe subpoenas require approval from a U.S. District Court and must meet the criteria set out in Section 7609 (f). Section 7609 (f) requires the summons to relate to the investigation of a specific person or an identifiable group or class of persons; The IRS must have a reasonable basis for believing that that person or group or group of people may have violated or failed to comply with any provision of internal tax law. The information that is to be obtained must not be readily available from other sources. and the information sought must be “closely tailored” to information related to non-compliance with one or more provisions of internal tax law. The final requirement was added to Section 7609 (f) in 2019 as part of the Taxpayer First Act.

A John Doe subpoena was previously used by the IRS to successfully obtain customer records from Coinbase, Inc. (“Coinbase”), a digital currency exchange. In November 2017, Coinbase was hired to provide the IRS client with information and transaction data for Coinbase client accounts who had bought, sent or sent Bitcoin, a type of cryptocurrency, worth at least $ 20,000 in any year over the years 2013 to 2015.

The IRS has used the information from Coinbase’s John Doe subpoena to investigate tax non-compliance. The IRS has sent letters to over 10,000 cryptocurrency owners who may not have reported any income from cryptocurrency transactions. The IRS has also opened audits of taxpayers identified by the materials it received in response to the subpoena from Coinbase John Doe. The recent subpoenas from John Doe are expected to lead to additional audits on taxpayers who have conducted cryptocurrency transactions.


The IRS is investigating taxpayers who have improperly reported their cryptocurrency transactions and is working with the DOJ to obtain information on a wide range of taxpayers through subpoena from John Doe. Failure to correctly report cryptocurrency transactions on Form 1040 can result in severe penalties and even possible criminal prosecution. Taxpayers who have conducted cryptocurrency transactions and are concerned about possible past violations or have questions about current reporting requirements should consult a legal advisor.

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© 2021 Greenberg Sad, LLP. All rights reserved. National Law Review, Volume XI, Number 103