Coinbase Customer Opposes IRS Summons Enforcement

UNITED STATES OF AMERICA,
Petitioner,
v.
COINBASE, INC.,
Respondent.

UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF CALIFORNIA

INTERVENOR JOHN DOE 4’S OPPOSITION TO PETITION TO
ENFORCE INTERNAL REVENUE SERVICE SUMMONS

Date: To be determined
Time: To be determined
Courtroom: F, 15th Floor
Judge: Hon. Jacqueline Scott Corley

Jeffrey K. Berns (SBN 131351)
jberns@law111.com
Albert G. Lum (SBN 259053)
alum@law111.com
BERNS WEISS LLP
6800 Owensmouth Avenue, Suite 310
Canoga Park, CA 91303
Telephone: (818) 961-2000

Lee A. Weiss (SBN 297834)
lweiss@law111.com
BERNS WEISS LLP
585 Stewart Avenue, Suite L-20
Garden City, NY 11530
Telephone: (516) 222-2900

Attorneys for Intervenor John Doe 4

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TABLE OF CONTENTS

I. INTRODUCTION

II. STATEMENT OF RELEVANT FACTS AND PROCEDURAL HISTORY

III. ARGUMENT

IV. CONCLUSION

TABLE OF AUTHORITIES

CASES

Agricultural Asset Mgt. Co. v. United States, 688 F.2d 144 (2d Cir. 1982)

Ramirez v. United States, No. SACV 13-00268 JVS, 2013 WL 10822053 (C.D. Cal. June 10, 2013)

Stewart v. United States, 511 F.3d 1251 (9th Cir. 2008)

True the Vote, Inc. v. Internal Revenue Serv., 831 F.3d 551 (D.C. Cir. 2016)

United States v. Bisceglia, 420 U.S. 141 (1975)

United States v. Church of Scientology of Cal., 520 F.2d 818 (9th Cir. 1975)

United States v. Humble Oil & Refining Co., 488 F.2d 953 (5th Cir. 1974)

United States v. Kersting, 891 F.2d 1407 (9th Cir. 1989)

United States v. Kis, 658 F.2d 526 (7th Cir. 1981)

United States v. LaSalle Nat. Bank, 437 U.S. 298 (1978)

United States v. Powell, 379 U.S. 48 (1964)

United States v. Ritchie, 15 F. 3d 592 (6th Cir. 1994)

United States v. Samuels, Kramer & Co., 712 F.2d 1342 (9th Cir. 1983)

STATUTES

26 U.S.C. § 7601(a)

26 U.S.C. § 7602(a)

OTHER AUTHORITIES

H.R. Rep. No. 94-658, at 311 (1976), as reprinted in 1976 U.S.C.C.A.N. 2897

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I. INTRODUCTION

More than 40 years ago, the Supreme Court stated that the duty of the District Court with respect to an IRS summons was “to see that a legitimate investigation was being conducted and that the summons was no broader than necessary to achieve its purpose.” United States v. Bisceglia, 420 U.S. 141, 146 (1975). The Supreme Court expounded on the District Court’s role by stating, “[o]nce a summons is challenged it must be scrutinized by a court to determine whether it seeks information relevant to a legitimate investigative purpose and is not meant ‘to harass the taxpayer or to put pressure on him to settle a collateral dispute, or for any other purpose reflecting on the good faith of the particular investigation.’” Id. at 151 (citing United States v. Powell, 379 U.S. 48, 58 (1964)). Shortly thereafter, Congress enacted the John Doe summons statute and the statute’s legislative history made it clear that the IRS could only employ this invasive investigative tool in circumstances “where the facts of a particular case are so suggestive of possible tax liability that the Service could be remiss in its duty of collection and enforcement of the Internal Revenue laws if it did not investigate.” The Government’s petition to enforce the subject IRS Summons (“Enforcement Petition”) does not even pay lip service to, let alone attempt to comply with, the foregoing standards.

At this point, there can be no doubt that the IRS did not issue its summons pursuant to any “legitimate investigation.” Indeed, the Enforcement Petition does not make any real attempt to offer facts concerning a legitimate IRS investigation, but instead, only claims, in wholly conclusory fashion, that the IRS is conducting an investigation to determine the correct income tax liability of every U.S. citizen who conducted virtual currency transactions over a three-year period. The IRS Agent’s declaration in support of the Enforcement Petition is also generally devoid of facts concerning the supposed investigation. Remarkably, the only action the IRS claims to have taken with respect to this supposed investigation is the issuance of the summons that is the subject of the Enforcement Petition. If this meager showing is sufficient to demonstrate the existence of a legitimate tax liability investigation, then the IRS effectively has unrestricted power to issue a John Doe summons to any entity for any records it chooses. As this Court readily recognized in its order entered on July 18, 2017, this would mean that “the IRS could request bank records for every United States customer from every bank branch in the United States because it is well known that tax liabilities in general are under reported and such records might turn up tax liabilities.” Dkt. No. 40, at 8. This type of boundless summons power is unquestionably not what the Supreme Court and Congress envisioned, which is why the Court observed that “[i]t is thus no surprise that the IRS cannot cite a single case that supports such broad discretion to obtain the records of every bank-account holding American.” Id.

