Court Enforces — Partially — IRS “John Doe” Summons Served on Virtual Currency Exchanger

by Ballard Spahr LLP

IRS Will Obtain Identifying Information Regarding Clients Who Conducted Any Transaction Equal to $20,000 or More

Last week, a federal magistrate judge in the Northern District of California granted in part and denied in part a motion by the IRS to enforce a “John Doe” summons served on Coinbase, Inc., which operates a virtual currency wallet and exchange business headquartered in San Francisco. As we have blogged, the court granted last year the IRS’s application to serve the summons on Coinbase, which then resisted and moved to quash. The recent ruling paves the way for potential criminal or civil tax investigations involving Coinbase customers, as well as potential money laundering investigations.  The ruling also indicates that the IRS might be able to seek more information from Coinbase about specific individuals as its investigation progresses.

Needless to say, the semi- or pseudo-anonymity offered by virtual currency – traits which historically have made virtual currency attractive to some of its users – are the same traits which have made the IRS and other law enforcement agencies and regulators intensely interested in the use of virtual currency. Although the use of virtual currency generally may cloak the user and create practical problems for investigators, the Coinbase action demonstrates that virtual currency is not truly anonymous in the face of a focused law enforcement inquiry.

To provide some context to the Coinbase action, we will first summarize the general approach taken by the IRS regarding the taxability of virtual currency, which the IRS treats as “property” – an approach which can create practical and legal complexities in ascertaining taxable income.

Taxability of Virtual Currency

Virtual currency, very generally, is a digital unit of exchange that is not backed by a government. It may be used to pay for goods or services, or held for investment.  For U.S. federal tax purposes, the IRS takes the position that virtual currency is treated as property rather than currency.  A taxpayer who receives virtual currency as payment for goods or services must include the fair market value of the currency (measured in U.S. dollars) when computing his gross income.  The basis of virtual currency that a taxpayer receives as payment for goods or services is the fair market value of the virtual currency (in U.S. dollars) as of the date of receipt.  Additionally, a taxpayer will have to recognize gain or loss upon an exchange of virtual currency for other property if the fair market of property received in exchange for virtual currency does not equal the taxpayer’s adjusted basis of the virtual currency.

Determining a taxpayer’s gross income, gain or loss, and basis with regard to a virtual currency transaction also requires the taxpayer to determine the fair market value of virtual currency in U.S. dollars as of the date of payment or receipt. If a virtual currency is listed on exchange, such as Coinbase, and the exchange rate is established by market supply and demand, the fair market value of the virtual currency is determined by converting the virtual currency into U.S. dollars (or into another “real” or “fiat” currency which in turn can be converted into U.S. dollars) at the exchange rate, in a reasonable manner that is consistently applied.  For other types of virtual currency, it is unclear how to measure fair market value and whether or not the value of the goods or services given in exchange for the currency can establish its value.  As with all property, the character of the gain or loss will generally depend on whether the virtual currency is a capital asset in the hands of the taxpayer. It is unclear under what circumstances virtual currency might be held as a capital asset versus an ordinary asset or as inventory.

Application of the above principles in real-world transactions can be a daunting practical challenge, particularly when many small transactions are performed overtime. Nonetheless, what is clear is that virtual currency transactions can give rise to income which must be reported on the user’s tax return.  This very basic principle is what led to the Coinbase summons.

The Summons Enforcement

The summons initially served by the IRS on Coinbase (the government has not alleged that Coinbase has violated any law) sought “information regarding United States persons who at any time during the period January 1, 2013 through December 31, 2015 conducted transactions in a convertible virtual currency . . .” The initial summons requested nine categories of documents regarding the identities and activities of Coinbase’s customers; in the memorandum and declaration supporting the petition to serve the summons, the IRS asserted that virtual currency represents not only a potential vehicle for tax evasion, but also a possible conduit for money laundering.

In the face of opposition by Coinbase and due to an apparent acknowledgement that most Coinbase users conduct numerous, low-value transactions, the IRS later narrowed its initial request and filed a “Notice of Narrowed Summons Request For Enforcement” (“Narrowed Summons”). As modified, the IRS sought information regarding accounts “with at least the equivalent of $20,000 in any one transaction type . . . . in any one year during the 2013-2015 period.” The Narrowed Summons excluded a user “(a) who only bought and held bitcoin during the 2013-15 period; or (b) for which Coinbase filed Forms 1099-K during the 2013-15 period.”

