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John Doe Summons Needed in Cryptocurrency Investigation, DOJ Says

MAR. 30, 2021

In the Matter of the Tax Liabilities of John Does

DATED MAR. 30, 2021
DOCUMENT ATTRIBUTES
  • Case Name
    In the Matter of the Tax Liabilities of John Does
  • Court
    United States District Court for the District of Massachusetts
  • Docket
    No. 1:21-mc-91201
  • Institutional Authors
    U.S. Department of Justice Tax Division
  • Cross-Reference

    Government petition.

  • Code Sections
  • Subject Area/Tax Topics
  • Jurisdictions
  • Tax Analysts Document Number
    2021-14109
  • Tax Analysts Electronic Citation
    2021 TNTF 65-24

In the Matter of the Tax Liabilities of John Does

[Editor's Note:

Attachments to the brief can be viewed in the PDF version of the document.

]

IN THE MATTER OF THE TAX LIABILITIES OF:
JOHN DOES, United States person(s) who directly or indirectly had authority over any combination of accounts held with Circle Internet Financial, Inc., or its predecessors, subsidiaries, divisions, affiliates, including Poloniex LLC (collectively “Circle”), with at least the equivalent of $20,000 in value of transactions (regardless of type) in cryptocurrency in any one year, for the period beginning January 1, 2016, through December 31, 2020.

IN THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS

BRIEF IN SUPPORT OF UNITED STATES OF AMERICA'S
PETITION FOR LEAVE TO SERVE JOHN DOE SUMMONS

Respectfully submitted,

DAVID A. HUBBERT
Acting Assistant Attorney General
Tax Division, U.S. Department of Justice

EDWARD J. MURPHY
Trial Attorney, Tax Division
U.S. Department of Justice
P.O. Box 55
Washington, D.C. 20044
202-307-6064 (v)/202-514-5238 (f)
Edward.J.Murphy@usdoj.gov


TABLE OF CONTENTS

I. Introduction

II. Background

A. “Cryptocurrency” Defined

B. Tax Treatment of Cryptocurrency Transactions

C. Information Regarding Cryptocurrency Transactions Held by Circle

D. Grounds for the IRS's Belief That Virtual Currency Transactions Are Not Being Properly Reported

1. The Lack of Third-Party Reporting to the IRS

2. The John Doe Summons to Coinbase, Inc., and Its Aftermath

3. MTRDB Search Results

4. Suspected Tax Non-Compliance by Circle Customers

III. Law and Argument

A. Governing Law

B. Application of § 7609(f)

1. The Summons Relates to the Investigation of an Ascertainable Class

2. There Is a Reasonable Basis for Believing That the John Doe Class May Fail, or May Have Failed, to Comply with the Internal Revenue Laws

3. The Information Sought in the Summons Is Not Readily Available From Other Sources

4. The Summons Is Narrowly Tailored to Information That Pertains to the Failure (or Potential Failure) of the Class to Comply with the Internal Revenue Laws

IV. Conclusion


BRIEF

The United States of America submits this brief in support of its petition for an order approving the service of an Internal Revenue Service John Doe summons on Circle Internet Financial, Inc., or its predecessors, subsidiaries, divisions, affiliates, including Poloniex LLC (collectively “Circle”). A copy of the summons and summons attachment (listing the items requested) are filed herewith, as well as a proposed order, the Declaration of IRS Revenue Agent John Mark Peil (hereinafter “Declaration”), and supporting exhibits.

I. Introduction

The summons is in furtherance of the IRS's ongoing investigation to determine the identity and correct federal income tax liability of U.S. persons who have conducted transactions in cryptocurrency. See Declaration ¶¶ 3, 8, 30. Transactions in cryptocurrency have grown substantially in recent years, and the IRS is concerned that taxpayers are not properly reporting these transactions. The summons seeks account and transaction records from Circle that are expected to aid the IRS's investigation.

The summons is a so-called “John Doe” summons because it does not identify the persons with respect to whose liabilities the summons is issued. 26 U.S.C. § 7609(f). The government therefore must obtain court approval prior to serving the John Doe summons. Id. As discussed below, the criteria for court approval of a John Doe summons in § 7609(f) are met.

Pursuant to 26 U.S.C. § 7609(h)(2), the Court's determination of whether a John Doe summons may be served shall be made ex parte and shall be made solely on the petition and supporting affidavits. The pleadings filed in this proceeding will therefore not be served upon any person or entity, and no other filings are permitted from other persons or entities. The United States requests that the Court review the petition and supporting documents and that it enter the proposed order at the Court's earliest opportunity.

II. Background

The summons seeks account and transaction records from Circle regarding a group of its customers whose identities are not known to the IRS (the “John Does”). The group of John Does is defined on the summons as follows: United States person(s) who directly or indirectly had authority over any combination of accounts held with Circle or its predecessors, subsidiaries, divisions, or affiliates, including Poloniex LLC, with at least the equivalent of $20,000 in value of transactions (regardless of type) in cryptocurrency in any one year, for the period January 1, 2016, through December 31, 2020 (the “John Doe Class”). The six document requests are for account registration records, Know-Your-Customer due diligence, account-related correspondence, anti-money laundering exception reports, records of account activity, and records of account funding. Before addressing why a summons for the requested items directed at this John Doe Class meets the criteria in § 7609(f), this brief will first provide relevant background regarding (A) the definition of cryptocurrency, (B) its tax treatment, (C) the information regarding taxable cryptocurrency transactions that is in the possession of Circle, and (D) the grounds for the IRS's belief that these transactions are not being properly reported.

A. “Cryptocurrency” Defined

“Crypotocurrency” is one kind of “virtual currency.” In Notice 2014-21, 2014-16 I.R.B. 938, 2014 WL 1224474 (Mar. 26, 2014), the IRS defined “virtual currency” as a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. It sometimes operates like “real” or “fiat” 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 virtual currency does not have legal tender status in any jurisdiction. When virtual currency has an equivalent value in real currency, or acts as a substitute for real currency, then it is referred to as “convertible” virtual currency.

The summons at issue here solely concerns “cryptocurrency.” Cryptocurrency is a type of virtual currency that utilizes cryptography to secure transactions that are digitally recorded on a distributed ledger (such as a blockchain). Distributed ledger technology uses independent digital systems to record, share, and synchronize transactions, the details of which are recorded in multiple places at the same time with no central data store or administration functionality. Units of cryptocurrency are generally referred to as coins or tokens. The most common cryptocurrency is Bitcoin, but there are many others.1 The technological innovation, rapid growth, and decentralized nature of cryptocurrency have created new challenges for regulators, including the IRS. See generally Report of the Attorney General's Cyber Digital Task Force: Cryptocurrency Enforcement Framework, Oct. 1, 2020, https://www.justice.gov/ag/page/file/1326061/download [https://perma.cc/Q2XH-5LF9].

B. Tax Treatment of Cryptocurrency Transactions

The IRS's position in Notice 2014-21 is that convertible virtual currencies (including cryptocurrency) are considered property for tax purposes, and a taxpayer can have a gain or loss on the sale or exchange of a virtual currency. Thus, taxpayers who transact in virtual currencies may have related tax filing and reporting requirements under various provisions of the Internal Revenue Code, including 26 U.S.C. §§ 61, 451, and 1011.

Taxpayers often complete their virtual currency transactions through businesses known as digital currency exchanges, which allow users to buy and sell cryptocurrency in exchange for fiat currency or other virtual currency. Declaration ¶ 25. Depending on the details, these transactions may be taxable. See id. ¶ 32. Taxpayers must report income, gain, or loss from all taxable transactions involving virtual currency on their federal income tax returns for the year of the transaction, regardless of the amount or whether they received a payee statement or information return. See Frequently Asked Questions on Virtual Currency Transactions (Q&A-42), https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions [https://perma.cc/634V-UW5P].

C. Information Regarding Cryptocurrency Transactions Held by Circle

Circle is a Boston-based company that launched operations in 2013. It has offered customers access to several virtual currency exchanges, including Poloniex2, Circle Trade, and Circle Invest. As of July 2019, Circle had served over 8 million customers with over $200 billion in trading volume of more than 60 types of virtual currency. Declaration ¶ 50 (citing https://web.archive.org/web/20191022123009/https:/www.circle.com/en/). As of May 2018, the trading volume of Circle Trade was “about $4 billion in the past month.” Telis Demos, Banking & Finance: Fintech Firm Circle's Equity Valuation Soars, Wall Street Journal, May 17, 2018.

Circle is regulated as a “money services business” (MSB), and more specifically as a “money transmitter.” See 31 C.F.R. § 1010.100(ff) (defining “money services business”); § 1010.100(ff)(5) (defining “money transmitter” as one type of MSB). It is currently registered as an MSB with the Financial Crimes Enforcement Network (FinCEN)3, and it has acknowledged being licensed as a money transmitter at the state level as well. See https://www.fincen.gov/msb-registrant-search [https://perma.cc/VRC8-8UUC]; Circle's May 16, 2016 Letter to Comptroller of the Currency, https://www.occ.gov/topics/supervision-and-examination/responsible-innovation/comments/comment-circle-financial.pdf [https://perma.cc/A8PE-GSL9].

An MSB like Circle is required to maintain certain records. See 31 C.F.R. §§ 1010.410 (Records to be made and retained by financial institutions) and 1022.400 (making these recordkeeping requirements applicable to MSBs). Those records include, for transactions worth more than $3,000, the name and address of both the sender and recipient, the amount of the transaction, the date of the transaction, and other identifying information. § 1010.410(e); see Declaration ¶¶ 53-56. MSBs are also required to obtain and maintain certain customer identification information and transactional data for the purpose of combating money laundering. See 31 C.F.R. § 1022.210.

In keeping with these rules, Circle has historically required new customers to create an account by submitting certain identifying information, including the user's full legal name. Declaration ¶ 61. Each underlying Circle service has had additional requirements as well. Id. For example, Poloniex required new users to provide their full legal name, current address, a picture of an identification card, and a picture that includes their face and documents with the current date and the word “Poloniex” visible. Id. ¶ 62. Similar information was required to access other Circle services. Id. ¶¶ 63-64.

Based on the regulations applicable to Circle, as well as Circle's historical business practices, the IRS expects that, in response to the John Doe summons, Circle will be able to provide information about its customers' cryptocurrency transactions, which the IRS will then be able to use in conjunction with other publicly-available information to examine whether an individual has complied with the internal revenue laws. Declaration ¶ 29.

D. Grounds for the IRS's Belief That Virtual Currency Transactions Are Not Being Properly Reported

The IRS, in recent years, has become aware of significant tax compliance issues relating to the use of virtual currencies. Declaration ¶ 4. Of particular relevance here are the lack of third-party reporting to the IRS, the experience with the John Doe summons that was served on Coinbase, Inc., data from the Modernized Tax Return Data Base (MTRDB), and previous audits of Circle customers.

1. The Lack of Third-Party Reporting to the IRS

Agent Peil searched and found no record that Circle provided information returns to the IRS relating to virtual currency transactions conducted by, or on behalf of, their customers. Declaration ¶ 66. This information gap is a concern for the IRS because, as Agent Peil's Declaration explains, cryptocurrency transactions can already be difficult to trace, with many having an inherent pseudo-anonymous aspect, making them especially attractive to taxpayers who may want to use them to hide taxable income. Id. ¶¶ 24, 35.

