Court Orders IRS to Amend Overbroad Summons for Cryptocurrency Information

Eli Noff, Esq., Partner
Mary F. Lundstedt, Esq., Associate

We've continued to report on the increasingly aggressive IRS posture towards uncovering tax evasion via cryptocurrency transactions.[1] Interestingly, we may now be seeing a trend in the courts indicating that the IRS will need to more carefully tailor summonses in cryptocurrency cases in order to survive the courts' scrutiny of the allowed breadth of IRS summons power.

Earlier in 2017, in an IRS John Doe summons involving one of the largest cryptocurrency exchanges, Coinbase Inc., a court ultimately forced the IRS to narrow its request.[2] More recently, on November 25, 2019, the court in Zietzke v. United States,[3] ordered the IRS to amend its third-party summons, because some of the requests for information about a cryptocurrency exchange were overbroad and irrelevant for purposes of determining taxpayer's tax liability. The court made it clear that the IRS would only be able to proceed with the summons if it narrows the request.

Background

In 2016, taxpayer self-prepared his 2016 tax return. In the return, taxpayer reported Schedule D long-term capital gains of over $100,000. Taxpayer determined this amount of capital gains by including two Bitcoin transactions. On the return, taxpayer listed these transaction as having occurred in 2016.

Subsequently, according to taxpayer, his CPA reviewed his returns in 2017 and pointed out to taxpayer that the two Bitcoin transactions did not occur in tax year 2016. Thus, taxpayer filed an amended 2016 tax return in August of 2017-omitting the two transactions. This significantly reduced his 2016 long-term capital gains to $410. Taxpayer would have a refund in the amount of over $15,000 if the amended return was accurate.

The IRS noticed taxpayer's refund request and began investigating. Per the document request, taxpayer provided the IRS with details about his Bitcoin holdings and transactions. During the audit, the IRS discovered (1) an undisclosed currency exchange (Bitstamp) used in 2016, and (2) that taxpayer had in fact conducted at least one Bitcoin transaction in tax year 2016.

So, the IRS issued a summons to Bitstamp, directing Bitstamp to produce books, records, papers, and other data relating to taxpayer's Bitstamp holdings. Included in the requested information was also taxpayer's public keys and blockchain addresses.

Thereafter, taxpayer filed a petition with the court to quash the summons. The IRS followed up to move that the court deny the petition to quash and enforce the summons.

Analysis and Holding

First, the court noted that the IRS is authorized to issue summonses in order to help it conduct investigations of a person who may have federal tax liabilities. Citing United States v. Powell,[4] the court noted that the government establishes a prima facie case that a summons is valid if:

(1) the IRS issued the summons for a legitimate purpose; (2) the summoned data may be relevant to that purpose; (3) the IRS does not already possess the summoned data; and (4) the IRS followed the administrative steps required by the United States Code for issuance and service of a summons.[5]

Although the taxpayer argued that the IRS failed all of the Powell factors, the court found that the IRS met all but one. Specifically, the court found that the IRS failed the second requirement-i.e., that the summoned data is relevant. The court stated that "as written, the Bitstamp summons seeks irrelevant material because it lacks a temporal limitation."[6] Referencing United States v. Goldman,[7] the court emphasized that:

the core question here is whether the IRS's request for pre-2016 records from Bitstamp asks for material that is irrelevant to the IRS's investigation of Petitioner's 2016 amended return.[8]

The court answered that core question with an unambiguous "yes." The court found that the information that would be relevant would be the price that taxpayer paid for the Bitcoin sold in 2016, while the summons asks for information relating to Bitcoin sales before 2016.

Therefore, the court denied the taxpayer's petitions to quash, but ordered the IRS to file a proposed amended summons.

Conclusion

We will continue to keep our readers apprised of cryptocurrency developments. Taxpayers should remember that the IRS's attention has significantly increased towards cryptocurrency transactions, but taxpayers should also note that courts are scrutinizing the breadth of the IRS's summons for information to ensure the information sought is relevant and not overly-broad.

If you find yourself in an IRS examination or if you have unreported cryptocurrency transactions, contact attorney Eli Noff at Frost & Associates, LLC today at 410-497-5947.


1 See https://www.districtofcolumbiataxattorney.com/blog/2019/07/irs-targets-taxpayers-suspected-of-virtual-currency-non-compliance.shtml.

2 United States v. Coinbase, Inc., No. 17-cv-01431-JSC (N.D. Cal. Nov. 28, 2017).

3 No. C19-1234-JCC (W.D. Wash. Nov. 25, 2019).

4 379 U.S. 48, 57-58, 85 S. Ct. 248, 13 L. Ed. 2d 112 (1964).

5 Zietzke, at 3.

6 Id. at 4.

7 637 F.2d 664, 667 (9th Cir. 1980).

8 Id. at 5.

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