While the Government will undoubtedly highlight its decision to narrow the scope of the information sought by the summons, that does not change the analysis here. Remarkably, the Government’s filing concerning the narrowed scope of the summons only identified the information that the Government was no longer seeking in this enforcement proceeding, without providing any facts indicating that the IRS is engaging in a legitimate investigation of any taxpayers who transacted in virtual currency. Nor did the filing explain why the Government is no longer seeking certain information. And most critically, yet again, the Government has failed to identify a specific tax avoidance practice purportedly employed by the virtual currency users that are the subjects of the narrowed summons. Thus, the IRS has merely narrowed the scope of its improper fishing expedition concerning taxpayers who have opted to transact in virtual currency.

Moreover, by narrowing the summons in scope, yet continuing to fail to identify specific tax avoidance conduct, the Government has not addressed the concerns raised by this Court’s bank account analogy. The core of the analogy is that a general assertion of potential tax underreporting is insufficient to justify a broad John Doe summons. As aptly stated in the legislative history for the John Doe statute, the IRS needs to provide the Court with “specific facts concerning a specific situation.” Unlike the typical John Doe summons, this is not a circumstance where there is a well-defined group of taxpayers who are engaging in specific suspicious activity, such as using illegal tax shelters or engaging in large cash transactions. In contrast to those practices, there are numerous reasons for purchasing and selling virtual currency, including for use as a store of value, as an investment, or as currency.

Finally, even if the Government could establish that the IRS is engaging in a legitimate investigation of the U.S. taxpayers that are the subjects of the narrowed summons, there are significant facts raising questions as to whether the IRS is proceeding in good faith here, including 1) that nearly a year ago the Treasury Department recommended that the IRS clarify its vague virtual currency guidance (that was issued over two years prior) and employ resources to educate taxpayers as to their obligations regarding the taxation of virtual currency, yet the IRS has failed to do that;¹ 2) the IRS’s only real basis for seeking the information in the IRS Summons is that Coinbase’s customers have transacted in virtual currency; 3) the IRS does not have the resources to allow it to effectively analyze the data it is seeking; 4) the IRS has claimed that it is seeking information from Coinbase in connection with tax compliance efforts, when it appears that the IRS is improperly using the John Does summons procedure to obtain data for research purposes; and 5) the IRS has previously used its power for improper purposes. Thus, at a minimum, the Court should allow for limited discovery and then conduct an evidentiary hearing concerning the IRS’s good faith in pursuing the IRS Summons.

II. STATEMENT OF RELEVANT FACTS AND PROCEDURAL HISTORY

A. The Treasury Department Sharply Criticizes the IRS’s Virtual Currency Policies Due to the IRS’s Inability to Provide Clear Guidance to Taxpayers.

In March 2014, the IRS issued Notice 2014-21 (the “2014 Notice”), which described how the IRS applies U.S. tax laws and general tax principles to transactions involving virtual currency. Declaration of David Utzke in Support of Petition to Enforce Internal Revenue Service Summons, filed on March 16, 2017 (“3/16/17 Utzke Declaration” or “3/16/17 Utzke Decl.”), Ex. B (Dkt. Nos. 1-1; 1-3).

On September 21, 2016, the Treasury Inspector General for Tax Administration issued a report titled “As the Use of Virtual Currencies in Taxable Transactions Becomes More Common, Additional Actions Are Needed to Ensure Taxpayer Compliance”² (“9/21/16 TIGTA Report”), which criticized the IRS for, among other things, its failure to provide adequate guidance to taxpayers concerning the tax consequences of virtual currency transactions. The Report noted that while the IRS had received and reviewed 36 public comments concerning the 2014 Notice, it had taken no action to address these comments even though “information requested by the public [would have been] helpful in understanding how to comply with the tax reporting requirements when using or receiving virtual currencies.” 9/21/16 TIGTA Report at 3. The Report further stated that, while the IRS acknowledges there may be “a risk of reporting noncompliance through the use of virtual currencies in taxable transactions,” the IRS does not even have “a methodology for gathering data on virtual currency use in taxable transactions — data that are necessary to analyze the risk of noncompliance and to estimate its significance.” 9/21/16 TIGTA Report at 13.

To address the IRS’s failures, the Treasury Inspector General recommended that the IRS:

9/21/16 TIGTA Report at Highlights; 8-16.