More generally, the IRS's experience is that tax noncompliance increases when there is less third-party information reporting, making the likelihood of underreporting significant. Id. ¶ 37; see Federal Tax Compliance Research: Tax Gap Estimates for Tax Years 2011–2013, IRS Publication 1415 (Rev. 9-2019), https://www.irs.gov/pub/irs-pdf/p1415.pdf, at 13 [https://perma.cc/2XM5-PDNH] (finding that the net misreporting percentage “for income amounts subject to little or no information reporting . . . is 55 percent.”); see also Patricia Cohen, If the I.R.S. Is Watching You, You'll Pay Up, N.Y. Times, Jan. 5, 2016, at B1, https://www.nytimes.com/2016/01/05/business/economy/if-the-irs-is-watching-you-youll-pay-up.html [https://perma.cc/S9DK-QYU6]. Unfortunately, the lack of third-party reporting of cryptocurrency transactions is not confined to Circle, See Wendy Walker, INSIGHT: The 5 Most Common Tax Reportable Crypto Events, Bloomberg Tax, Aug. 20, 2020, available at https://news.bloombergtax.com/daily-tax-report/insight-the-5-most-common-tax-reportable-crypto-events [https://perma.cc/TH2J-5TT6] (noting that “a recent survey of crypto CPAs found that more than 35% of crypto investors do not receive Form 1099 information related to their crypto transactions”). As the Treasury Inspector General for Tax Administration has reported, “[t]he IRS cannot easily identify taxpayers with virtual currency transactions because of the lack of third-party information reporting that specifically identifies virtual currency transactions.” The Internal Revenue Service Can Improve Taxpayer Compliance for Virtual Currency Transactions, TIGTA Ref. No. 2020-30-066 (Sept. 24, 2020), https://www.treasury.gov/tigta/auditreports/2020reports/202030066fr.pdf [https://perma.cc/83SZ-YJUK].

2. The John Doe Summons to Coinbase, Inc., and Its Aftermath

In November 2016, the U.S. District Court for the Northern District of California authorized service of a John Doe summons on Coinbase, Inc. (“Coinbase”), a U.S.-based cryptocurrency exchange, for information to be used in identifying taxpayers who conducted transactions in virtual currency. See United States v. John Doe, No. 3:16-cv-06658-JSC (N.D. Cal.). Coinbase was served with the summons but did not voluntarily comply with it. Declaration ¶ 10. The government then filed a petition to enforce the summons in March 2017, and after the IRS agreed to narrow the scope of the summons, the court granted in part and denied in part the enforcement petition. See United States v. Coinbase, Inc., Case No.17-cv-01431-JSC, 2017 WL 5890052 (N.D. Cal. Nov. 28, 2017). Coinbase was ordered to produce documents for accounts with at least the equivalent of $20,000 in any one transaction type (buy, sell, send, or receive)4 in any one year for the period between 2013 and 2015. Id. at *8.

Since Coinbase complied with the John Doe summons, the IRS has continued to reach out to taxpayers regarding their reporting requirements, to conduct examinations, and to make criminal investigation referrals. Declaration ¶ 40. On July 26, 2019, the IRS announced that it had begun sending letters to virtual currency owners, advising them to pay back taxes and file amended returns. Declaration ¶ 14. By the end of August 2019, the IRS had issued more than 10,000 such letters to taxpayers who owned virtual currency. Id. Following the issuance of the letters, taxpayers filed amended returns reporting virtual currency transactions for tax years 2013 through 2018 that were not previously reported. Id. To date, these IRS letters have resulted in more than 1,000 amended returns and more than $13.1 million in assessments. Id. ¶ 40. The IRS has also opened audits of taxpayers identified by materials it received in response to the Coinbase John Doe summons, and it has received submissions through its voluntary disclosure practice as well. Id. Separately, the IRS has contacted taxpayers who have not filed returns reporting virtual currency by sending notices related to virtual currency. Those notices have already resulted in more than $11.9 million in assessments. Id. The IRS expects these numbers to increase as the investigations continue. More recently, the IRS sent letters to taxpayers who conducted transactions with foreign virtual currency exchanges and may have failed to properly report such transactions and associated income. Id. ¶ 41.

3. MTRDB Search Results

During the summons enforcement litigation against Coinbase, the IRS determined that for the years 2013-2015 only 800 to 900 taxpayers per year filed tax returns with a property description related to bitcoin or virtual currency, despite the fact that Coinbase alone had serviced more than 5.9 million customers and handled more than $6 billion in transactions during that time. This was strong evidence of likely large-scale underreporting of taxable transactions. See 2017 WL 5890052, *1-2, 4-5; Declaration ¶ 38. The number of taxpayers filing returns with a property description related to bitcoin or virtual currency increased in 2016-2018, but the numbers still fall far short of what would be expected given the number of users, transactions, and value that the exchanges publicize occur on an annual basis. See Declaration ¶ 39.

4. Suspected Tax Non-Compliance by Circle Customers

Agent Peil explains in detail in his Declaration that he is personally aware of individual taxpayer audits where the IRS learned of previously unreported, and likely taxable, virtual currency transactions involving Circle. Declaration ¶¶ 67-72. The Declaration discusses seven individual taxpayers in this regard, identifying them as “Taxpayer 1” through “Taxpayer 7.”

Taxpayer 1 filed tax returns that failed to report more than 700 transactions conducted through Poloniex. Declaration ¶ 67. The IRS served a summons to Circle for information relating to Taxpayer 1, and Circle's response to the summons included Taxpayer 1's name, address, phone number, email address, login history with IP addresses, pictures, driver's license image, chat name, account status, communications with Poloniex, and account balances by type of virtual currency. Id.

Taxpayers 2 and 3 are married. Id. ¶ 68. They filed joint tax returns for 2015 and 2016 that did not disclose any virtual currency transactions. Id. A subsequent IRS examination uncovered bank account statements indicating transactions with Circle. Id. In response to an IRS summons, Circle provided the IRS with information about a Circle account that had more than 40 unreported transactions as well as a Poloniex account that had more than 500 unreported transactions. Id.

Taxpayer 4 filed tax returns for 2015-17 reporting no virtual currency transactions. Id. ¶ 69. A summons to Circle uncovered three Circle accounts and three Poloniex accounts through which Taxpayer 4 had made more than 250 transactions. Id. Taxpayer 4 did not disclose any of these transactions in an audit interview with an IRS revenue agent. Id.

Taxpayer 5 and Taxpayer 6 are married persons who both pleaded guilty to (i) conspiracy to distribute a controlled substance and (ii) money laundering-transportation of stolen property, for conduct occurring during 2015. Id. ¶ 71. They used an account at Circle to hold, and convert into U.S. dollars, payments received in bitcoin arising from the Taxpayers' illegal activities. Id. Again, Circle responded to an IRS summons with substantial transactional and identifying information, including more than 40 previously undisclosed transactions. Id.

Finally, the IRS identified Taxpayer 7 through data provided by Coinbase pursuant to the John Doe summons discussed above. Id. ¶ 72. After the IRS sent Taxpayer 7 one of the 10,000 letters that went out as a result of the Coinbase summons response, Taxpayer 7 filed amended tax returns for 2014, 2015, 2016 and 2017, reporting previously unreported virtual currency sales of more than $1,600,000, as well as additional tax on those sales. Id. Poloniex is one of the exchanges that Taxpayer 7 used to complete those transactions. Id.

Based on these individual examples, the IRS suspects that there may be many more Circle users who have failed to report their cryptocurrency transactions, and to pay their associated tax liabilities, in accordance with the internal revenue laws.

III. Law and Argument

A. Governing Law

The IRS is statutorily required to have its employees “proceed, from time to time, through each internal revenue district and inquire after and concerning all persons therein who may be liable to pay any internal revenue tax[.]” 26 U.S.C. § 7601(a). To this end, the IRS also has broad investigative powers “for the purpose of ascertaining the correctness of any return, making a return where none has been made, determining the liability of any person for any internal revenue tax or the liability at law or in equity of any transferee or fiduciary of any person in respect of any internal revenue tax, or collecting any such liability[.]” 26 U.S.C. § 7602(a). To fulfill these purposes, the IRS “is authorized” by statute:

(1) To examine any books, papers, records, or other data which may be relevant or material to such inquiry;

(2) To summon the person liable for tax or required to perform the act, or any officer or employee of such person, or any person having possession, custody, or care of books of account containing entries relating to the business of the person liable for tax or required to perform the act, or any other person the Secretary may deem proper, to appear before the Secretary at a time and place named in the summons and to produce such books, papers, records, or other data, and to give such testimony, under oath, as may be relevant or material to such inquiry; and

(3) To take such testimony of the person concerned, under oath, as may be relevant or material to such inquiry.

Id. All told, “[t]he IRS has 'expansive information gathering authority' to determine tax liability under the Internal Revenue Code, including by issuance of summonses to taxpayers and third party record holders.” Sugarloaf Funding, LLC v. U.S. Dept. of Treas., 584 F.3d 340, 345 (1st Cir. 2009) (quoting United States v. Arthur Young & Co., 465 U.S. 805, 816 (1984)).

When issuing an administrative summons to a third party, the IRS is generally required to give notice to the taxpayer. 26 U.S.C. § 7609(a)(1). The taxpayer then has the right to file a petition in court seeking to quash the summons. § 7609(b)(2)(A). However, the third-party notice rules do not apply to certain types of summonses, including a so-called “John Doe summons,” § 7609(c), defined as a summons that “does not identify the person with respect to whose liability the summons is issued.” § 7609(f). Instead, a John Doe summons “may be served only after a court proceeding” establishing the elements listed in § 7609(f). Id. This proceeding is necessarily ex parte because the point of a John Doe summons is to allow the IRS to obtain information when the identity of the taxpayer is unknown. See § 7609(h)(2) (stating that the court's determination under § 7609(f) “shall be made ex parte and shall be made solely on the petition and supporting affidavits”).

The court in this ex parte proceeding effectively serves the same function as a taxpayer in a § 7609(b)(2)(A) petition to quash. See Tiffany Fine Arts, Inc. v. United States, 469 U.S. 310, 317 (1985) (“As a substitute for the procedures of §§ 7609(a) and (b), Congress enacted § 7609(f)[.]”); United States v. Gertner, 65 F.3d 963, 965 n.1 (1st Cir. 1995) (“[T]he court in effect 'takes the place of the affected taxpayer' who, being unnamed, cannot herself be expected to know about — let alone to oppose — the summons even if it is irregular.” (quoting Tiffany Fine Arts, 469 U.S. at 321)). “Congress did not intend to impose stringent restrictions on the Service's investigatory function but merely sought to prevent the indiscriminate exercise of the John Doe summons power.” United States v. Ernst & Whinney, 750 F.2d 516, 519-20 (6th Cir. 1984) (quotation omitted).

Section 7609(f) provides that the IRS may not serve a John Doe summons until after a court proceeding in which the government establishes the following three numbered elements:

(1) the summons relates to the investigation of a particular person or ascertainable group or class of persons,

(2) there is a reasonable basis for believing that such person or group or class of persons may fail or may have failed to comply with any provision of any internal revenue law, and

(3) the information sought to be obtained from the examination of the records or testimony (and the identity of the person or persons with respect to whose liability the summons is issued) is not readily available from other sources.

Additionally, as of 2019, § 7609(f)'s new flush language requires that the summons be “narrowly tailored to information that pertains to the failure (or potential failure) of the person or group or class of persons referred to in paragraph (2) to comply with one or more provisions of the internal revenue law which have been identified for purposes of such paragraph.”

B. Application of § 7609(f)

The summons at issue here meets all three of the numbered criteria in § 7609(f) as well as the new “narrowly tailored” requirement.

1. The Summons Relates to the Investigation of an Ascertainable Class

The first of the three numbered requirements in § 7609(f) is that “the summons relates to the investigation of a particular person or ascertainable group or class of persons.” § 7609(f)(1). This first prong is met because the John Doe Class is particularized from the general public and Circle has the information necessary to ascertain whether its customers are members of the class.

