IRS Is Cleared to Serve John Doe Summons on Cryptocurrency Exchange

On April 1, 2020, the U.S. District Court for the District of Massachusetts granted the IRS leave to serve a “John Doe summons” on Boston-based Circle Internet Financial Inc. and its affiliates,¹ the administrators of a prominent cryptocurrency exchange called Poloniex. Circle reportedly has planned to establish Poloniex as “the U.S.’s first regulated crypto exchange.”²

A “John Doe summons” is a peculiar creature of the Internal Revenue Code. It is a mechanism through which the IRS, with court approval, can compel information from a third-party concerning a taxpayer or class of taxpayers not identified by name in the summons. A John Doe summons needs to identify a particular taxpayer or taxpayer class by some other ascertainable criteria. In order to obtain approval for such a summons to be served under Code section 7609(f), the IRS and Department of Justice have to convince a district court that: (1) the summons relates to the investigation of an ascertainable set of taxpayers; (2) there is a reasonable basis to believe that such taxpayers failed to comply with the tax laws; and (3) the information the summons seeks to obtain is not readily available from other sources.³ In addition, since Congress amended the John Doe summons statute in 2019, IRS and DOJ also have to show that the summons is “narrowly tailored” to identify the noncompliance with the tax laws that it is intended to address.⁴

In the early 2000s, IRS and DOJ used the John Doe summons process to great effect to begin their long crackdown on abusive offshore banking. A handful of such summonses set events in motion that eventually led to the collapse of bank secrecy in Switzerland and other jurisdictions, and enhanced international cooperation on tax information exchange. More recently, the IRS has turned this powerful tool on the cryptocurrency industry. For example, it obtained leave to serve such a summons on the Coinbase virtual currency exchange in 2016.⁵ In addition, in a petition that remains pending with the U.S. District Court for the Northern District of California, the IRS seeks leave to serve a John Doe summons on Payward Ventures, administrators of the Kraken cryptocurrency exchange.⁶

It should be noted that — at present, anyway — the IRS and DOJ are not necessarily accusing prominent cryptocurrency exchanges of wrongdoing. Rather, as indicated by the public statements that accompanied the Circle order, their efforts appear focused on individual account-holders who are using virtual currency to hide taxable income, or potentially to conceal illicit activity.⁷ This focus dovetails with the U.S. government’s broader, cross-agency efforts to bring cryptocurrency users and the exchange industry “into the fold” of tax and financial institution reporting. For instance, IRS Notice 2014-21 “describes how existing general tax principles apply to transactions using virtual currency”;⁸ and FinCEN’s guidance of May 9, 2019 “remind[s] persons subject to the Bank Secrecy Act (BSA) how FinCEN regulations… apply to certain business models involving money transmission denominated in… virtual currencies.”⁹

It remains to be seen whether the IRS’s recent suite of cryptocurrency-focused John Doe summonses will affect the same magnitude of change that the offshore banking industry and foreign bank account-holders experienced a decade ago. After all, there has been a change to the relevant tax code provision in the intervening years — the addition of the “narrowly tailored” summons requirement by Congress in 2019 — that at least has the potential to narrow the impact of these summonses. Many eyes will be on the IRS’s request for John Doe summons in the Payward Ventures matter, and on subsequent litigation that may address or attempt to resolve any discrepancies in how the district courts have handled the recent cryptocurrency summonses.

In the meantime, the IRS has served a court-approved summons on Circle Internet Financial seeking documents and information concerning any and all U.S. taxpayers who conducted transactions with or through Circle in cryptocurrency totaling at least $20,000 in any calendar year from 2016 through 2020, inclusive.¹⁰ The records under summons include registration and due-diligence papers, account-related correspondence, and records of account activity.¹¹ It is a good bet that enforcement activity regarding individual account-holders will eventually follow. Circle or Polniex account-holders who fit the summons criteria would be wise to assess their tax compliance.