B. The IRS Acknowledges Its Failure to Provide Meaningful Virtual Currency Guidance to Taxpayers and the Need for It to Promulgate Such Guidance.

The IRS agreed with all of the Treasury Inspector General’s recommendations (9/21/16 TIGTA Report at 8, 11, 16), but raised its limited budget as an excuse for any future delays in issuing revised virtual currency guidance:

The IRS agreed that additional guidance would be helpful; however, the IRS conveyed that guidance allocation decisions are based on available resources and other competing organizational and legislative priorities. The IRS will share this recommendation for guidance with the IRS’s Office of Chief Counsel for coordination with the Department of the Treasury’s Office of Tax Policy.

9/21/16 TIGTA Report at 11. In response, the Treasury Inspector General noted the importance of this guidance such that the IRS should make it a priority:

9/21/16 TIGTA Report at 12.

C. The IRS Fails to Issue Any Further Virtual Currency Guidance, but Seeks Information Concerning Hundreds of Thousands of Coinbase Customers for Supposed Enforcement Purposes.

Despite agreeing with the 9/21/16 TIGTA Report’s recommendations, the IRS still has not issued any further guidance concerning virtual currency. Yet, on November 17, 2016, less than two months after the issuance of the 9/21/16 TIGTA Report, the Government filed its Ex Parte Petition for Leave to Serve the IRS Summons on Coinbase.³ On November 30, 2016, this Court issued its Order Granting the Petition.

D. The Government Files Its Enforcement Petition Well after a Coinbase Customer Raises Concerns Regarding the Breadth of the IRS Summons and the IRS’s Motive in Issuing the Summons.

On December 13, 2016, Coinbase user Jeffrey K. Berns filed a motion to intervene and to quash the IRS Summons, arguing among other things that the IRS had no legitimate purpose in seeking the requested documents from Coinbase concerning its users, that enforcement of the IRS Summons would constitute an abuse of process as the IRS did not have the ability to enforce compliance with its 2014 virtual currency guidance or to prevent hackers from accessing private user information, and that the categories of requested documents were so overbroad such that the IRS Summons would require the disclosure of a substantial amount of wholly irrelevant information and documents.

On December 27, 2016, the Government filed its opposition brief to Mr. Berns’ motion and a notice that it was withdrawing its request for records with respect to Mr. Berns’ account because the IRS “now knows Mr. Berns’ identity.” Mr. Berns filed a reply on January 3, 2017, in which he contended, among other things, that the Government’s willingness to withdraw the IRS Summons as to him, without obtaining any of the information sought by the summons, other than his identity, was further evidence of bad faith.

On January 11, 2017, Coinbase filed a motion to intervene in the Summons Issuance Proceeding to preserve its right to be heard on the merits (or lack thereof) of the IRS Summons, which the Government opposed.

On February 2, 2017, the Government filed a stipulation, in which it sought a continuance of the hearing on the intervention motions because it was “considering filing a petition to enforce or taking other action.” Counsel for Mr. Berns agreed to the continuance, and agreed to withdraw the intervention motion, if the Government would file a petition to enforce the IRS Summons. On February 3, 2017, the Court approved the stipulation and continued the hearing on Coinbase’s and Mr. Berns’ motions to March 23, 2017.

On March 16, 2017, the Government filed its Petition to Enforce the IRS Summons (“Enforcement Petition” or “Pet.”) (Dkt. No. 1), in which it requested the Court enter an order directing Coinbase to show cause why it should not fully comply with the IRS Summons, and directing Coinbase to produce the requested records. Pet. at 4. On May 4, 2017, rather than issuing the Government’s proposed order to show cause, the Court directed Coinbase and the Government to submit a proposed briefing schedule “[i]n light of the unique procedural history of this case, and especially given that Coinbase has already raised a number of challenges to the summons in the context of the related case.” Dkt. No. 9.

E. Coinbase Customers File Motions to Intervene in This Enforcement Proceeding and Seek to Oppose the Enforcement Petition.

On May 15, 2017, Proposed Intervenors John Does 1 and 2, Coinbase users whose identities and information were sought by the IRS Summons, filed a motion to intervene and for other relief. Dkt. No. 10. On May 26, 2017, the parties and John Does 1 and 2 filed a Stipulation wherein, among other things, the parties set a briefing schedule concerning the Enforcement Petition and John Does 1 and 2 agreed not to pursue any of the relief in their motion other than intervention for the purpose of opposing the Enforcement Petition, which Stipulation was approved by the Court on May 30, 2017. Dkt. No. 22.

F. Congress Questions the IRS’s Motives in Pursuing the IRS Summons and Urges the IRS to Issue Clear Virtual Currency Tax Guidance.