Again, the face of the summons defines the John Doe Class this way: “United States person(s), who directly or indirectly had authority over any combination of accounts held with Circle Internet Financial, Inc., or its predecessors, subsidiaries, divisions, or affiliates, including Poloniex LLC (collectively 'Circle') with at least the equivalent of $20,000 in value of transactions (regardless of type) in cryptocurrency in any one year, for the period January 1, 2016 through December 31, 2020.” This class is ascertainable because it is limited in at least four ways. First, it is limited to Circle account holders. Second, it is limited to United States persons.5 Third, it is limited to those account holders whose transactions were worth at least $20,000 in a year. Fourth, it is limited to the five-year time period of 2016-2020.

The John Doe Class identified in the summons is “ascertainable” because courts have repeatedly found § 7609(f)(1) to be satisfied where a summons identifies a particular group of taxpayers in a similar manner. For example, this test was passed where a summons “squarely particularize[d] the individuals sought from the general public” by identifying the class as California residents who, between 2005 and 2010, were involved in certain property transfers for little or no consideration. See In re Tax Liab. of Does, No. 2:10-mc-00130-MCE-EFB, 2011 WL 6302284, at *2 (E.D. Cal. Dec. 15, 2011). Likewise, the IRS satisfied the “ascertainable group” standard where a summons concerned U.S. taxpayers who, as agents for subsidiaries of a certain company, sold credit insurance policies reinsured with entities in the Turks and Caicos Islands. See In re Tax Liab. of Does, No. 03-22793-CIV, 2003 WL 22953182, at *1 (S.D. Fla. Oct. 30, 2003) (“American Bankers Insurance Group”); see also Matter of Does, Case No. CV-13-3393 YGR, 2013 WL 5503135 (N.D. Cal. Aug. 29, 2013) (approving John Doe class of U.S. taxpayers who had accounts with CIBC First Caribbean International Bank Limited through correspondent accounts at Wells Fargo Bank, N.A., during 2004-2012); In Matter of Tax Liabilities of Does, Civ. No. 3:96-CV-25(DF), 1996 WL 196633, at *1 (M.D. Ga. Feb. 5, 1996) (“As required by 26 U.S.C. § 7609(f)(1), the summons relates to the investigation of an ascertainable group or class of persons, that is, individuals, businesses, corporations, partnerships, joint ventures, and companies within the State of Georgia that received payments from The Loef Company for the sale of recyclable materials, (also referred to as scrap metal), including commissions, for the calendar years 1992, 1993 and 1994.”).

Moreover, as discussed in Part II.C above, Circle should be able to ascertain from its records which of its virtual currency exchange customers were U.S persons, and who among them engaged in the $20,000 floor transactional levels6 during the years specified in the summons, based on the information that we know they collect on their customers. The availability of this information to Circle means that the John Doe Class is an “ascertainable group or class of persons” and that § 7609(f)(1) is satisfied.

2. There Is a Reasonable Basis for Believing That the John Doe Class May Fail, or May Have Failed, to Comply with the Internal Revenue Laws

The second numbered element of § 7609(f) that the government must establish for the Court to approve service of the summons relating to the John Doe Class is that “there is a reasonable basis for believing that such person or group or class of persons may fail or may have failed to comply with any provision of any internal revenue law.” § 7609(f)(2). There is a reasonable basis for believing that members of the John Doe Class may fail (or may have already failed) to report, or to pay tax associated with, cryptocurrency transactions. This belief is based upon the information discussed in Part II.D, above: the lack of third-party reporting to the IRS by Circle regarding its customers' transactions; the IRS's experience with the Coinbase John Doe summons and its aftermath; the MTRDB search results showing likely large-scale underreporting of taxable cryptocurrency transactions; and Agent Peil's personal experience with audits of Circle users.

To meet the “reasonable basis” prong of § 7609(f)(2), the government need only show that a transaction has occurred that is “of such a nature as to be reasonabl[y] suggestive of the possibility that the correct tax liability with respect to that transaction may not have been reported.” H.R. Rep. No. 94-658 at 311 (1975), reprinted in 1976 U.S.C.C.A.N. 2897, 3208; see, e.g., United States v. Ritchie, 15 F.3d 592, 601 (6th Cir. 1994) (clients' payment for legal services with large amounts of cash provided reasonable basis for John Doe summons). When enacting Section 7609(f), Congress did “not intend to impose an undue burden on the [IRS] in connection with obtaining a court authorization to serve this type of summons.” H.R. Rep. No. 94-658 at 311, reprinted in 1976 U.S.C.C.A.N. at 3207. Rather, Congress sought to ensure that the IRS would have “a specific situation to present in the court,” instead of using the summonses to engage in a “possible 'fishing expedition.'” Id.; see also In re Tax Liabs. of Does, 688 F.2d 144, 149 (2d Cir. 1982) (Section 7609(f) was “concerned only with . . . preclud[ing] the IRS from using [John Doe] summonses to engage in possible 'fishing expeditions.'” (quoting H.R. Rep. No. 94-658 at 311)). The government need not “produce conclusive evidence of an actual tax violation as a prerequisite to obtaining a John Doe summons.” Matter of Does, 671 F.2d 977, 980 (6th Cir. 1982) (per curiam) (“Columbus Trade Exchange”). The point of the statute is merely “to prevent the Service from exercising its summons power in an arbitrary or quixotic manner.” Id.; see also Byers v. United States Internal Revenue Service, 963 F.3d 548, 553 (6th Cir. 2020) (“when the government seeks information about an unnamed person from a third party, it must show the district court that it has some reason to believe that this unnamed person violated or may violate the law.”).

Prior experience with similar transactions involving similar parties is a reasonable basis under § 7609(f)(2). For example, Columbus Trade Exchange is one of a group of cases from the early 1980s involving John Doe summonses that the IRS sought approval to serve on barter exchanges. Those barter exchanges are analogous to virtual currency exchanges insofar as the IRS's experience showed that the barter exchange customers, whose identities were unknown, were likely to be underreporting the tax on their transactions. The Sixth Circuit held that the IRS's “past experience with this problem is a 'reasonable basis' for its decision to investigate the returns of Columbus Exchange members,” 671 F.2d at 980, and other courts made similar rulings. See United States v. Pittsburgh Trade Exchange, Inc., 644 F.2d 302, 306 (3d Cir. 1981) (finding, based on IRS agent's testimony, that “barter transactions such as those arranged by The Exchange are inherently susceptible to tax error since no cash is involved and the only records of the members' credits are kept by The Exchange, which allegedly does not provide members any information regarding their trade accounts. Such circumstances provide a sufficient basis for the Internal Revenue Service's action.”); United States v. Island Trade Exchange, Inc., 535 F. Supp. 993, 996-97 (E.D.N.Y. 1982) (approving John Doe summons to barter exchange and finding “reasonable basis” requirement in § 7609(f)(2) met based on IRS agent's declaration that “prior examinations of bartering exchanges and their members by the Internal Revenue Service revealed high levels of omitted or improperly reported income”). Equally here, the IRS's past experience with individual audits of Circle customers, the Coinbase John Doe summons, and other situations in which there is a lack of third-party reporting all strongly suggest that there is a reasonable basis for the summons in this case.

As in the barter-exchange cases, all of the cases arising from the IRS's Offshore Credit Card Project have found a “reasonable basis” for suspecting non-compliance based on the IRS's experience with undisclosed foreign accounts, even in the absence of audits involving the summoned parties, because individuals using credit cards to repatriate funds from offshore bank accounts are likely to be engaged in tax evasion. See, e.g., In re John Does, No. 1:00-CV-3919, 2000 WL 34538137 (S.D. Fla. Oct. 30, 2000) (American Express & MasterCard International, Inc.); In re John Does, No. CV-02-0049-MISC-PJH (N.D. Cal. 2002) (VISA International); In re John Does, No. 02-22404 CIV-UNGARO-BENAGES (S.D. Fla. 2002) (MasterCard International, Inc.); In re John Does, No. 03-22177 CIV-Martinez (S.D. Fla. 2003) (Credomatic of Florida Inc.); In re John Does, No. 04-F-1548 (OES) (D. Col. 2004) (First Data Corporation); In re John Does, No. 04-21986-CIV-UNGARO-BENAGES (S.D. Fla. 2004) (TecniCard, Inc.); and In re John Does, No. 4:04-cv-94-1 (CDL) (M.D. Ga. 2004) (Total Systems Services, Inc.).

This Court has also approved service of a John Doe summons for similar reasons. See In the Matter of the Tax Liabilities of John Does, M.B.D. No. 84-133, 1984 WL 1109 at *1 (D. Mass. Oct. 2. 1984) (First National Bank of Boston). In that case, the court had previously approved a John Doe summons to First National Bank of Boston that sought records of account holders who had received more than $100,000 in interest from certificates of deposit. The IRS had a reasonable basis for the summons because it had obtained the same information from a different bank in Buffalo, after which audits of those account holders “revealed that 107 individual holders out of 115 examined had underreported interest income earned on the certificates.” Id.

Here, the evidence that the IRS has developed to date suggests the possibility that the correct tax liability with respect to cryptocurrency transactions conducted through Circle's virtual currency exchanges may not have been properly reported. Declaration ¶ 42. Again, the IRS knows that when third-party reporting is lacking the incidence of tax non-compliance increases greatly. That concern is a valid one where Circle, like many other virtual currency exchanges, does not issue Forms 1099 or otherwise engage in third-party transactional reporting to the IRS. Additionally, as in the barter-exchange cases, the IRS's past experience with cryptocurrency, especially with respect to the Coinbase John Doe summons, indicates a likelihood of non-compliance by Circle customers. This suspicion is bolstered by the MTRDB search results. Moroever, Agent Peil is personally aware of several instances where IRS audits have uncovered previously unreported (and likely taxable) transactions involving Circle users. See Declaration ¶¶ 67-72, 92, 94. Given all that, the IRS does not have a mere suspicion that the John Doe Class includes taxpayers who are not complying with the law; rather, it knows that the class in the past included such violators, and very likely includes others.

This evidence goes far beyond being the kind of “conclusory” declaration that the First Circuit has found to be insufficient to satisfy § 7609(f)(2). See United States v. Gertner, 65 F.3d 963, 972 (1st Cir. 1995). It strongly suggests that there has been, and continues to be, failure by certain taxpayers to comply with the internal revenue laws in reporting income from cryptocurrency transactions. The “reasonable basis” prong of § 7609(f)(2) is therefore satisfied.

3. The Information Sought in the Summons Is Not Readily Available From Other Sources

The third numbered requirement of § 7609(f) is “the information sought to be obtained from the examination of the records or testimony (and the identity of the person or persons with respect to whose liability the summons is issued) is not readily available from other sources.” This third prong of the test is met because the information sought in the summons to Circle is not readily available from other sources. As noted above, there is no third-party reporting by Circle to the IRS regarding the cryptocurrency transactions that are conducted on its exchanges. Declaration ¶¶ 37, 66. The IRS also has reason to believe that a significant portion of such transactions are not being properly reported by the taxpayers themselves either, but the IRS is presently unable to audit such taxpayers because their identities are unknown. With these limitations, the only repository of the information sought by the summons that is readily available to the IRS is Circle. Declaration ¶ 95. See American Bankers Insurance Group, 2003 WL 22953182, at *1 (finding § 7609(f)(3) met because “information sought by the IRS to continue their investigation is not readily available through a means other than from [the summoned party] itself”).