According to Coinbase, the Narrowed Summons still was overly broad because it requested information regarding approximately 8.9 million transactions and over 14,000 account holders. Further, and among other arguments, Coinbase challenged the legitimacy of the investigative purpose of the Narrowed Summons. However, the court noted that the burden of the IRS was “slight” under the governing Supreme Court case, United States v. Powell, and that the IRS could satisfy its burden of “good faith” through a declaration from the investigative agent that that the Powell requirements had been met, i.e., that the summons “(1) is issued for a legitimate purpose; (2) seeks information relevant to that purpose; (3) seeks information that is not already in the IRS’s possession; and (4) satisfies all of the administrative steps set forth in the Internal Revenue Code.” Applying this lenient standard, the court found that the IRS had demonstrated a legitimate investigative purpose:

[T]he investigative purpose is not a bare conclusion: it is premised upon [an IRS] declaration that Coinbase is the largest bitcoin exchange company in the United States with 5.9 million users yet only 800 to 900 taxpayers have reported property transactions related to bitcoin in each of the relevant years.

Moreover, Coinbase itself admits that the Narrowed Summons requests information regarding 8.9 million Coinbase transactions and 14,355 Coinbase account holders. That only 800 to 900 taxpayers reported gains related to bitcoin in each of the relevant years and that more than 14,000 Coinbase users have either bought, sold, sent or received at least $20,000 worth of bitcoin in a given year suggests that many Coinbase users may not be reporting their bitcoin gains. The IRS has a legitimate interest in investigating these taxpayers.

The Court therefore granted the petition in part and ordered disclosure of the following for each relevant account:

  • The customer’s (1) taxpayer ID number, (2) name, (3) date of birth, and (4) address; and
  • Records of account activity including transaction logs or other records identifying the date, amount, and type of transaction (purchase/sale/exchange), the post transaction balance, and the names of counterparties to the transaction.

However, the court denied the IRS’s request – at least for now – for a variety of other records as not relevant or necessary at this state, including the following:

  • Account opening records, copies of passports or driver’s licenses, all wallet addresses, and all public keys for all accounts/wallets/vaults;
  • Requests or instructions to send or receive bitcoin and information identifying the users of such accounts where counterparties transact through their own Coinbase accounts/wallets/vaults and their contact information;
  • Records of Know-Your-Customer diligence;
  • Agreements or instructions granting a third-party access, control, or transaction approval authority; and
  • Correspondence between Coinbase and the user or any third party with access to the account/wallet/vault pertaining to the account/wallet/vault opening, closing, or transaction activity.

The court explained its partial denial as follows, although it observed that the IRS might be entitled to at least some of the above records pertaining to certain individuals later in the investigation:

The Government claims to need these records to verify an account holder’s identity and determine if the holder used others to make transactions on the account holder’s behalf. However, at this stage, where the Government is seeking records on over 10,000 account holders, these requests seek information than is “broader than necessary.” [citation omitted]. The first question for the IRS is whether an account holder had a taxable gain. If the account holder did not, then correspondence between Coinbase and a user is not even potentially relevant. Similarly, while the Government needs an account holder’s name, date of birth, taxpayer identification and address to determine if a taxable gain was reported, it only needs additional identity information such as copies of passports and driver’ licenses or “Know Your Customer” due diligence if there is potentially a taxable gain and if there is some doubt as to the taxpayer’s identity. If there is not, these additional records will not shed any light on a legitimate investigation.

These records may become necessary for a specific account holder once the IRS reviews the relevant records; but for many or even most of the account holders they may never be relevant and thus the Court will not order their production.

As the above reflects, the IRS will have the benefit of time to review the records it receives and select targets for further scrutiny. As we previously observed, the Coinbase summons highlights the fact that virtual currency is not truly anonymous, and that those who use it to hide income or illicit activity should not assume otherwise.  The U.S. government presumably will use the powerful tool of a John Doe summons against other virtual currency exchanges, just as it used this tool repeatedly against banks in the decade-long enforcement campaign against undisclosed foreign bank accounts held by U.S. taxpayers, with long-term and substantial results.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Ballard Spahr LLP | Attorney Advertising

Written by:

Ballard Spahr LLP

Ballard Spahr LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.