On May 17, 2017, House Ways and Means Committee Chairman Kevin Brady, Senate Finance Committee Chairman Orrin G. Hatch, and House Ways and Means Oversight Subcommittee Chairman Vern Buchanan sent a letter to IRS Commissioner John Koskinen “request[ing] information about the IRS’s digital currency strategy as well as recent events surrounding the IRS’s summons to Coinbase.”⁴ They discussed TIGTA’s findings that there was “a need for the IRS to update its initial guidance to reflect the various uses of digital currencies” and noted that “no such update has appeared.” Moreover, they questioned the IRS’s motive in pursuing the IRS Summons:

[W]e strongly question whether the IRS has actually established a reasonable basis to support the mass production of records for half of a million people, the vast majority of whom appear to not be conducting the volume of transactions needed to report them to the IRS. Based on the information before us, this summons seems overly broad, extremely burdensome, and highly intrusive to a large population of individuals. The IRS's actions in this case also set a dangerous precedent for companies facilitating virtual currency transactions that could be subject to a similar summons.

A few weeks later, on June 2, 2017, Congressmen Jared Polis and David Schweikert, who also recounted TIGTA’s recommendations, wrote to Commissioner Koskinen “urg[ing] the Internal Revenue Service (IRS) to issue additional guidance on the tax consequences and basic tax reporting requirements for transactions using virtual currencies. . . . [A]dditional guidance could assist businesses facilitate virtual currency transactions and purchases and individual tax payers to increase reporting on income gained or loss on virtual currency transactions.”⁵

G. The Government Narrows the Scope of the Information Sought by the IRS Summons, but Fails to Offer Any Explanation for This Action.

On June 29, 2017, the Court heard oral arguments concerning John Does 1 and 2’s motion to intervene, and took the matter under submission. At the hearing, counsel for the Government stated that the Government was considering narrowing the scope of the information sought by the IRS Summons.

On July 6, 2017, the Government filed a Notice of Narrowed Summons Requests for Enforcement (“July 6, 2017 Notice”), stating that it was no longer seeking enforcement of the IRS Summons in full, but instead, it was now seeking only certain records concerning a subset of Coinbase users:

Dkt. No. 37. The July 6, 2017 Notice did not offer any explanation as to why the Government had opted to narrow the information sought by the IRS Summons or why the narrowed information was relevant to an IRS investigation.

Because John Does 1 and 2 were not “covered users,” as defined in the July 6, 2017 Notice, on July 14, 2017, the parties filed a Stipulation providing, among other things, that, subject to Court approval, another client of counsel for John Does 1 and 2, John Doe 4, would substitute for John Does 1 and 2 in this proceeding. Dkt. No. 39.

H. The Court Grants the Motion to Intervene and Allows John Doe 4 to Oppose the Enforcement Petition Based, in Part, on a Sufficient Showing of Abuse of Process by the IRS.

On July 18, 2017, the Court issued an Order (“7/18/17 Order”) permitting John Doe 4 to substitute for John Does 1 and 2 and granting John Doe 4’s motion to intervene as of right and for permissive intervention. Dkt. No. 40. The Court concluded that “John Doe 4 has made a sufficient showing of abuse of process to support intervention as of right,” stating:

The IRS offers no explanation as to how the IRS can legitimately use most of these millions of records on hundreds of thousands of users; instead, it claims that as long as it has submitted a declaration from an IRS agent that the IRS “is conducting an investigation to determine the identity and correct federal income tax liabilities of United States persons who conducted transactions in a virtual currency during 2013-2015” the Court must find that the Summons does not involve an abuse of process. It contends that “there seems to be a substantial gap between the number of people transacting in virtual currency (for which tax consequences might attach) and those that are reporting such transactions.” (Dkt. No. 28 at 13.) But that argument proves too much. Under that reasoning the IRS could request bank records for every United States customer from every bank branch in the United States because it is well known that tax liabilities in general are under reported and such records might turn up tax liabilities. It is thus no surprise that the IRS cannot cite a single case that supports such broad discretion to obtain the records of every bank-account holding American.

7/18/17 Order at 8.

III. ARGUMENT

A. The Court Should Deny the Petition to Enforce the IRS Summons as the Government Has Abused the John Doe Summons Procedure.

Once an IRS summons is challenged, “the IRS must make a prima facie showing that the summons was issued in good faith.” Stewart v. United States, 511 F.3d 1251, 1254 (9th Cir. 2008) (citing Powell, 379 U.S. at 57). “Specifically, the IRS must establish that the summons (1) was issued pursuant to a ‘legitimate purpose’; (2) seeks information ‘relevant’ to that purpose; (3) seeks information that is ‘not already within the Commissioner's possession’; and (4) satisfies all ‘administrative steps required by the Code.’” Id. If the government can satisfy this burden, the party challenging the summons needs to “show an abuse of process or a lack of good faith by the IRS.” Ramirez v. United States, No. SACV 13-00268 JVS, 2013 WL 10822053, at *3 (C.D. Cal. June 10, 2013), aff'd, 604 F. App'x 567 (9th Cir. 2015) (citing Fortney v. United States, 59 F.3d 117, 120 (9th Cir. 1995)).