Where, as here, the IRS is unable to identify the members of the John Doe Class, and one of the principal purposes of the summons is to discover the class members' identities, courts have repeatedly found the § 7609(f)(3) prong of the test to be satisfied. To give one common example, courts have approved summonses where the identities of the persons to be investigated are not readily available but are known to foreign institutions. See In re Tax Liabs. of Does, No. 11-cv-01686-PJH, Dkt. No. 10 (N.D. Cal. Apr. 7, 2011) (authorizing John Doe summons to HSBC Bank USA, N.A. seeking financial account records establishing the identities of U.S. taxpayers with interests in HSBC's Indian bank accounts); MasterCard International, Inc., 2002 WL 32879613, at *1 (authorizing service of a John Doe summons seeking the identity of U.S. taxpayers who held certain credit card accounts with ties to foreign banks); American Express & MasterCard International, Inc., 2000 WL 34538137, at *1 (identities of taxpayers not readily available except from American Express and MasterCard International, Inc., who possessed credit card information for cards issued by offshore banks).

Even if it were theoretically possible for the IRS to obtain some of the information sought in the summons from a labor-intensive review of its own files, that would not prevent § 7609(f)(3) from being satisfied.7 Courts take a “practical” approach when information “cannot without unreasonable burden, expense and unwarranted delay be retrieved from the files of the Internal Revenue Service.” United States v. Reprints, Inc., 43 A.F.T.R.2d 79-463, 1978 WL 1238 (N.D. Ga. Nov. 18, 1978); see also United States v. John G. Mutschler & Assocs., Inc., 734 F.2d 363, 367-68 (8th Cir. 1984) (taking “practical approach to IRS accessibility” in declining to order “manual search of 18,000 opinion letter applications” to identify those prepared by summoned party, calling that “an unreasonable and imprecise method” of locating information); United States v. Berkowitz, 488 F.2d 1235, 1236 (3d Cir. 1973) (per curiam) (“To require the Internal Revenue Service to review individually the millions of forms filed in 1971” to locate those sought by summons “is so obviously burdensome as to make the procedure prohibitive” and concluding “from a practical standpoint those returns would not be readily available to the government”).

The only entities possessing information relating to virtual currency transactions that identify the persons involved in the transactions, and that hold material relating to the transactions, are the exchangers and any intermediaries. Therefore, it is logical to summon Circle for this identifying and transactional information regarding Circle's customers, which is not readily available from any other source.

4. The Summons Is Narrowly Tailored to Information That Pertains to the Failure (or Potential Failure) of the Class to Comply with the Internal Revenue Laws

An additional requirement that Congress added to § 7609(f) in 2019 is that a John Doe summons must be “narrowly tailored to information that pertains to the failure (or potential failure) of the person or group or class of persons referred to in paragraph (2) to comply with one or more provisions of the internal revenue law which have been identified for purposes of such paragraph.” This new narrow-tailoring requirement is met because the summons requests are specifically directed at information that will shed light on the potential non-compliance that the IRS is concerned about — non-reporting of cryptocurrency transactions and non-payment of associated tax — as well as the identities of those taxpayers who may not be in compliance. As mentioned above, this includes potential non-compliance with several provisions of the Internal Revenue Code, such as 26 U.S.C. §§ 61, 451, and 1011.

Congress added the new flush language at the end of § 7609(f) as part of the Taxpayer First Act, Pub. L. No. 116-25, § 1204(a), 133 Stat. 988 (2019), and it became effective on August 16, 2019. Congress's intent was to ensure that “the information sought in the summons [is] at least potentially relevant to the tax liability of an ascertainable group,” and that the summons is not used “for the purposes of a fishing expedition.” H.R. Rep No. 116-39, at 41 (2019). The added text “is not intended to change the Powell standard [i.e., the showing the IRS must make in support of summons enforcement, see United States v. Powell, 379 U.S. 48 (1964)] or otherwise affect the IRS's burden of proof.” Id. at 42; see also Joint Committee on Taxation, Description of H.R. 1957, the “Taxpayer First Act of 2019, at 15 (2019), available at https://www.jct.gov/CMSPages/GetFile.aspx?guid=673878f4-0d0f-4304-a14c-c9740276676a [https://perma.cc/49QV-GWV6].

This new statutory requirement is satisfied here. Agent Peil's Declaration explains in detail the direct connection between each of the six items requested in the summons attachment and the IRS's investigation concerning non-compliance with the internal revenue laws. See Declaration ¶¶ 77-90. Those six document requests fit within two broad categories. Id. ¶ 77. The first category of requests is “directed at adequately identifying the John Doe class members so that transactional data can reasonably be associated with a particular person. Id. ¶ 78. For example, Request #1 on the summons attachment, seeking account registration records, will assist the IRS in this process. See id. ¶¶ 81-85. The second category of requests is “directed at obtaining transactional information that may permit the Service to evaluate whether a particular, previously unknown taxpayer identified through the summons has fully complied with the internal revenue laws with respect to the treatment of cryptocurrency.” Id. ¶ 79. For example, Request #5 on the summons attachment seeks all records of account activity, including transaction logs or other records that reflect the particulars of a transaction such as the date, the amount, the transaction type, the account post-transaction balance, and requests or instructions to send or receive virtual currency. These records should contain the information necessary to determine the correct federal tax liability of applicable Circle users. Id. ¶ 89.

As these and other more detailed explanations in Agent Peil's Declaration show, each of the items sought by the summons is specifically targeted toward obtaining information that may further the IRS's investigation of the John Doe Class and its members' failure (or potential failure) to comply with the internal revenue laws. The narrow-tailoring requirement of the new flush language in § 7609(f) is therefore satisfied.

IV. Conclusion

Based on the foregoing, the government has met all of the requirements for a John Doe summons in § 7609(f). The United States requests that its petition be granted and that the Court enter the proposed order approving the IRS to serve the John Doe summons on Circle.

Respectfully submitted,

DAVID A. HUBBERT
Acting Assistant Attorney General
Tax Division, U.S. Department of Justice

EDWARD J. MURPHY
Trial Attorney, Tax Division
U.S. Department of Justice
P.O. Box 55
Washington, D.C. 20044
202-307-6064 (v)/202-514-5238 (f)
Edward.J.Murphy@usdoj.gov


DECLARATION OF SENIOR REVENUE AGENT JOHN MARK PEIL IN SUPPORT OF EX PARTE PETITION TO SERVE JOHN DOE SUMMONS

DECLARATION OF JOHN MARK PEIL

I, John Mark Peil, pursuant to 28 U.S.C. § 1746, declare and state:

1. I am a duly commissioned Internal Revenue Agent (“Revenue Agent”) assigned as a Senior Revenue Agent in the Internal Revenue Service's (“IRS” or “Service”) Offshore Compliance Initiatives (“OCI”). OCI develops projects, methodologies, and techniques for identifying United States (“U.S.”) taxpayers who are involved in abusive offshore transactions and financial arrangements for tax-avoidance purposes. Although OCI's work typically involves abusive offshore transactions and financial arrangements, the virtual currency issues I have been working on are not limited to offshore activities.

2. I have been a Revenue Agent since 2006 and have served in OCI since September 2013. Prior to September 2013, I served as a Revenue Agent in the Small Business/Self-Employed Division and the Large Business and International Division of the IRS. I have been assigned to the Virtual Currency Campaign since July 2018. My post of duty is in Farmers Branch, Texas.

I. Background

3. The IRS is conducting an investigation to determine the identity and correct federal income tax liability of U.S. persons who conducted transactions in cryptocurrency for the years ended December 31, 2016, 2017, 2018, 2019, and 2020.

4. As the organization responsible for enforcing and administering the internal revenue laws of the United States, the IRS, in recent years, has become aware of significant tax compliance issues relating to the use of virtual currencies, including cryptocurrencies, as detailed below.

A. Tax Compliance Concerns Associated With the Use of Virtual Currencies and the Service's Compliance Initiative

5. In 2013, at the request of the Senate Finance Committee, the Government Accountability Office (“GAO”) completed a study of the use of virtual currency. Through interviews with industry representatives, tax professionals, IRS officials and academics, GAO identified several tax compliance risks associated with virtual currencies, ranging from lack of knowledge of tax requirements and uncertainty over how to report virtual currency transactions, to deliberate underreporting of income and tax evasion. See U.S. Gov't Accountability Office, GAO-13-516, Virtual Economies and Currencies: Additional IRS Guidance Could Reduce Tax Compliance Risks (2013), https://www.gao.gov/products/GAO-13-516 [https://perma.cc/H83E-BFSD].

6. In September 2016, the Treasury Inspector General for Tax Administration (“TIGTA”) issued a report explaining that taxpayer use of virtual currencies, including cryptocurrencies, had expanded significantly in recent years. See As the Use of Virtual Currencies in Taxable Transactions Becomes More Common, Additional Actions Are Needed to Ensure Taxpayer Compliance, Reference Number 2016-30-083 (Sept. 21, 2016), https://www.treasury.gov/tigta/auditreports/2016reports/201630083fr.pdf [https://perma.cc/5BW9-YXWT]. The report reflects TIGTA's independent determination that while there are legitimate reasons to use virtual currency — lower transaction fees and faster transfers of funds compared to traditional currencies — some virtual currencies are also popular because the identity of the parties involved is generally anonymous, leading to a greater possibility of their use in illegal transactions.

7. Since 2005, the Service's Electronic Payment Systems Initiative (“EPSI”) has focused on developing projects, methodologies, and techniques for identifying U.S. taxpayers who use electronic funds transfer and payment systems for tax avoidance purposes. In September 2013, OCI expanded the scope of the EPSI to address U.S. taxpayers who use virtual currencies for tax avoidance purposes, recognizing that some U.S. taxpayers use such currencies to expatriate and repatriate funds to and from offshore accounts.

8. In furtherance of the EPSI, the IRS is conducting an investigation to identify tax noncompliance related to the use of virtual currency, including cryptocurrency. In December 2013, the IRS established a Virtual Currency Issue Team (“VCIT”). The VCIT was established to study the issue and then consider the compliance impact related to virtual currencies. The VCIT developed a three-pronged approach involving first learning about virtual currency, next educating the examination workforce regarding the issue, and then developing examination techniques to identify and address issues during an examination. This “John Doe” summons is one of the tools being used in the investigation.

9. In June 2015, TIGTA contacted the IRS to gather information for a review of the IRS's compliance strategy for addressing the reporting of revenue and expenses occurring through the use of virtual currencies and other alternative payment methods. At that time, the IRS shared information with TIGTA regarding the VCIT and EPSI. In October 2015, TIGTA sent the IRS an engagement letter formally initiating its review. In December 2015, the IRS advised TIGTA that it was working to further its virtual currency investigation.

10. On November 30, 2016, the District Court for the Northern District of California authorized the IRS to issue a John Doe summons to Coinbase, Inc., a U.S.-based cryptocurrency exchange, to identify U.S. taxpayers who, at any time during the period from January 1, 2013 through December 31, 2015, conducted transactions in a convertible virtual currency as defined in IRS Notice 2014-21. See United States v. John Doe, No. 3:16-cv-06658-JSC (N.D. Cal. Nov. 30, 2016) (Order (Doc. 7)). Coinbase was served with the summons on December 8, 2016. Coinbase did not comply voluntarily with the summons.

11. On March 16, 2017, a petition to enforce the John Doe summons was filed against Coinbase in the District Court for the Northern District of California. On November 29, 2017, the court granted the petition to enforce the John Doe summons as narrowed during the course of the enforcement litigation. See United States v. Coinbase, Inc., No. 17-cv-01431-JSC (N.D. Cal. Nov. 29, 2017) (Judgment (Doc. 77)). Coinbase was ordered to produce documents for accounts with at least the equivalent of $20,000 in any one transaction type (buy, sell, send, or receive) in any one year for the 2013 through 2015 tax years.

