Federal judge orders Coinbase to turn over bitcoin user data

A federal court in the Northern District of California has authorized the Internal Revenue Service (IRS) to obtain information about U.S. taxpayers who conducted transactions through Coinbase from 2013 to 2015.

While the IRS makes no allegation that Coinbase has engaged in any wrongdoing, the authorization is instead targeting the company’s customers. “There is a reasonable basis for believing that such group or class of persons may fail, or may have failed, to comply with one or more provisions of the internal revenue laws.”

“Because the IRS considers virtual currencies to be property, United States taxpayers can realize a taxable gain from buying, selling, or trading in virtual currencies. There is a likelihood that United States taxpayers are failing to properly determine and report any taxable gain from such transactions.”
— – Internal Revenue Service

Bitcoin taxation in the US dates back to May 2013, when the Government Accountability Office (GAO) issued a report on tax compliance issues relating to digital currencies. Several tax compliance risks associated with digital currencies were identified, including a lack of third-party reporting, a lack of knowledge among taxpayers, and uncertainty over the characterization of gains realized from virtual currencies.

Responding to this report, the IRS issued Notice 2014-21 in March 2014: “In some environments, virtual currency operates like “real” currency — i.e., the coin and paper money of the United States or of any other country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance — but it does not have legal tender status in any jurisdiction.” The agency concluded that, “General tax principles that apply to property transactions apply to transactions using virtual currency.”

A couple of months later, the GAO issued a second report that focused more broadly on the public policy challenges posed by the use of virtual currencies. The report found that due in part to “the higher degree of anonymity” offered by digital currencies, they may be attractive to parties seeking to move or conceal money obtained by illegal means.

“Some taxpayers may use virtual economies and currencies as a way to evade taxes. Because transactions can be difficult to trace and many virtual economies and currencies offer some level of anonymity, taxpayers may use them to hide taxable income.”
— – Government Accountability Office

About a week before this week’s judicial order, the Treasury Inspector General for Tax Administration (TIGTA) issued a report about the increased use of digital currencies and the associated risks of reporting noncompliance in taxable transactions. The agency acts as a watchdog over the IRS and makes sure that they are using and gathering taxpayer money properly.

TIGTA reprimanded the IRS for its lack of action in dealing with digital currency users. “It is imperative that the IRS ensures that those who engage in activities using virtual currencies comply with all of their tax obligations,” they stated. The agency made it clear that the IRS has not been doing enough, and suggested three courses of action to remedy the situation. The IRS agreed to a number of points.

The IRS then quickly filed a civil petition with the Northern District Court of California on November 17, seeking digital currency user data, including identity from the San Francisco-based exchange. The following day, the case was assigned to Judge Jacqueline Scott Corley.

Just days before the IRS’s summons was approved, cryptocurrency lawyer Marco Santori speculated that the judge was unlikely to enforce the request. In an interview with Forbes, Santori predicted that the IRS would eventually scale back its demand and then ask Coinbase to turn over just the “bigger fish” among its clients. “This is a blanket request—it’s an opening offer. They have to come in with something crazy, then agree to limit it something reasonable.”

The IRS routinely uses John Doe summonses to obtain information about possible violations of internal revenue laws by individuals whose identities are unknown. The IRS’s authority to issue ‘John Doe’ summonses to banks or other depositories to discover the identity of individuals who may have failed to disclose all of their income was expressly recognized by the Supreme Court in United States. v. Bisceglia, (1975).

This summons seeks account registration records and any KYC due diligence performed for any account. “These types of documents should reveal the identity of account holders, as well as amounts of transactions from those accounts,” stated the IRS.

“The court’s order grants the IRS permission to serve what is known as a ‘John Doe’ summons on Coinbase.”
— – US Department of Justice

Coinbase has been consistent throughout the proceedings, promising that they will fight it to the best of their abilities. The company stated that they “are extremely concerned with the indiscriminate breadth of the government’s request,” and that in its current form, they “will oppose the government’s petition in court.”

The company has since clarified that it will oppose the latest summons, too. “We are aware of, and expected, the Court’s ex parte order today,” Coinbase spokesperson David Farmer told Ars Technica Wednesday. Further, the startup says they are looking forward to opposing the DOJ’s request after they are served with a subpoena. “As we previously stated, we remain concerned with our US customers’ legitimate privacy rights in the face of the government’s sweeping request.”

A case management conference, where lawyers from both sides will meet with the judge discuss how to handle the case, has been scheduled February 16, 2017, according to Ars.