In Powell, the Court explained that in a summons enforcement proceeding:

It is the court’s process which is invoked to enforce the administrative summons and a court may not permit its process to be abused. Such an abuse would take place if the summons had been issued for an improper purpose, such as to harass the taxpayer or to put pressure on him to settle a collateral dispute, or for any other purpose reflecting on the good faith of the particular investigation.

379 U.S. at 58. “The purpose of the good-faith inquiry is to determine whether the agency is honestly pursuing the goals of § 7602⁶ by issuing the summons.” United States v. LaSalle Nat. Bank, 437 U.S. 298, 316 (1978). The facts and circumstances present here demonstrate that the IRS has not met its burden of demonstrating that the IRS Summons was issued for a legitimate investigative purpose.

1. The IRS Did Not Have a Legitimate Purpose in Issuing the Summons.

a. The Government Has Not Provided Specific Facts Demonstrating Any Potential Tax Liability on the Part of Coinbase Customers.

When Congress enacted the IRS John Doe summons statute, it wanted to insure that “the use of this important investigative tool should not unreasonably infringe on the civil rights of taxpayers, including the right to privacy.” H.R. Rep. No. 94-658, at 311 (1976), as reprinted in 1976 U.S.C.C.A.N. 2897, 3203. Indeed, it expressly stated that a John Doe summons should only be used “where the facts of a particular case are so suggestive of possible tax liability that the Service could be remiss in its duty of collection and enforcement of the Internal Revenue laws if it did not investigate.” Id. at 3207. Congress further made it clear that the John Doe summons procedure was not designed to permit the IRS to engage in a fishing expedition:

While the committee believes it is important to preserve the John Doe summons as an investigative tool which may be used in appropriate circumstances, at the same time, the committee does not intend that the John Doe summons is to be available for purposes of enabling the Service to engage in a possible “fishing expedition.” For this reason, the committee intends that when the Service does seek court authorization to serve (a) John Doe summons, it will have specific facts concerning a specific situation to present to the court.

Id. (emphasis added). Consistent with this legislative history, a John Doe summons typically focuses on identifying taxpayers who engage in inherently suspicious or illegal activities, such as large cash transactions or investing in questionable tax shelters. See, e.g., United States v. Samuels, Kramer & Co., 712 F.2d 1342, 1344 (9th Cir. 1983) (John Doe summons issued on two corporations in the course of investigating 25 customers who invested in abusive tax shelters); Agricultural Asset Mgt. Co. v. United States, 688 F.2d 144, 147 (2d Cir. 1982) (John Doe summons issued on corporation in the course of investigating 19 partnerships and 10 individuals who invested in dairy herd tax shelter program); Bisceglia, 420 U.S. at 150 (John Doe summons issued to identify persons who deposited decrepit $100 bills within the space of a few weeks).

The Enforcement Petition does not contend that transacting in virtual currency is inherently suspicious. Nor does the Enforcement Petition satisfy Congress’ expectation that the IRS would “have specific facts concerning a specific situation to present to the court.” Instead, it only contends that the Government is conducting a supposed investigation of the tax liability of every U.S. taxpayer who conducted virtual currency transactions over a three-year period. 3/16/17 Utzke Decl., ¶ 2. (“The IRS is conducting an investigation to determine the identity and correct federal income tax liabilities, for the years ended December 31, 2013, 2014, and 2015, of United States persons who conducted transactions in a convertible virtual currency as that term is defined in IRS Notice 2014-21”). The IRS has literally provided no details concerning this supposed investigation.

Frankly, it is hard to believe that any formal investigation actually exists. For example, even though the Government has now narrowed the scope of the IRS Summons, it has not stated whether, and if so, why, it has similarly narrowed the scope of its supposed investigation. Does that investigation now only concern “covered users,” as that term is defined in the July 6, 2017 Notice, and if so, why? The lack of this information is particularly galling in view of the fact that the existence of a legitimate investigation has been questioned by John Doe 4, members of Congress, and this Court.

Finally, at the hearing on the motion to intervene, the Government essentially admitted that it is engaging in a fishing expedition by acknowledging that the IRS currently has no basis to conclude that any of the subjects of the IRS Summons have engaged in conduct that is suggestive of tax liability:

The IRS isn't going to just go after all of these people. The IRS is going to take a look at who they are, take at look at what their filing status is, and then depending upon what they learn in their — in the course of their legitimate, you know, investigation, determine whether any kind of further examination is necessary.