12. Coinbase advised impacted account holders that it was required to disclose the information described in the enforcement order. Coinbase's webpage states that, “On February 23rd, 2018, Coinbase notified a group of approximately 13,000 customers concerning a summons from the IRS regarding their Coinbase accounts.” https://help.coinbase.com/en/coinbase/taxes-reports-and-financial-services/taxes/irs-notification [https://perma.cc/GL68-BSLM].

13. On July 2, 2018, the IRS announced its Virtual Currency Compliance campaign directed at addressing “noncompliance related to the use of virtual currency through multiple treatment streams including outreach and examinations.” See IRS Announces the Identification and Selection of Five Large Business and International Compliance Campaigns, available at https://www.irs.gov/businesses/irs-announces-the-identification-and-selection-of-five-large-business-and-international-compliance-campaigns, [https://perma.cc/KU4F-VKMQ].

14. Then, on July 26, 2019, the IRS announced that it began sending letters to virtual currency owners, advising them to pay back taxes and file amended returns. By the end of August 2019, the IRS had issued more than 10,000 letters to taxpayers who owned virtual currency. Following the issuance of the letters, additional taxpayers filed amended returns reporting virtual currency transactions that were not previously reported.

B. Cryptocurrency in General

15. Cryptocurrency is a particular type of virtual currency as the IRS has used that term in Notice 2014-21. Cryptocurrency, however, can be further divided into two general categories — crypto-coins and crypto-tokens — although the two are often referred to generally as cryptocurrency.

16. As of January 15, 2021, cryptocurrency tracking website www.coinmarketcap.com indicated that more than 8,000 separate cryptocurrencies existed. The most widely known cryptocurrency, and largest by capitalization, is bitcoin. Given bitcoin's prominence in the cryptocurrency ecosystem, other cryptocurrencies are often generically referred to as alternative coins or “altcoins” for short. A few examples of altcoins are ethereum (ether or ETH), Litecoin (LTC), XRP (ripple or XRP), and stellar (XLM).

17. In general, cryptocurrency is based on distributed ledger (blockchain1) technology.2 In a distributed ledger technology system, a user creates a cryptocurrency wallet to engage in cryptocurrency transactions. A wallet is a computer file that contains information (software and protocols) used in transferring units of a cryptocurrency. When the wallet is downloaded or purchased (as in the case of a hardware wallet), the user prompts software in the wallet to generate a private key. The private key is then used to generate a public key, which, in turn, is used to generate an address. The private key, public key, and address are linked, but the particular encryption protocols employed to create the public key and address are only one-way, which prevents the reverse engineering of the private key from the address or public key.3

18. A wallet may hold any number of private/public key pairs. Addresses and public keys are shared with other users in order to conduct cryptocurrency transactions. Private keys, which are used as the last piece in forming the digital signature to conduct a transaction, generally should not be shared. Sharing of a private key would permit another individual to engage in transactions on the original user's behalf.4

19. The method described above for transacting in cryptocurrency is generally the same regardless of whether it is a crypto-coin or crypto-token. There is a difference, however, in how those two assets are created and how transactions for each are validated and tracked.

20. Crypto-coins are created as a component of the distributed ledger itself. As such, crypto-coin transactions are confirmed by computer nodes participating in the maintenance of the distributed ledger and those transactions are then recorded in blocks that make up the distributed ledger's blockchain (assuming the crypto-coin uses a blockchain-type distributed ledger).

21. Generally, all transactions on a crypto-coin blockchain can be viewed by the public on any computer connected to the Internet.5 However, the blockchain transactional history generally only reveals the date, time, units, address, wallet ID (to which the address belongs to), and transaction ID associated with a transaction. The blockchain does not identify the actual identities of the address and wallet owners.

22. Separately, crypto-tokens are not an inherent part of a distributed ledger. Tokens, rather, are created through particular computer scripts or programs such as smart contracts or decentralized applications (DApps) that are hosted or built off of a distributed ledger. For example, the Ethereum blockchain is a distributed ledger platform that uses the crypto-coin ether. See generally https://ethereum.org/learn/ [https://perma.cc/MN7S-9ZW8]. The Ethereum blockchain, however, is also designed to host crypto-tokens created through smart contracts or DApps built off of the Ethereum blockchain. Id. The crypto-coin ether is designed to function as the “gas” (compensation) for running the smart contracts and DApps on the Ethereum platform. Id.

23. As with crypto-coins, crypto-tokens can be transferred using a cryptocurrency wallet.

24. The peer-to-peer nature of cryptocurrencies, compounded by the pseudo-anonymous nature of publicly-available-transactional information, makes the examination of an individual's cryptocurrency transactions for tax purposes — particularly, the receipt of income or investment gains — more difficult than examinations involving traditional transactions conducted through regular banking or financial institutions.

25. In order to buy cryptocurrency (coins or tokens), a user must transfer traditional (fiat) currency to someone who already has cryptocurrency and wishes to exchange it for traditional currency. This exchange can occur directly with anyone holding cryptocurrency, but also can be handled through businesses known as digital currency exchanges. Such businesses (like Circle discussed below), trade between cryptocurrencies and traditional currencies or sometimes just between different cryptocurrencies (coins and tokens).

26. A digital currency exchange functions much like a traditional currency exchange, except it deals with the conversion of cryptocurrency for traditional currency or vice versa, as well as the exchange of one cryptocurrency for another cryptocurrency. Digital currency exchanges may also provide wallet services. These hosted wallet services allow a user to quickly authorize cryptocurrency transactions with another user through the use of a user account held at the exchange. Hosted wallet accounts are accessible through a computer or mobile device like a smartphone.6

27. Digital currency exchanges are generally regulated as “money transmitters” under Title 31 of the United States Code (“U.S.C.”). See generally FinCEN Guidance No. FIN-2013-G001: Application of FinCEN's Regulations to Persons Administering, Exchanging, or Using Virtual Currencies (Mar. 18, 2013), available at https://www.fincen.gov/sites/default/files/shared/FIN-2013-G001.pdf [https://perma.cc/E9C8-YH3C]; FinCEN Guidance No. FIN-2019-G001: Application of FinCEN's Regulations to Certain Business Models Involving Convertible Virtual Currencies (May 9, 2019), available at https://www.fincen.gov/sites/default/files/2019-05/FinCEN%20Guidance%20CVC%20FINAL%20508.pdf [https://perma.cc/6BVK-AJVP].

28. As a money transmitter, digital currency exchanges are required to obtain and maintain certain customer identification information and transactional data for the purpose of combating illicit activity such as money laundering, tax evasion, and terrorism financing. See 31 U.S.C. § 5311; 31 C.F.R. § 1010.100(ff)(5), § 1022.210; FinCEN Guidance No. FIN-2019-A003: Advisory on Illicit Activity Involving Convertible Virtual Currency (May 9, 2019), available at: https://www.fincen.gov/sites/default/files/advisory/2019-05-10/FinCEN%20Advisory%20CVC%20FINAL%20508.pdf [https://perma.cc/3MCL-5YQ9].

29. With respect to cryptocurrencies, digital currency exchanges, such as Circle, discussed below, provide valuable information about an individual customer's cryptocurrency transactions that can be used in conjunction with other publicly-available blockchain information to adequately examine whether an individual has complied with internal revenue laws.

30. As detailed below, the Service is pursuing this John Doe summons to Circle in order to obtain customer and transactional information belonging to members of the John Doe class that can be used to conduct examinations of persons that may not have complied with the internal revenue laws.

C. Taxation of Virtual Currency

31. Virtual currency, including cryptocurrency, is treated as property for tax purposes. See generally Notice 2014-21. The following examples provide an overview of how tax principles applicable to transactions in property apply to transactions in virtual currency:

  • Wage, salary, or other income paid to an employee with virtual currency is reportable by the employee as ordinary income and subject to employment taxes paid by the employer.

  • Virtual currency received by a self-employed individual in exchange for goods or services is reportable as ordinary income and is subject to self-employment tax. This would include a person who “mines” virtual currency as a trade or business.

  • Virtual currency received in exchange for goods or services by a business is reportable as ordinary income.

  • Gain on the exchange of virtual currency for other property is generally reportable as a capital gain if the virtual currency was held as a capital asset and as ordinary income if it is property held for sale to customers in a trade or business.

  • Gain on the sale of property held as a capital asset in exchange for virtual currency is reportable as a capital gain.

  • Payments made in virtual currency are subject to information reporting requirements to the same extent as payments made in real currency or instruments denominated in real currency.

32. Users of digital currency exchanges such as Circle may engage in taxable transactions through the receipt of cryptocurrency into the person's digital currency exchange account as payment for goods or services, or through the buying and selling of cryptocurrency through the person's digital currency exchange account.

D. The Service's Experience with Tax Non-Compliance Involving Virtual Currency

33. As noted above, both GAO and TIGTA have raised concerns about tax compliance issues relating to virtual currency. And, as discussed above, the Service has initiated specific programs and campaigns to address compliance issues through both taxpayer education and enforcement.

34. Some taxpayers may deliberately use virtual currencies to evade taxes. Certain taxpayers have openly acknowledged their plans to violate internal revenue laws by intentionally not reporting income from the use of virtual currency. See 36% of Bitcoin Investors Plan to Commit Tax Fraud This Year, The Motley Fool (January 7, 2018) https://www.fool.com/taxes/2018/01/07/36-of-bitcoin-investors-plan-to-commit-tax-fraud-t.aspx [https://perma.cc/4K92-R3XJ] (referencing a cryptocurrency user poll conducted by www.lendedu.com, https://www.lendedu.com/blog/investing-in-bitcoin [https://perma.cc/4QWZ-AUNM]).

35. Since transactions can be difficult to trace and many virtual currencies inherently have a pseudo-anonymous aspect, taxpayers may use them to hide taxable income. This is illustrated by the actions of the taxpayers described in Part II.C., below. Each of the taxpayers described in Part II.C. held assets and conducted transactions through Circle, which were not reported on federal income tax returns.

36. My research also identified individuals (married Taxpayers 5 and 6) who were prosecuted and convicted of money laundering and other federal crimes, and who used a Circle account to hold and convert their profits from illegal activities, as discussed in Part II.C., below.

37. In the experience of the IRS, tax noncompliance increases when there is no third-party information reporting. Taxpayers are less likely to report and pay taxes on income that is not independently reported to the IRS by a third party. IRS “tax gap” studies consistently show that tax compliance is far higher when reported income amounts are subject to information reporting by third parties. The most recent such study, published on September 26, 2019 based on 2011-2013 data, concluded that the overall rate of underreporting of income that was not subject to third-party information reporting was 55 percent, compared to 5 percent for amounts subject to substantial information reporting but no withholding, and 1 percent for amounts subject to substantial information reporting and withholding. See IRS Publication 1415,Federal Tax Compliance Research: Tax Gap Estimates for Tax Years 2011-2013, (September 2019), available at https://www.irs.gov/pub/irs-pdf/p1415.pdf [https://perma.cc/2XM5-PDNH]. Where there is no third-party information reporting of virtual currency transactions for tax purposes, as is the case with Circle, the likelihood of underreporting is significant.

38. During the Service's summons enforcement litigation against Coinbase, the IRS determined that for 2013-2015 only 800 to 900 taxpayers per year filed tax returns with a property description related to bitcoin or virtual currency despite the fact that Coinbase alone had serviced more than 5.9 million customers and handled more than $6 billion in transactions during that time. United States v. Coinbase, Inc., et al., 120 A.F.T.R.2d 2017-6671, 2017 WL 5890052, *4 (N.D. Cal. Nov. 28, 2017).

