Since at least 2016 the IRS has been ferreting out taxpayers who failed to report their taxable gains from cryptocurrency transactions by issuing John Doe summonses to crypto exchanges and dealers. (See prior articles here and here). A John Doe summons enables the IRS to obtain information, such as a list of unrelated customers from a business or service provider that is not itself a target of the investigation. John Doe summonses are often used when the IRS has a reasonable basis to believe the targeted customers failed to comply with one or more provisions of the tax law, but the IRS cannot determine the taxpayer’s identity. Thus, a John Doe summons serves as an information-gathering tool for the IRS. In August the IRS issued a John Doe summons seeking customer information from SFOX, a cryptocurrency prime dealer and trading platform with more than 175,000 registered users. The summons explicitly stated that SFOX itself was not alleged of any wrongdoing (see here).
The IRS also sought to issue a related John Doe summons to a banking institution (M.Y. Safra Bank) that had partnered with SFOX to offer SFOX’s users access to cash deposit bank accounts at the bank, and thereby facilitate the crypto trading activity of such SFOX customers. On September 21, 2022 the U.S. District Court for the Southern District of New York approved this John Doe summons to M.Y. Safra Bank. Interestingly, by issuing these summonses to both the crypto dealers and banks involved in the targeted customers’ crypto, the IRS has effectively increased the investigatory power of a single summons standing alone and likely gained a more comprehensive understanding of any identified taxpayer’s crypto activity. It is unclear if such concurrent summonses will now become the norm for the IRS whenever a bank has close relationships with particular crypto exchanges and dealers.
At least one taxpayer, James Harper, is challenging the validity of using John Doe summonses for crypto. The IRS’s use of John Doe summonses in these concurrent situations may also be subject to future challenge.
In 2020 James Harper, who was identified to the IRS in response to a John Doe summons served on the cryptocurrency exchange platform Coinbase Inc. (as previously reported here), challenged the validity of the Coinbase summons for failing to satisfy the statutory issuance requirements and on grounds that it violated Mr. Harper’s Fourth and Fifth Amendment rights. (Harper v. Rettig, No. 20-cv-771-JD (D.N.H 2022)). Without addressing the merits, the IRS moved to dismiss the case as prohibited by the Anti-Injunction Act (the “AIA”) (which bars suits whose purpose is restraining the “collection or assessment” of tax), and the district court agreed. However, the First Circuit Court of Appeals recently reversed that ruling and allowed the case to continue to a determination on the merits (Harper v. Rettig, No. 21-1316 (1st Cir. 2022)). The First Circuit narrowly read the AIA to only prohibit actions directly involving “collection or assessment.” Since a John Doe summons only implicates the IRS’s information-gathering efforts, the court found that such summonses fall outside the reach of the AIA. While the taxpayer’s Constitutional and procedural claims in Harper may not ultimately succeed (similar claims in other contexts have been rejected), the taxpayer has at least won his right to claims adjudicated on the merits, and if Mr. Harper does ultimately succeed, the implications for the IRS’s use of John Doe summonses could be wide-ranging.
The Harper case indicates that at least as a preliminary matter, future challenges to the validity of the John Doe summonses issued concurrently to crypto dealers and partnering banking institutions may be adjudicated, and taxpayers as well as the crypto industry may have another opportunity to challenge the John Doe summons.