Transcript of the June 29, 2017 hearing regarding the motion to intervene by John Does 1 and 2 (“6/29/17 Tr.”) (Weiss Decl, Ex. 3) at 19:14-19.

Again, the purpose of the John Doe Summons is to identify taxpayers who have engaged in a specific type of tax avoidance behavior. Yet, here, the Government wants the right to identify taxpayers who have transacted in virtual currency — behavior that is not inherently suspicious — and then determine if those taxpayers should be subject to a further investigation. This is the precise circumstance about which the Court expressed its concern at the prior hearing, when it acknowledged that taxpayers would suffer a clear injury if the Government obtained their records when it had no right to do so. 6/29/17 Tr. at 29:7-13. Where, as here, the IRS cannot identify a specific tax liability scenario in support of a broad John Doe summons, there can be no doubt that enforcement of the summons will lead to the improper disclosure of the identities and documents of a substantial number of taxpayers who have not underpaid their taxes. As the Court noted in the 7/18/17 Order, a Coinbase customer’s interests will be impaired if “the IRS will possess its personal information and other transaction history on the Coinbase platform” when the IRS is not legitimately entitled to that information. 7/18/17 Order at 9.

Returning to the Court’s bank account analogy, the general assertion that some taxpayers are underreporting their income is simply not sufficient to justify the issuance of a John Doe summons to an entity for taxpayers’ financial records, be it a bank or a virtual currency exchange. The narrowing of the IRS Summons, without more, does not disturb that analogy. There must be some showing of conduct suggestive of tax liability on the part of the taxpayers that are the subject of the John Doe summons. Here, there is none.

b. The Government’s Purported Statistical Evidence Does Not Demonstrate Conduct Suggestive of Tax Liability.

The sole fact on which the Government relies to support its Enforcement Petition is that several database searches purportedly did not reveal that a substantial number of taxpayers had identified bitcoin transactions on their tax returns. 3/16/17 Utzke Decl., ¶¶ 11-13. However, the Government only provides minimal information concerning those searches and does not offer any statement as to why those figures are meaningful, including whether the searches reasonably capture all individuals who reported capital gains from virtual currency transactions. Instead, the Government merely provides the numbers and is presumably implying that this means that many taxpayers are failing to report virtual currency capital gains.

In addition to the fact that the Court has already stated that these statistics cannot justify the enforcement of a wide-ranging John Doe summons, the statistics pale in comparison to the specific types of suspicious activity that the Government has previously used to justify John Doe summonses, which include illegal tax shelters and large cash transactions. See United States v. Kersting, 891 F.2d 1407 (9th Cir. 1989); United States v. Ritchie, 15 F. 3d 592 (6th Cir. 1994). In those circumstances, the IRS sought the identification of a narrow class of persons that had engaged in suspect activity. Here, the IRS is still seeking the identification of thousands of individuals, and substantial transactional data, without any showing of suspect activity by any of these individuals, let alone a likelihood that any significant number of them engaged in suspect activity.

Moreover, conspicuous by its absence is any statement by the Government as to when it performed the subject searches. To the extent that those searches were performed after the Court approved the IRS Summons — a reasonable inference based on the noticeable lack of dates in the IRS Agent’s declaration — they certainly do not demonstrate that the IRS was engaging in a legitimate investigation at the time it issued the IRS Summons. In fact, the Government appears to have admitted that there was no legitimate investigation at the time it issued the IRS Summons, as these searches appear to be nothing more than an after-the-fact attempt to justify a summons that never should have been issued in the first place.

B. If the Court Does Not Deny the Enforcement Petition, It Should Allow John Doe 4 to Conduct Limited Discovery and Then Conduct an Evidentiary Hearing Based on the Specific Facts That Raise Doubts Concerning the IRS’s Good Faith in Issuing the IRS Summons.

A taxpayer, who has “[made] a sufficient showing of bad faith on the Government’s part, . . . is entitled to a limited evidentiary hearing.” Samuels, 712 F.2d at 1346-47. To make a showing of bad faith, the taxpayer must introduce “some evidence” to support his allegations. United States v. Church of Scientology of Cal., 520 F.2d 818, 824 (9th Cir. 1975) (quoting United States v. Salter, 432 F.2d 697, 700 (1st Cir. 1970)). The burden is not strict, as the Ninth Circuit has explained:

A taxpayer must answer the Government's prima facie case “through responsive pleadings, supported by affidavits, that allege specific facts in rebuttal.” [United States v. Kis, 658 F.2d 526, 539 (7th Cir. 1981)] (emphasis in original). The facts, however, need only raise “sufficient doubt” about the Government's purposes in seeking enforcement of a summons. Church of Scientology, 520 F.2d at 825. The taxpayer must thus allege facts “from which a court might infer a possibility of some wrongful conduct by the Government.” Kis, 658 F.2d at 540 (emphasis in original). This implication alone is enough to trigger a limited evidentiary hearing. At this stage, the taxpayer need not actually be able to prove the Government's lack of good faith. See id.

