As part of “Operation Hidden Treasure,” the Internal Revenue Service (IRS) has once again launched an initiative to identify noncompliance and determine the correct federal income tax liabilities of those individuals transacting in cryptocurrency.
Earlier this year, the IRS, through the Department of Justice, requested court approval to issue a “John Doe” summons to the cryptocurrency exchange Payward Ventures Inc. d/b/a/ Kraken, or its predecessors, subsidiaries, divisions or affiliates (collectively, “Kraken”) pursuant to 26 U.S.C. § 7609(f). This is not the IRS’s first rodeo in the crypto world. In 2017, the IRS served a John Doe summons on Coinbase Inc. in United States v. Coinbase, Inc., No. 17-cv-01431-JSC, 2017 WL 5890052, at *6–7 (N.D. Cal. Nov. 28, 2017).
The IRS has dedicated substantial resources in its quest to identify tax cheats in the crypto space. This ongoing and extensive investigation has proven successful for the IRS. To date, the IRS has recovered millions of dollars in previously unreported and unpaid taxes surrounding cryptocurrency transactions, and the IRS continues to make headway in its mission to root out this area of noncompliance. May 5, 2021, marked another breakthrough when the U.S. District Court for the Northern District of California granted the IRS’s petition to serve Kraken with a John Doe summons.
The revised summons requests Kraken to produce four categories of records on U.S. account holders for the period 2016 through 2020, whose transactions were worth at least $20,000, specifically: 1) account registration records; 2) know-your-customer due diligence; 3) anti-money-laundering exception reports and 4) records of account activity.
The IRS contends that taxpayers being investigated have failed or potentially have failed to comply with federal tax laws requiring the reporting of taxable income from cryptocurrency transactions. In furtherance of this investigation, the IRS sought permission to serve the administrative John Doe summonses targeting those taxpayers, who directly or indirectly had authority over any combination of accounts held with Kraken, with at least the equivalent of $20,000 in value of transactions (regardless of type) in cryptocurrency during the period Jan. 1, 2016, through Dec. 31, 2020. The IRS’s goal is to analyze the requested records to aid in assessing the potential tax liability of Kraken users.
For almost a decade, the agency has focused on this emerging issue. The IRS has instituted a variety of efforts, ranging from taxpayer education to civil and criminal enforcement actions. In its education campaign, the IRS has issued a number of notices, revenue rulings and periodic updates to its FAQ on virtual currency transactions. In 2014, the IRS issued Notice 2014-21, 2014-16 I.R.B. 938, explaining that cryptocurrency is treated as property for federal income tax purposes and provided examples of how longstanding tax principles applicable to transactions involving property apply to cryptocurrency. In 2019, the IRS included a question related to cryptocurrencies on the Form 1040, Schedule 1,
