First Circuit Adds Another Notch to the IRS’ Belt — Upholds Power To Summons Information from Virtual Currency Exchanges

10/07/2024|4 minute read

Key Takeaways:

• The First Circuit recently held that a bitcoin investor did not have a reasonable expectation of privacy in his records held by a cryptocurrency exchange, rejecting his argument that cryptocurrency transactions are confidential.

• Following years of increased IRS and DOJ enforcement efforts, a Court of Appeals has provided prosecutors the green light to seize taxpayer records using John Doe summonses. This recent victory will continue to embolden prosecutors across the U.S. in their use of John Doe summonses, as courts in numerous districts have upheld their use.
• This court decision reaffirms the government's ability to find records of income, gains and losses from cryptocurrency and digital assets transactions, and taxpayers who have failed to report these taxable events and any resulting tax liability should consider taking appropriate action as soon as possible.

Anyone who thought blockchain would keep their cryptocurrency transactions private from the IRS needs to think again. According to the First Circuit's recent holding, cryptocurrency users do not have a Fourth Amendment reasonable expectation of privacy in their records held by cryptocurrency exchanges. Moreover, taxpayers who voluntarily provide their personal information to third parties - whether they are traditional banks or crypto exchanges using blockchain technology - should be cognizant of the fact that their information could be disclosed to law enforcement for reporting and investigation purposes.

Federal prosecutors have been chomping at the bit for years, trying to ramp up IRS criminal enforcement against those who use digital assets to evade tax liabilities, and have started to bring cases against those who end up in their crosshairs. Two years ago, the IRS Criminal Investigation division (IRS-CI) warned taxpayers that it had hundreds of crypto-related cases for which it planned to bring charges, so more should be coming soon. Now, the First Circuit has blessed one of the IRS-CI's most powerful tools to find these transactions - the John Doe summons. While the IRS-CI has been using these summonses for years against cryptocurrency exchanges, the legality of doing so has been challenged by the exchanges and their users, who argued that the users had expected their transactions to remain private. Thus far, these fights have played out at the district court level, and while some courts have directed that the IRS narrow the scope of its information requests, no court has outright rejected the IRS' ability to issue these summonses to obtain information.

For example, in 2016, the IRS issued one of these John Doe summonses to Coinbase seeking information on all U.S. Coinbase accountholders who engaged in cryptocurrency transactions between 2013 and 2015. After a challenge from Coinbase regarding the breadth of the summons issued, the IRS tailored the summons to only capture users who engaged in upward of $20,000 worth of cryptocurrency transactions in a calendar year.[1] Since then, the scope of information obtained by the IRS in summonses has expanded as the IRS has increased its knowledge of the use of digital assets to evade taxes.

James Harper was one of those users. He received a letter from the IRS in 2019 - by which time he had already liquidated all of his Bitcoin holdings or transferred them to a hardcore wallet - notifying him that the IRS had information that indicated he had not accurately reported his virtual currency transactions. Upon receiving this letter, Harper filed a complaint in the U.S. District Court for the District of New Hampshire alleging, among other things, that the John Doe summons the IRS used to ascertain his identity and personal information violated the Fourth and Fifth Amendments of the Constitution.

The district court ultimately dismissed Harper's complaint, finding that Harper's claim could not support a cause of action under the Fourth Amendment because he lacked the required reasonable expectation of privacy in the information, which he voluntarily shared with Coinbase. Additionally, the court dismissed his Fifth Amendment claim, finding that he had received adequate due process. The Court of Appeals for the First Circuit agreed.

In upholding the district court, the First Circuit relied heavily on a 1976 Supreme Court case, U.S. v. Miller[2], in which the Court found that information individuals voluntarily provide to third parties (e.g., banks) is not subject to a reasonable expectation of privacy. In establishing this "third party doctrine," the Court found that the government is legally allowed to obtain this kind of information without violating the Fourth Amendment.

Unfortunately for Harper, the First Circuit analogized his Coinbase records to the bank statements from Miller, finding that the information the IRS obtained through the John Doe summonses fell squarely within the precedent set by the Supreme Court. Judge Kermit Lipez's First Circuit opinion even highlighted that Coinbase's own terms of service explicitly warn customers of the possibility that their information would be disclosed to law enforcement.

Ultimately, because the court found that Harper lacked a reasonable expectation of privacy in his records, he additionally could not sustain a Fifth Amendment argument that he had been stripped of a privacy or property right. Ultimately the court was unpersuaded that crypto records, such as Harper's from Coinbase, are significantly different from traditional bank records.

Thus, taxpayers should take care to ensure that their gains and losses are diligently reported, especially for digital asset transactions. And those who have failed to accurately report these transactions in the past should consult competent counsel to determine their best course of action.

The BakerHostetler Tax Practice Group is skilled at avoiding both criminal prosecutions and large fines under these and similar circumstances. The key in defending a tax case is to mitigate any nonreporting and resolve the dispute where possible, while also being willing to bring cases to trial when necessary. The Tax Practice Group provides clients with sound and practical advice in federal, international, tax controversy, employee benefits, private wealth, tax-exempt, and state and local matters. The group's experience extends to representing clients in the course of IRS examinations. The Criminal Tax Defense team assists individuals and institutions with assessing and identifying issues of concern and implementing measures to reduce potential exposure. The team has successfully represented clients at each stage of the criminal tax process in administrative IRS investigations, joint IRS-DOJ grand jury investigations, and indictments and prosecutions by U.S. attorneys' offices. The Blockchain Technologies and Digital Assets team has members across all our core groups, and our attorneys have extensive experience across all sectors of the blockchain and cryptocurrency markets, including in investigations, securities law, commodities law, compliance with the Bank Secrecy Act and anti-money laundering regulations, taxes, privacy issues, transactions, advertising law, intellectual property, and technology design, as well as in government affairs, public policy, and advocacy across federal departments and agencies and Congress.

[1]United States v. Payward Ventures, No. 23-MC-80029-JCS, 2023 WL 4303653, at *29 (N.D. Cal. June 30, 2023).

[2] 307 U.S. 174 (1976).

Public link

Please use the above public link if you want to share this noodl on another website.