Samuels, 712 F.2d at 1347-48 (emphasis in original); see also Church of Scientology, 520 F.2d at 825 (ordering limited evidentiary hearing where bad faith allegations were “thin”). “On the basis of evidence revealed at the limited evidentiary hearing, the court must determine whether the taxpayer should be permitted further discovery to uncover facts to support the assertion of bad faith.” Samuels, 712 F.2d at 1347; Kis, 658 F.2d at 542 (“If the court cannot decide the merits of the enforcement petition at the hearing, then further discovery would clearly be helpful to the ultimate resolution of the case. The district court should therefore permit some discovery at this stage.”).

There are numerous facts that raise serious questions concerning the IRS’s good faith in issuing the IRS Summons, such that if the Court does not deny the Enforcement Petition at this time, it should order limited discovery and an evidentiary hearing.

1. The 9/21/16 TIGTA Report Shows That the IRS Does Not Currently Have the Ability to Enforce Compliance with Its Vague Virtual Currency Guidance Issued in 2014.

As set forth above, the 9/21/16 TIGTA Report demonstrates that the IRS’s 2014 virtual currency guidance is woefully insufficient, and thus, in the absence of clearer guidance, the IRS is not in a position to enforce compliance with the tax code with respect to virtual currency. The IRS’s failure to issue any further virtual currency guidance since 2014, including in response to the 9/21/16 TIGTA Report, is stunning. The Report noted that while the IRS received and reviewed 36 public comments to its 2014 virtual currency guidance, it took no action in response to these comments, even though “information requested by the public [would have been] helpful in understanding how to comply with the tax reporting requirements when using or receiving virtual currencies.” 9/21/16 TIGTA Report at 3. Further, the Treasury Department indicated that regardless of the IRS’s budget constraints, the IRS should focus resources to clarify guidance to aid taxpayers in “voluntarily” complying with the tax code.

Despite the demonstrable need for clarifying virtual currency tax guidance, the IRS has opted not to issue a single word of virtual currency guidance since promulgating admittedly insufficient guidance more than three years ago. Indeed, members of Congress have recently demanded publicly that the IRS clarify its convoluted virtual currency guidance. Having been unable, or unwilling, to issue such new guidance, it is hard to believe that the IRS has issued the IRS Summons in good faith. After all, if the IRS admits that it has not properly informed taxpayers of the virtual currency taxation rules, and refuses to clarify those rules, how could it now reasonably seek to review the records of thousands taxpayers for virtual currency tax compliance purposes?

2. The IRS Summons Improperly Seeks Information for Research, as Opposed to Tax Compliance, Purposes.

As the IRS did not dispute the 9/21/16 TIGTA Report’s conclusion that it did not have a method for gathering the necessary data to analyze the risk and scope of non-compliance with the tax code with respect to virtual currency, how could enforcement possibly be the goal of a summons issued only two months later? Rather than enforcement, it appears that the IRS is trying to use a John Doe summons to gather data for research purposes in response to the 9/21/16 TIGTA Report’s criticism. This is improper in the absence of a specific investigation regarding tax compliance. A summons issued under Section 7602 may not be used solely for research purposes under Section 7601.⁷ See United States v. Humble Oil & Refining Co., 488 F.2d 953, 962-63 (5th Cir. 1974), vacated and remanded, 421 U.S. 943 (1975), aff'd. per curiam, 518 F.2d 747 (5th Cir. 1975) (“[W]e hold that the Internal Revenue Service is not empowered by section 7602 to issue a summons in aid of its section 7601 research projects or inquiries, absent an investigation of taxpayers or individuals and corporations from whom information is sought.”).

The Government’s assertion that the requested information is needed as part of a supposed investigation into the tax compliance of virtual currency users is undoubtedly a pretext, as the Commissioner of the IRS has repeatedly stated that the IRS does not have sufficient funding to pursue enforcement efforts. See, e.g., October 23, 2015 Prepared Remarks of Commissioner John A. Koskinen Before The Council for Electronic Revenue Communication Advancement (“Since 2010, the IRS has suffered deep, dramatic funding reductions that have undermined our ability to provide taxpayers with top quality service and ensure compliance with the tax laws.”) (RFJN, Ex. 2). See also April 4, 2016 report⁸ from Center on Budget and Policy Priorities, entitled “IRS Funding Cuts Compromise Taxpayer Service and Weaken Enforcement,” at 6 (“As a result of cuts, the IRS is conducting fewer audits overall and fewer audits of high-income taxpayers and businesses.”). It is hard to believe that the current budget-strained IRS is going to review three years of tax returns for thousands of taxpayers to determine if they properly paid taxes with respect to their virtual currency transactions.

