Coinbase Customer’s Lawsuit Against IRS Reminds Taxpayers of Government’s Interest in Auditing Virtual Currency Traders
A year ago, the IRS sent nearly 10,000 letters relating to cryptocurrency tax compliance to a large virtual currency exchange’s customer. A year later, one of those customers has filed a lawsuit against the IRS for violating his Fourth and Fifth Amendment rights under the U.S. constitution, forcing a showdown in the U.S. court system that challenges the IRS purported authority to demand large swaths of information without reasonable suspicion as to whether a crime has been committed. Regardless of the outcome of that case, U.S. traders of cryptocurrency who have not paid taxes upon the sale of appreciated virtual currency, especially where day trading has occurred, should consult with an experienced tax attorney to determine the best strategy to come into tax compliance.
Coinbase is one of the largest virtual currency exchanges in the U.S. Customers create a virtual wallet from which they store cryptocurrency that they have bought. Although Coinbase does not support every virtual currency, it does allow trading of all the major players such as Bitcoin, Bitcoin Cash, and Ethereum. Coinbase became an obvious target as a source of information on cryptocurrency transactions.
In 2018, a federal court granted the IRS a “John Doe summons”, a request for information about unnamed individuals, targeting Coinbase’s customers that made virtual currency purchases or sales between 2013 and 2015. John Doe summons are a tool frequently used by the IRS when they are unsure about the identity of an individual who has potentially engaged in illegal conduct. In this case, the summons was undoubtedly a method aimed at both gaining evidence to build cases against individuals and help the Service understand the activities of cryptocurrency traders.
James Harper, one of Coinbase’s customers, has filed a lawsuit in federal court alleging that the IRS John Doe summons violated his Fourth and Fifth Amendment rights. Harper’s argument rests on the notion that the government cannot intrude upon an American’s private records without articulating at least a reasonable suspicion that a crime has been committed.
The IRS has taken the position that virtual currency is not currency but rather is property, subject to general principles of taxation regarding the property. If a person sells virtual currency and realizes a profit, he or she is required to report that amount as income and pay the associated taxes. Harper indeed engaged in virtual currency trades during the period covered by the John Doe summons but paid all required federal income tax on the income that he earned.
Harper’s argument is that the government had no reason to believe that he had violated any law. Which is relatively difficult to rebut. The Fifth Circuit Court of Appeals recently ruled that a person does not have an expectation of privacy in their Coinbase virtual currency transaction records. But that is likely not the end-all-be-all decision on virtual currency privacy.
If you have engaged in virtual currency transactions, either through Coinbase or otherwise, it may be in your best interest to contact an experienced tax attorney to ensure that you are in tax compliance. The IRS has obviously targeted cryptocurrency as an area of enforcement and practitioners expect increased audits of those who have bought or sold cryptocurrency. It is up to each individual taxpayer to determine whether they have complied with the relevant tax laws surrounding the sale and other transfer of virtual currency.
Note: As long as a taxpayer that has willfully committed tax crimes (potentially including non-reported cryptocurrency income) self-reports the tax fraud (including a pattern of non-filed returns) through a domestic or offshore voluntary disclosure before the IRS has started an audit or criminal tax investigation / prosecution, the taxpayer can ordinarily be successfully brought back into tax compliance and receive a nearly guaranteed pass on criminal tax prosecution and simultaneously often receive a break on the civil penalties that would otherwise apply.
It is imperative that you hire an experienced and reputable criminal tax defense attorney to take you through the voluntary disclosure process. Only an Attorney has the Attorney Client Privilege and Work Product Privileges that will prevent the very professional that you hire from being potentially being forced to become a witness against you, especially where they prepared the returns that need to be amended, in a subsequent criminal tax audit, investigation or prosecution.
Moreover, only an Attorney can enter you into a voluntary disclosure without engaging in the unauthorized practice of law (a crime in itself). Only an Attorney trained in Criminal Tax Defense fully understands the risks and rewards involved in voluntary disclosures and how to protect you if you do not qualify for a voluntary disclosure.
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