Warning to All U.S. Taxpayers Who Use Cryptocurrency: “Crypto” Doesn’t Mean Your Currency is Secret — or Protected — from the IRS

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On August 15, 2022, the federal court in the Central District of California authorized the IRS to serve a John Doe summons on SFOX, a cryptocurrency prime dealer headquartered in California. A John Doe summons is a device (e.g., a subpoena) to gather information from a third party, where the IRS does not know the identity of the person about whom they are seeking the information. This is not the first time the IRS has issued a John Doe summons on a crypto-entity, but this is the first time the IRS has specifically investigated and sought out taxpayers with high-value cryptocurrency transactions. This also marks the first time the IRS has targeted a cryptocurrency trading platform, highlighting the IRS’s interest in underreported cryptocurrency transactions.

Although there is no allegation that SFOX is engaged in any wrongdoing, the John Doe summons requires SFOX to produce records identifying U.S. taxpayers who have used its services and any other documents relating to the taxpayers’ cryptocurrency transactions. The summons allows the IRS to obtain information about U.S. taxpayers who conducted at least $20,000 in any year, in cryptocurrency transactions from 2016 to 2020, using SFOX.

This is not the first time a federal court has used a John Doe summons to extract information from non-parties about U.S. taxpayers involved in cryptocurrency transactions. In 2016, a federal court authorized the IRS to serve a John Doe summons on a U.S.-based cryptocurrency exchange. In 2021, two federal courts in California authorized the IRS to serve two John Doe summons on two cryptocurrency exchanges and one digital wallet institution.

When the IRS investigates potential violations of internal revenue law by unknown persons, groups, or classes of persons, the IRS will seek a John Doe summons, which is authorized under Internal Revenue Code § 7609(f). With a normal summons, the IRS seeks information about a specific taxpayer whose identity is known; in contrast, a John Doe summons allows the IRS to obtain information about any taxpayer within an “ascertainable group or class of persons.” I.R.C. § 7609(f)(1). The IRS also must have a “reasonable basis” for believing such group or class of persons may have violated the internal revenue law. I.R.C. § 7609(f)(2).

John Doe summonses are not limited to cryptocurrency transactions. In 2008 and 2013, the IRS obtained John Doe summonses on Swiss-based banks to obtain information about U.S. taxpayers who used Swiss bank accounts to evade U.S. federal income taxes.

The IRS has made clear its intent on focusing its efforts on obtaining information on those using cryptocurrency to prosecute violations of the internal revenue laws.

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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.

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