Moreover, based on the current dollar volume of virtual currency transactions, it seems unlikely that the IRS would devote a substantial portion of its resources to enforcement of virtual currency tax obligations. According to the IRS, the 2015 transactional value of bitcoin was approximately $10 billion.⁹ Unpaid taxes on any portion of that amount which reflects taxable gains in the trading or use of bitcoin would pale in comparison to the total amount of U.S. tax revenue, which in 2014 was approximately $1.7 trillion,¹⁰ and the annual Tax Gap, which is approximately $387 billion. It strains credulity that the financially-strapped IRS is going to spend substantial resources on reviewing the trading data and tax returns of Coinbase customers, when that is not likely to yield tax revenue that would justify that expense.

3. The IRS Has Previously Been Accused of Abusing Its Power to Improperly Further the Government’s Political Agenda.

While the Court need not determine the IRS’s true motive in order to find a lack of good faith, it is hardly far-fetched to conclude that the IRS has an ulterior motive for pursuing the IRS Summons. As this Court may be aware, the IRS recently used its power to retaliate against anti-administration political associations and political speech. In 2013, the IRS revealed that it had selected political groups applying for tax-exempt status, “Tea Party,” for intensive scrutiny based on their names or political themes, which triggered widespread condemnation of the agency. Multiple investigations of the IRS by the FBI and the U.S. Attorney General are pending, while lawsuits filed against the IRS were recently reinstated by the D.C. Circuit. See True the Vote, Inc. v. Internal Revenue Serv., 831 F.3d 551 (D.C. Cir. 2016).

It is not a stretch to conclude that the government is similarly using the IRS’s John Doe summons authority to harass taxpayers who use virtual currencies, as politicians and financial leaders have suggested an anti-virtual currency bias by the government. For example, Jamie Dimon, CEO of JPMorgan Chase, stated: “Virtual currency, where it’s called a bitcoin vs. a U.S. dollar, that’s going to be stopped. No government will ever support a virtual currency that goes around borders and doesn’t have the same controls. It’s not going to happen.”¹¹ Similarly, Sen. Joe Manchin (D-W. Va.), a former member of the Senate banking committee, stated: “If the feds can't get their hands around [bitcoin] to where they can secure it, then I would be very leery of investing in it or trading with it or buying with it."¹²

4. Limited Discovery in Advance of an Evidentiary Hearing is Appropriate Here.

As set forth above, the typical procedure in an enforcement proceeding where there is evidence of bad faith is for the Court to conduct a limited evidentiary hearing. Then, if the hearing does not provide the Court with sufficient evidence to rule on the enforcement petition, it can order limited discovery. Here, it seems apparent that an evidentiary hearing confined to the facts raised in the Government’s Enforcement Petition will not provide the Court with significant evidence. Among other things, the Government’s declarations offer only the barest details of its supposed investigation into the tax liabilities of virtual currency users.

Further, as set forth above, the Government has sought to imply that many Coinbase customers are not paying taxes on their bitcoin trading gains by providing certain figures regarding the number of tax returns that “us[e] a property description likely related to bitcoin.” 3/16/17 Utzke Decl., ¶¶ 11-13. However, the Government has failed to provide any evidentiary basis for these figures, as it has not provided any supporting evidence concerning the supposed searches that were performed to derive these figures, or even a declaration from the IRS employee who purportedly performed these searches.

In order for the Court to make a determination of good faith on a sufficient record, it should permit John Doe 4 (and Coinbase) to take the deposition of the IRS Agent who filed a declaration in support of the Enforcement Petition and require the Government to produce the documents that underlie the statements in that declaration. This limited deposition and document production will not be burdensome or time-consuming, and thus, will not prejudice the Government. Indeed, as previously noted by this Court, “if [discovery] is appropriate, it will not unduly delay this enforcement action.” 7/18/17 Order at 11-12 (emphasis in original).

IV. CONCLUSION

Based on the foregoing, John Doe 4 respectfully requests that the Court deny the Government’s Petition to Enforce the IRS Summons.

Dated: July 27, 2017

Lee A. Weiss (SBN 297834)
lweiss@law111.com
BERNS WEISS LLP
585 Stewart Avenue, Suite L-20
Garden City, NY 11530
Telephone: (516) 222-2900

Jeffrey K. Berns (SBN 131351)
jberns@law111.com
Albert G. Lum (SBN 259053)
alum@law111.com
BERNS WEISS LLP
6800 Owensmouth Avenue, Suite 310
Canoga Park, CA 91303
Telephone: (818) 961-2000

Attorneys for Intervenor John Doe 4