Kraken Loses Bid To Avoid Turning Over Customer Information to IRS | JD Supra

key takeaways

• A court has approved the issuance of a John Doe subpoena by the IRS to major cryptocurrency platform Kraken, with the goal of identifying individuals who are potentially dodging their income tax obligations related to cryptocurrency transactions.
• The IRS and other prosecution agencies have made it clear that John Doe subpoenas are a powerful tool to pursue the non-reporting and underreporting of virtual currency.

In a recent ruling, a federal judge in California held that Kraken, an online cryptocurrency exchange program, has to turn over user information to the IRS as a result of a John Doe subpoena originally served on Kraken in 2021.[1] The IRS launched Operation Hidden Treasure in May 2021 in an effort to root out tax abuse among cryptocurrency users. As part of these efforts, the IRS has been issuing John Doe subpoenas to major cryptocurrency platforms, seeking information that would allow the IRS to identify users who are not in compliance with tax filing and payment obligations. Cryptocurrency platforms and users should hope that this decision will further embolden an already aggressive IRS and Department of Justice.

Due to the perceived pseudo-anonymous nature of cryptocurrency, the IRS has identified the multitude of tax compliance risks associated with its use. As an IRS agent said in a statement in support of the Kraken subpoena, the number of taxpayers reporting cryptocurrencies “drops.”[s] well below what would be expected given the number of users, transactions, and value that virtual currency exchanges advertise annually.”[2] A 2016 study by the Treasury Inspector General for Tax Administration found that "taxpayer use of virtual currencies, including cryptocurrencies, has expanded significantly in recent years" and that "while there are legitimate reasons to use virtual currency… some virtual currencies are… popular because the identities of the parties involved are generally anonymous, leading to a greater possibility of their use in illegal transactions.”[3]

In response to concerns about cryptocurrency tax noncompliance, the IRS expanded its Electronic Payment Systems Initiative, which was launched in 2005 to target U.S. taxpayers who use electronic funds payment and transfer services with tax evasion purposes. The broker noted that this expansion is "to address US taxpayers who use virtual currencies for tax evasion purposes, recognizing that some US taxpayers use such currencies to expatriate and repatriate funds to and from overseas accounts." As part of this initiative, the IRS has established the Virtual Currency Issuance Team to, among other things, "consider the compliance impact related to virtual currencies."[4]

Also in evidence of the strong focus in these areas, IRS Criminal Investigation (IRS-CI) recently announced the launch of a pilot program in which "cyber attaches" will be deployed across four continents to combat tax and financial crimes involving cryptocurrencies, decentralized finance and pairs. -peer-to-peer mix and pay services. The four individuals selected to serve as cyber attachés have significant experience in cybercrime investigation and will work with IRS-CI's law enforcement counterparts in Asia, Europe, South America and Australia. The 120-day program, which runs from June to September 2023, aims to strengthen relationships with foreign law enforcement and ensure foreign counterparts have access to the same tools and expertise used in the States. United to effectively combat cybercrime on a global scale. .

John Doe subpoenas are an incredibly powerful tool for the IRS because they allow the agency to pull user information for these platforms and match it against taxpayer information. The IRS then uses that data to launch tax audits and civil and criminal investigations of cryptocurrency users who failed or underreported cryptocurrency activity.

In the Kraken case, the court ordered the company to hand over customer and transaction data, including names, dates of birth, tax identification numbers, phone numbers, addresses, email addresses, blockchain and hash addresses. for accounts with at least $20,000 in transactions between 2016 and 2020. The judge did deny some of the requests included in the subpoena, including information related to sources of wealth and employment, holding that the information was not necessary to prove the identity of users.

Similar John Doe subpoenas have been used successfully to obtain customer information from other major cryptocurrency platforms, including Coinbase, sFox, and Poloneix. In a previous case, a subpoena issued to a major cryptocurrency exchange resulted in information that led the IRS to issue 10,000 letters to taxpayers reminding them of their tax filing responsibilities. The IRS estimated that these letters resulted in 577 amended income tax returns and an additional $15 million in assessed federal tax liability. Therefore, individuals should expect the IRS to continue to investigate such transactions to find those who have shirked their responsibilities and make those individuals pay back taxes, as well as potentially impose civil penalties and, in extreme cases, pursue criminal liability. .

The IRS has made no secret of the fact that it intends to hold accountable those who fail or fail to report their virtual currency transactions, including stating the obligation to report such transactions on the first page of taxpayers' 1040 forms. It's also no secret that more John Doe subpoenas are likely to hit cryptocurrency platforms, given the IRS's successes both in litigation where subpoenas have been challenged and in using information gleaned from subpoenas to entrap taxpayers. that do not declare or do not declare cryptocurrencies. proceedings.

Cryptocurrency platforms should be prepared to receive a subpoena from the IRS John Doe requesting information about their users, and users of cryptocurrency platforms should ensure they comply with applicable tax laws and regulations.

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