39. The IRS has recently determined that post-Coinbase the number of taxpayers filing tax returns with a property description related to bitcoin or virtual currency has increased. Running the same search ran in the Coinbase litigation, the IRS found that 3,926 taxpayers in 2016, 82,518 for 2017, and 88,976 in 2018 filed a return reporting bitcoin or virtual currency. While these numbers reflect a positive increase in reporting, these numbers still fall far short of what would be expected given the number of users, transactions, and value that the virtual currency exchanges publicize occur on an annual basis.

40. Since Coinbase complied with the John Doe summons, the IRS has continued to reach out to taxpayers regarding their reporting requirements, conduct examinations and make criminal investigation referrals. These compliance efforts are ongoing and will remain a priority. The IRS has also received submissions through its voluntary disclosure practice reporting additional taxes or changes in tax attributes relating to failures to report income from virtual currency transactions. Since issuing more than 10,000 Virtual Currency Compliance campaign letters to taxpayers in July 2019, the IRS has received amended returns reporting virtual currency transactions for tax years 2013 through 2018. As a result of the letters, the IRS has made more than $13.1 million in assessments to date. These assessments are the result of taxpayers filing amended returns that contain previously unreported virtual currency transactions. Separately, the IRS has contacted taxpayers who have not filed returns reporting virtual currency by sending notices related to virtual currency. Those notices have already resulted in more than $11.9 million in assessments. The IRS anticipates assessments will increase as it continues to pursue civil and criminal investigations.

41. More recently based on internal and external data available to the IRS, letters were sent to taxpayers who conducted transactions with foreign virtual currency exchanges and may have failed to properly report such transactions and associated income.

42. As detailed below in paragraphs 67 to 72, and supported by further information available to the IRS and my experience as a Senior Revenue Agent, the IRS has a reasonable basis for believing there are U.S. taxpayers with accounts at Circle who are not in compliance with U.S. income tax reporting requirements because they are not correctly reporting certain items or are simply failing to report any income or tax relating to virtual currency transactions.

II. Circle

A. Organizational Structure

43. Circle Internet Financial Limited, organized under the laws of Ireland, is the parent company of multiple subsidiaries, including Circle Internet Financial, Inc. and Circle Trade Europe Limited.

44. Circle Internet Financial, Inc. was incorporated under the laws of Delaware on August 12, 2013.

45. Circle Trade Europe Limited was incorporated under the laws of the United Kingdom on March 16, 2018.

46. Circle was founded in 2013 by Jeremy Allaire and Sean Neville. Allaire currently serves as the Chief Executive Officer of Circle. See Crunchbase, https://www.crunchbase.com/organization/circle-2 [https://perma.cc/9ALP-4Q3Z] and https://www.linkedin.com/company/circle-internet-financial (copy attached as Exhibit 1).

47. As of October 2019, subsidiaries of Circle Internet Financial Limited included, but were not limited to: Pluto Holdings Inc.; Poloniex, LLC; SeedInvest, LLC; SI Securities, LLC dba SeedInvest; SeedInvest Technology, LLC; and SI Portal, LLC. Circle Internet Financial Limited and its subsidiaries collectively operate as the Circle group of affiliated companies. See In re: Poloniex, LLC, Stipulation and Consent Order https://dfr.vermont.gov/reg-bul-ord/re-poloniex-llc-stipulation-and-consent-order (copy attached as Exhibit 2); BrokerCheck by FINRA, SI Securities, LLC, https://brokercheck.finra.org/firm/summary/170937 [https://perma.cc/BRH4-EN56]; Circle Closes Acquisiton of SeedInvest, Another Step Towards the Democratization of Finance, https://www.circle.com/blog/circle-closes-acquisition-of-seedinvest-another-step-towards-the-democratization-of-finance [https://perma.cc/8Y5E-76UN]. The John Doe summons only seeks records with respect to Circle group customer accounts through which taxpayers engaged in cryptocurrency transactions and records to identify such Circle group customers and the persons with whom these customers transacted.

48. Circle describes itself as “a new kind of global financial services company. A platform for individuals, institutions and entrepreneurs to use, trade, invest and raise capital with open crypto technologies.” https://web.archive.org/web/20191022123009/https://www.circle.com/en/.

49. In October 2013, Circle launched operations serving only invited customers. In September 2014, Circle opened its services to the public. See Circle Opens Doors to Global Audience (Sept. 29, 2014), https://www.circle.com/blog/circle-opens-doors-to-global-audience [https://perma.cc/2PG6-FTPY]. Initially, Circle provided consumer finance products designed to allow customers to store and use digital money anywhere in the world. See What We Have Been Up to at Circle (May 16, 2014), https://www.circle.com/blog/what-we-have-been-up-to-at-circle [https://perma.cc/8KXM-4GRG]. However, Circle has expanded its product line through acquisitions, including Trigger Finance, Inc. (2017), Poloniex, Inc. (2018) and SeedInvest, LLC (2019). See Circle Acquires Trigger and Opens New York Office (Oct. 16, 2017), https://www.circle.com/blog/circle-acquires-trigger-and-opens-new-york-office [https://perma.cc/EKH6-8UB9]; Circle Acquires Poloniex (Feb. 26, 2018), https://www.circle.com/blog/circle-acquires-poloniex [https://perma.cc/P54D-TP32]; Circle Closes Acquisiton of SeedInvest, Another Step Towards the Democratization of Finance, https://www.circle.com/blog/circle-closes-acquisition-of-seedinvest-another-step-towards-the-democratization-of-finance [https://perma.cc/8Y5E-76UN].

50. Circle is headquartered in Boston, Massachusetts, with additional offices in New York, San Francisco, Dublin, London, and Hong Kong. See https://www.linkedin.com/company/circle-internet-financial (copy attached as Exhibit 1); Circle's New Capital, China and Euro Expansion, https://www.circle.com/blog/circles-new-capital-china-and-euro-expansion [https://perma.cc/B6KS-9A9Q]. As of July 3, 2019,7 Circle had served more than 8 million customers and 1,000 institutions with over $200 billion in trading volume of more than 60 assets. See https://web.archive.org/web/20191022123009/https:/www.circle.com/en/.

51. Circle Internet Financial, Inc. and Poloniex, LLC have had active registrations with the United States Financial Crimes Enforcement Network as money service businesses (“MSBs”). Circle Internet Financial registered as of February 19, 2019. See https://www.fincen.gov/msb-registrant-search [https://perma.cc/VRC8-8UUC]. Poloniex, LLC registered as of May 28, 2019. See id. A MSB is required by the Bank Secrecy Act (Title 31, U.S. Code) to conduct basic customer risk assessments to determine the level of risk associated with the account and whether further due diligence is necessary. See 31 U.S.C. § 5311; 31 C.F.R § 1010.100(ff)(5), § 1022.210; FinCEN Guidance No. FIN-2019-A003: Advisory on Illicit Activity Involving Convertible Virtual Currency (May 9, 2019), available at: https://www.fincen.gov/sites/default/files/advisory/2019-05-10/FinCEN%20Advisory%20CVC%20FINAL%20508.pdf [https://perma.cc/LR6Z-ZMUB].

52. Each MSB is required to retain the records described below with respect to any transmittal of funds in the amount of $3,000 or more. 31 C.F.R. §§ 1010.100(ff)(5), 1010.410, 1022.210. Such records are required to be retained by the MSB for 5 years. 31 C.F.R. § 1010.430(d).

53. If the sender of the funds is an established customer of the MSB, the MSB must retain the following information:

  • Name and address of the transmitter;

  • Amount of the transmittal order;

  • Execution date of the transmittal order;

  • Any payment instructions received from the transmitter;

  • The identity of the recipient's financial institution;

  • As many of the following items as are received with the transmittal order: (i) name and address of the recipient, (ii) the account number of the recipient, and (iii) any other specific identifier of the recipient; and

  • Any form relating to the transmittal of funds that is completed or signed by the person placing the transmittal order.

31 C.F.R. § 1010.410(e)(1)(i).

54. If the sender of the funds is not an established customer of the MSB, the MSB must retain all of the information specified in the preceding paragraph, plus:

  • The type and number of the identification documents reviewed to verify the transmitter's identity, such as a driver's license, social security number or other tax identification number, or a passport or alien identification number; and

  • A copy or record of the transmitter's method of payment.

55. If the recipient of the funds is an established customer of the MSB, the MSB must retain an original, microfilm, other copy, or electronic record of the transmittal order. 31 C.F.R. § 1010.410(e)(1)(iii).

56. If the recipient of the funds is not an established customer of the MSB, the

  • The same types of information described in paragraphs 53 and 54 above, but substituting “recipient” for “transmitter”;

  • An original, microfilm, other copy, or electronic record of the transmittal order;

  • If the MSB knows that the person receiving the proceeds is not the ultimate recipient, the ultimate recipient's name, address, and taxpayer identification number, alien identification number, or passport number (along with the country of issuance); and

  • If the proceeds are delivered other than in person, a copy of the check or other instrument used to pay the transmittal, or the information contained on the check or other instrument, as well as the name and address of the person to whom it was sent.

31 C.F.R. § 1010.410(e)(3).

57. In addition, each MSB must develop, implement, and maintain an effective anti-money laundering program. 31 C.F.R. § 1022.210(a). At a minimum, the program must include provisions for verifying customer identification, filing reports, creating and retaining records, and responding to law enforcement requests. 31 C.F.R. § 1022.210(d)(1)(i).

58. Additionally, Circle subsidiary SI Securities, LLC is a registered brokerage firm with the U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority. https://brokercheck.finra.org/firm/summary/170937 [https://perma.cc/BRH4-EN56].

59. On October 18, 2019, Circle announced that Poloniex would be spinning out from Circle into a new independent international company, Polo Digital Assets, Ltd. Poloniex to Spin Out of Circle (Oct. 18, 2019), https://www.circle.com/blog/poloniex-to-spin-out-of-circle [https://perma.cc/K2R6-KVED]); Poloniex Spins Out from Circle with New Backing & Global Focus, https://support.poloniex.com/hc/en-us/articles/360040020993-Poloniex-Spins-Out-from-Circle-with-New-Backing-Global-Focus [https://perma.cc/6P2B-UPXH]. As of November 1, 2019, U.S. customers are no longer able to trade on the Poloniex exchange. U.S. customers were required to withdraw their assets from Poloniex no later than December 15, 2019. Trading for US Poloniex Customers Has Ended, https://support.poloniexus.circle.com/hc/en-us/articles/360037489272-Trading-for-US-Poloniex-Customers-Has-Ended [https://perma.cc/CK7Y-L3DV].

B. Circle's Products and Operations

60. As of early October 2019, Circle offered its financial products and services through subsidiaries, divisions, or affiliates, which Circle identified as: Poloniex, Circle Trade, USD Coin, Circle Invest, SeedInvest, and Circle Research. See https://web.archive.org/web/20191022123009/https://www.circle.com/en/..

61. To access Circle's products, users historically have had to create a single master account through which the various services can be accessed. See Circle U.S. User Agreement (Updated Mar. 21, 2017), https://web.archive.org/web/20170712031709/https://www.circle.com/en/legal/us-user-agreement. To create a master account, Circle requires certain information, including the user's full legal name. As described in more detail below, additional information must be provided, and further eligibility requirements must be met, to access each underlying service.

62. Poloniex is a virtual currency exchange. Prior to October 2019, Poloniex was open to United States customers, and allowed its users to trade more than 60 types of virtual currency assets. Users opening an account with Poloniex were required to provide their full legal name, full current address, a picture of an identification card, and a picture that includes their face and documents with the current date and the word “Poloniex” visible. https://support.poloniex.com/hc/en-us/articles/360039542734-Verification-Tips [https://perma.cc/8FPU-36WN]. Poloniex uses an automated system to verify customer information. Id. On its webpage “Verification Tips,” Poloniex included an example of what the picture should look like. Id. Poloniex also reserved the right to request additional documents, such as a current utility bill with their name and address listed on it. Id. Users funded Poloniex accounts by depositing virtual currency, wiring funds from a linked bank account, or by purchasing bitcoin with a debit card through Simplex. See https://support.poloniex.com/hc/en-us/articles/360040016493-How-to-fund-your-account [https://perma.cc/B77G-L4L3]. A single bank account linked to a Poloniex account could be used for inbound and outbound wire transfers. See Exhibit 3 (copy of former Poloniex support web page).

63. Circle Invest allows customers to invest in 14 types of virtual currencies.8 Circle Invest is a differentiated product, offering more limited trading options than Circle Trade or Poloniex to customers who are starting to invest in virtual currency. In order to open a Circle Invest account, users are required to provide their name, email address, phone number, date of birth, home address, and last four digits of their Social Security number. https://support.invest.circle.com/hc/en-us/articles/360000209726-Why-am-I-being-asked-information-to-verify-my-identity-[https://perma.cc/9CFZ-3PV7]. Circle explained to prospective users that “[t]hose pieces of information are instrumental to verifying your identity.” See id. Circle reserves the right to request a government issued photo ID and a picture of the user to verify certain identities. Id. Users of Circle Invest must link their account to a United States bank account. https://support.invest.circle.com/hc/en-us/articles/360000210443-How-can-I-deposit-money-into-Circle-Invest-[https://perma.cc/66FS-55KA].

64. USD Coin is a “stablecoin” backed by the United States dollar. See https://www.circle.com/en/usdc [https://perma.cc/E5N5-N4SQ] and https://support.usdc.circle.com/hc/en-us/articles/360015439351-Know-your-customer-and-identity-verification [https://perma.cc/TPN5-XH73]. Specifically, USD Coin (USDC) enables users to tokenize fiat currency into USDC by making a wire transfer to Circle USDC's bank account and to redeem USDC into fiat currency by receiving a USD wire transfer to the user's bank account. See https://support.usdc.circle.com/hc/en-us/articles/360015179712-Circle-USDC-Basics [https://perma.cc/5CQJ-LX46]. According to these pages on Circle's web site, in order to transact USDC in a Circle account, users have been required to provide their full legal name, country of birth, country of residence, date of birth, tax identification number, residential address, email address, phone number, government issued identification and a photo of the user. Users of USDC have also been required to link a bank account to their Circle account.

65. SeedInvest is a startup investing platform that allows its customers to invest in certain pre-vetted startup and investment opportunities. See https://www.seedinvest.com/faqs [https://perma.cc/9M7D-9KFR] Since SeedInvest accounts do not hold virtual currency, this subsidiary will not be discussed further in this declaration. Id.

66. As of January 2021 I did a search of IRS records on whether Circle and its affiliated companies provide information returns to the IRS with respect to any transactions, including those involving virtual currency. I have found no IRS records that indicate Circle and its affiliated companies provided information returns to the IRS relating to virtual currency transactions conducted by, or on behalf of, their customers.

C. Suspected Non-Compliance by Circle Users

67. Taxpayer 1 is a U.S. person. For 2014, 2016 and 2017, Taxpayer 1 filed Forms 1040 with the IRS. Taxpayer 1 failed to file a Form 1040 for tax year 2015 with the IRS. While under IRS examination, Taxpayer 1 admitted in an interview with a Revenue Agent that he conducted transactions through an account with Poloniex during 2014, 2016 and 2017. However, Taxpayer 1's returns for such years did not report any transactions conducted through Poloniex. The Service issued a summons to Circle. Circle's response included information about two accounts held by Taxpayer 1 through Poloniex. The information included Taxpayer 1's name, address, phone number, email address, login history with IP addresses, pictures, driver's license image, chat name, account status, communications with Poloniex, account balances by type of virtual currency and information on more than 700 virtual currency transactions. None of these more than 700 virtual currency transactions were reported on any tax return filed with the IRS by Taxpayer 1. Based on my experience as a Senior Revenue Agent, these types of transactions are indicative of taxable income. However, Taxpayer 1 failed to file a return reporting income from this activity.

68. Taxpayer 2 and Taxpayer 3 are married U.S. persons. Taxpayer 2 and Taxpayer 3 hold a Working Visa and International Student Visa, respectively. While Taxpayers 2 and 3 filed joint income tax returns for 2015 and 2016 with the IRS, such returns did not report any virtual currency transactions. During an IRS examination, the IRS discovered entries on Taxpayers' bank statements showing transactions with Circle. Subsequently, the IRS issued a summons to Circle. Circle's response to the summons included information about a Circle account and a previously unknown Poloniex account, each held by Taxpayer 3. The information related to the Circle account included the account holder's name, date of birth, address, phone number, email address, linked checking account, login history with IP addresses, communications with Circle, account balances by type of virtual currency, and information on more than 40 transactions. None of these more than 40 virtual currency transactions were reported on any tax return filed with the IRS by Taxpayer 3. The information related to the previously unknown Poloniex account included the account holder's name, address, phone number, email address, login history with IP addresses, self-pictures, passport image, chat name, communications with Poloniex, account balances by type of virtual currency, and information on more than 500 transactions. None of these more than 500 virtual currency transactions were reported on any tax return filed with the IRS by Taxpayer 3. Based on my experience as a Senior Revenue Agent, these types of transactions are indicative of taxable income. However, Taxpayers 2 and 3 have failed to file a return reporting income from this activity.

69. Taxpayer 4 is a U.S. person who filed Forms 1040 with the IRS for 2015-2017. While under IRS examination, during an interview with a Revenue Agent, Taxpayer 4 stated that Taxpayer 4 had no virtual currency transactions before 2017. However, the Schedule D attached to Taxpayer 4's 2016 income tax return reported bitcoin transactions with basis of $0 and proceeds of $0. Furthermore, the Schedule C attached to Taxpayer 4's 2017 income tax return reported expenses from virtual currency mining, but no income. During the IRS examination of Taxpayer 4's 2017 tax year, Taxpayer 4 stated that only losses were incurred through the virtual currency mining activity. During the examination, the IRS issued a summons to Circle. Circle's response to the summons included information about six previously unknown accounts related to Taxpayer 4, three accounts at Circle and three at Poloniex. Information related to the Circle accounts included the account holder's name, date of birth, address, phone number, email address, linked debit, credit, and checking accounts, login history with IP addresses, self-picture, passport image, communications with Circle, account balances, and information on more than 170 transactions. None of these more than 170 virtual currency transactions were reported on any tax return filed with the IRS by Taxpayer 4. Information related to the Poloniex accounts included the account holder's name, address, phone number, email address, login history with IP addresses, chat name, account status, communications with Poloniex, and information on more than 80 transactions. None of these more than 80 virtual currency transactions were reported on any tax return filed with the IRS by Taxpayer 4. The summons information included transaction data from 2015 to 2017. Based on my experience as a Senior Revenue Agent, these types of transactions are indicative of taxable income. However, Taxpayer 4 failed to file a tax return with the IRS reporting income from this activity conducted through Circle and Poloniex.

70. Additionally, I learned that in 2018, Taxpayer 4 attempted to start a new virtual currency. The proposed virtual currency was a health care related token, Token 1. Documents related to Token 1 described Taxpayer 4 as a “cryptocurrency expert,” “owner of a mid-size mining operation,” and an “experienced business owner in the IT industry.”

71. Taxpayer 5 and Taxpayer 6 are married U.S. persons. They did not file income tax returns for 2014 or 2015 with the IRS, so the IRS generated substitute for returns for both years based upon information return filings. Taxpayers 5 and 6 filed an income tax return with the IRS for 2016. During 2016, Taxpayers 5 and 6 both pleaded guilty to (i) conspiracy to distribute a controlled substance and (ii) money laundering-transportation of stolen property, for conduct occurring during 2015. Taxpayers 5 and 6 used an account at Circle to hold, and convert into U.S. dollars, payments received in bitcoin arising from the Taxpayers' illegal activities. During an IRS examination of Taxpayers' 2015 tax year, the IRS issued a summons to Circle. Circle's response to the summons included information about an account held in Taxpayer 5's name. The information included the account holder's name, date of birth, address, phone number, email address, linked checking account, IP addresses, communications with Circle, as well as account balances by type of virtual currency, and information on more than 40 transactions. None of these more than 40 virtual currency transactions were reported on any tax return filed with the IRS by Taxpayer 5. At the time the summons was served, Circle had closed Taxpayer 5's account due to prohibited activities. Based on my experience as a Senior Revenue Agent, these types of transactions are indicative of taxable income. However, Taxpayers 5 and 6 have failed to file a return reporting income from this activity.

72. Taxpayer 7 is a U.S. person. Taxpayer 7 filed income tax returns with the IRS for each of the 2014, 2015, 2016 and 2017 tax years. Information relating to Taxpayer 7 was present in the data that Coinbase provided to the IRS pursuant to a John Doe summons. As a result, Taxpayer 7 received Letter 6173 as part of the Virtual Currency Campaign. Letter 6173 informs the recipient that the IRS has information about virtual currency accounts held by the recipient, and that the recipient may not have met the applicable filing and reporting requirements. After issuance of Letter 6173, Taxpayer 7 filed amended tax returns with the IRS for 2014, 2015, 2016 and 2017. The amended tax returns included previously unreported virtual currency sales of more than $1,600,000 as well as additional tax on those sales. In his response to Letter 6173, Taxpayer 7 listed Poloniex as one of the exchanges that he used to buy and sell virtual currency.

III. The John Doe Summons Requirements Are Met

73. The IRS has commenced an investigation of unknown U.S. persons (John Does) who directly or indirectly had authority over any combination of accounts held with Circle with at least the equivalent of $20,000 in value of transactions (regardless of type) in cryptocurrency in any one year for the period January 1, 2016 through

74. To facilitate this investigation, the IRS is seeking the Court's permission to serve, pursuant to sections 7602 and 7609(f) of the Internal Revenue Code (26 U.S.C.), a John Doe summons on Circle. A copy of this summons is attached as Exhibit A.

75. As described below: (1) the John Doe summons relates to the investigation of an ascertainable group or class of persons; (2) there is a reasonable basis for believing that this group or class of persons has failed or may have failed to comply with provisions of the internal revenue laws; and (3) the information and documents sought to be obtained from the examination of the records or testimony (and the identity of the persons with respect to whose tax liabilities the summons has been issued) are not readily available from sources other than Circle.

76. Additionally, the information sought in the summons is narrowly tailored to seek only information that is necessary for the IRS to identify and investigate whether individuals in the John Doe class complied with the internal revenue laws with respect to their cryptocurrency activity.

77. The summons, attached as Exhibit A, seeks records that may reveal the identity and cryptocurrency transaction activity of U.S. persons who were Circle users with at least the equivalent of $20,000 in value of any cryptocurrency transactions (regardless of type or account) in any one year during the period from January 1, 2016 through December 31, 2020. The information requested is narrowly tailored to assist the Service with identifying U.S. taxpayers meeting the transaction limitations set forth above in any combination of accounts through Circle and who may have failed to comply with the internal revenue laws. The requests in the summons are directed at two broad categories.

78. First, requests one through four are directed at adequately identifying the John Doe class members so that transactional data can reasonably be associated with a particular person. Unlike traditional financial accounts, Circle accounts can be opened with limited personal-identifying information. Unlike traditional bank accounts, there are no signature cards or written account applications. As a result, linking a particular account to an actual person for purposes of examining such taxpayer's compliance with the internal revenue laws requires access to whatever identifying information Circle obtained from the user during the opening of the account or during its subsequent usage.

79. Second, requests five and six are directed at obtaining transactional information that may permit the Service to evaluate whether a particular, previously unknown taxpayer identified through the summons has fully complied with the internal revenue laws with respect to the treatment of cryptocurrency.

80. The IRS expects the summoned records to produce leads that will help it to identify U.S. taxpayers that have transacted in cryptocurrency through Circle at a specified floor level at any time during the period specified in the John Doe summons, who have failed to comply with the internal revenue laws with respect to their reporting of those transactions. The floor transactional level and specified tax period for the John Doe summons are described in paragraph 77 above.

81. Addressing the requests specifically, summons request number 1 reflected on Exhibit A seeks account registration records for each account owned or controlled by a user, including the complete user profile, history of changes to the user profile, user preferences, user history (including confirmed devices and account activity), user payment methods, and any other information related to the funding sources for the account. The IRS is not seeking any individual user's personal password, pin information, private keys, security settings, or account recovery information.

82. The requested account registration records and user profile will be used by the IRS to verify the identity of each Circle user in the John Doe class and to assist the IRS in determining whether that user is a U.S. person.

83. The requested history of changes to the user profile may assist the IRS in identifying whether an applicable Circle user has employed an alias, nominee, or some other tactic to disguise his identity after the initial user account setup. This information is relevant in determining, and verifying, the identity of Circle users who are U.S. persons.

84. The requested user preferences and history are to help the IRS understand how the account was managed or controlled by the user and any other third parties. This information may also be relevant in determining, and verifying, the identity and transaction activity of Circle users who are U.S. persons.

85. The requested user's payment methods may identify for the IRS sources of funds that may have been undisclosed by the taxpayer for tax purposes. This information may be relevant in determining, and verifying, the identity and transaction activity of applicable Circle users who are U.S. persons.

86. Summons request number 2 reflected on Exhibit A seeks any records associated with Know-Your-Customer due diligence that Circle performed on its applicable users that was not produced in response to request number 1. These records are relevant in determining, and verifying, the identity of Circle users who are U.S. persons.

87. Summons request number 3 reflected on Exhibit A seeks all correspondence between Circle and its applicable users (or any third party that has access to the account) about the account. This information may be relevant in determining, and verifying, the identity of the account user or how the account was used. Moreover, communications pertaining to the account may be relevant to revealing other accounts controlled by the same user.

88. Summons request number 4 reflected on Exhibit A seeks all exception reports produced by Circle's anti-money laundering (“AML”) system and all records related to investigations of those reported exceptions. These records may be relevant in assisting with tax-compliance investigations by identifying beneficial owners and parties involved in virtual currency transactions conducted through aliases, pseudonyms, or nominees as well as identifying internet protocol and email addresses of U.S. persons. The records sought do not include any suspicious activity reports (“SARs”) that were ultimately generated as a consequence of an AML alert or any other information that would reveal the existence of a SAR.

89. Summons request number 5 reflected on Exhibit A seeks all records relating to a user's cryptocurrency transactions in the account including the buying or selling of cryptocurrency units, the lending or margin trading of cryptocurrency units, the deposit or withdrawal of cryptocurrency units into the account, and the receipt of any units into the account by other means such as a chain-splitting fork or promotional events. Because cryptocurrency is treated as property for federal tax purposes and a taxpayer is required to report cost basis of cryptocurrency dispositions based on either specific identification or the “first-in, first-out” method, the IRS needs the complete transaction history to verify whether cryptocurrency transactions were properly reported.

90. Summons request number 6 reflected on Exhibit A seeks all records relating to a user's U.S. dollar or foreign legal tender transactions (together, fiat currency) in the account. Funding information is necessary for the IRS to determine the source of funds for cryptocurrency purchases and whether a user properly reported all taxable income for a particular tax year. For example, it is the IRS's experience that a taxpayer who reports minimal taxable income for a tax year while simultaneously purchasing large amounts of property (such as virtual currency) in the same tax year may not be fully reporting their taxable income.

A. The Summons Describes an Ascertainable Class of Persons

91. The proposed John Doe summons to Circle seeks information regarding U.S. taxpayers who, directly or indirectly held or had control over any combination of user accounts at Circle with at least the equivalent of $20,000 in value of any transaction types in any one year during the period January 1, 2016 through December 31, 2020. This class of persons is ascertainable, in that the persons in the class are particularized from the general public by their characteristics of having held or controlled a cryptocurrency account at Circle during the specified time period and in the specified floor amount.

B. There is a Reasonable Basis to Believe that Members of the John Doe Class May Have Failed to Comply with Internal Revenue Laws

92. Cryptocurrency, along with other virtual currencies, are treated as property under the internal revenue laws. The receipt and disposition of cryptocurrency may give rise to federal tax liabilities. As detailed in this declaration, the IRS is aware of numerous situations where owners of cryptocurrency have failed to comply with internal revenue laws as it relates to transactions conducted with cryptocurrency.

93. The information and experience of the IRS suggests that many unknown U.S. taxpayers engage in cryptocurrency transactions or structures. Because the IRS does not know the identity of the individuals within the John Doe class, the IRS cannot yet examine the income tax returns filed by those United States taxpayers to determine whether they have properly reported any income attributable to cryptocurrencies.

94. In addition, during my investigation, I was able to identify specific individuals, discussed above, who held cryptocurrency accounts with Circle and, based on my knowledge and experience, failed to comply with their tax reporting requirements under the internal revenue laws.

C. The Requested Materials (and the Identities of the Members of the John Doe Class) are Not Readily Available from Other Sources

95. To my knowledge, and based on my experience, the only repository of the information sought by the proposed summons that is readily available to the Service is Circle. To the extent that there are U.S. taxpayers who are also Circle users and their identities are known to the IRS at the time the summons is issued, such U.S. taxpayers/Circle users will be excluded from the John Doe class.

96. In light of the above, the records sought by the John Doe summons are not otherwise readily available to the IRS.

IV. Conclusion

97. Based upon the foregoing, the information sought in the John Doe summons to be served on Circle Internet Financial Inc., will allow the IRS to identify United States persons who may have failed to comply with their obligation to report and pay U.S. tax on income realized in cryptocurrency transactions during the years ending December 31, 2016 through December 31, 2020.

I declare under penalty of perjury, pursuant to 28 U.S.C. § 1746, that the foregoing is true and correct.

Executed this 30th day of March 2021, in Farmers Branch, Texas.

JOHN MARK PEIL
Senior Revenue Agent
Internal Revenue Service

FOOTNOTES

1As of January 15, 2021, cryptocurrency tracking website www.coinmarketcap.com indicated that more than 8,000 separate cryptocurrencies existed. https://coinmarketcap.com/all/views/all/ [https://perma.cc/6TEC-2W8B].

2Circle sold the Poloniex cryptocurrency exchange in late 2019, and U.S.-based customers can no longer trade on that exchange. But the summons covers the period when Poloniex was owned by Circle, and the John Doe Class definition expressly includes Poloniex.

3FinCEN has issued guidance explaining that digital currency exchanges are generally to be regulated as money transmitters. See FinCEN Guidance No. FIN-2013-G001: Application of FinCEN's Regulations to Persons Administering, Exchanging, or Using Virtual Currencies (Mar. 18, 2013), available at https://www.fincen.gov/sites/default/files/shared/FIN-2013-G001.pdf [https://perma.cc/E9C8-YH3C]; FinCEN Guidance No. FIN-2019-G001: Application of FinCEN's Regulations to Certain Business Models Involving Convertible Virtual Currencies (May 9, 2019), available at https://www.fincen.gov/sites/default/files/2019-05/FinCEN%20Guidance%20CVC%20FINAL%20508.pdf [https://perma.cc/6BVK-AJVP].

4There is no similar limitation in the summons to Circle because the terminology of Circle's exchanges differs. That is why the summons covers all transactions “regardless of type.”

5The term 'United States person' means —

(A) a citizen or resident of the United States,

(B) a domestic partnership,

(C) a domestic corporation,

(D) any estate (other than a foreign estate, within the meaning of paragraph (31)), and

(E) any trust if —

(i) a court within the United States is able to exercise primary supervision over the administration of the trust, and

(ii) one or more United States persons have the authority to control all substantial decisions of the trust.

26 U.S.C. § 7701(a)(30).

6At least one case has addressed whether a class is “ascertainable” where the class is defined based on a dollar-value threshold but the summoned party “does not record members' transactions in terms of monetary value, and is unaware of the monetary value applied to the transactions by the members.” United States v. Coble, Civil No. 82-71-B, 1982 WL 1661 at *5 (S.D. Iowa June 2, 1982). But we have reason to believe that this dollar-value information is available to Circle such that the class can be ascertained and the summons readily complied with.

7Cf. Sugarloaf Funding, 584 F.3d at 350 (holding, in summons enforcement proceeding, that “the IRS is entitled to obtain relevant records from third parties to compare for accuracy any records obtained from the taxpayer”).

1While distributed ledger technology is commonly referred to as a “blockchain” this is not entirely accurate. There are some types of distributed ledgers that do not use “blocks”. See, e.g., https://www.iota.org/get-started/what-is-iota [https://perma.cc/PN63-XNKZ] (discussing IOTA distributed ledger's use of a “tangle” chain rather than conventional “block” chain).

2See Financial Action Task Force Report, Virtual Currencies Key Definitions and Potential AML/CFT Risks, June 2014, http://www.fatf-gafi.org/publications/methodsandtrends/documents/virtual-currency-definitions-aml-cft-risk.html [https://perma.cc/3W7X-R6TD]; see also generally Bitcoin, https://en.bitcoin.it/wiki/Main_Page [https://perma.cc/DZ44-XBZV].

3See https://www.mycryptopedia.com/public-key-private-key-explained/ [https://perma.cc/QQE2-PG6F]; see also David W. Perkins, Cong. Research Serv., IF10824, Financial Innovation: “Cryptocurrencies,” (February 2018) https://crsreports.congress.gov/product/pdf/IF/IF10824 [https://perma.cc/6JAD-VSM7].

4See https://support.coinbase.com/customer/en/portal/articles/2275614-is-a-wallet-address-safe-to-display-publicly-?b_id=13521 [https://perma.cc/N8E7-5NFU].

5Not all crypto-coins operate this way. Some are designed specifically to protect all transactional information or at least to provide users the option to do so. See e.g., https://web.getmonero.org/get-started/what-is-monero/ [https://perma.cc/46KZ-NDJ4]; https://docs.dash.org/en/stable/introduction/features.html#privatesend [https://perma.cc/T6X7-5GH4].

6See Edward V. Murphy, M. Maureen Murphy, Michael V. Seitzinger, Cong. Research Serv., R43339, Bitcoin: Questions, Answers, and Analysis of Legal Issues (October 2015), https://crsreports.congress.gov/product/pdf/R/R43339 [https://perma.cc/V5QH-VFWW].

7As discussed in paragraph 59, below, in November 2019, Circle spun Poloniex into a separate entity and closed Poloniex's services to U.S. investors. The figures in this paragraph apply to the period before the spin off of Poloniex.

8Circle divested Circle Invest in March 2020. The number of cryptocurrencies cited in this sentence applies to the period before Circle Invest was divested.

END FOOTNOTES

DOCUMENT ATTRIBUTES
  • Case Name
    In the Matter of the Tax Liabilities of John Does
  • Court
    United States District Court for the District of Massachusetts
  • Docket
    No. 1:21-mc-91201
  • Institutional Authors
    U.S. Department of Justice Tax Division
  • Cross-Reference

    Government petition.

  • Code Sections
  • Subject Area/Tax Topics
  • Jurisdictions
  • Tax Analysts Document Number
    2021-14109
  • Tax Analysts Electronic Citation
    2021 TNTF 65-24
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