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IRS Probe of Bitcoin Accounts Sparks Legal Showdown

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In a case testing the government’s ability to unmask individuals who do business in cryptocurrency, San Francisco digital currency company Coinbase Inc. is challenging an IRS request for information about customers.

Coinbase, which claims to have more than 5 million users worldwide, provides “wallets” that allow consumers and merchants to conduct transactions in currencies such as bitcoin and ethereum. Tax enforcers want to sift through reams of Coinbase data to look for unreported income belonging to the company’s U.S. account holders.

Brian Klein of Los Angeles’ Baker Marquart, whose practice centers on digital currency issues, called the showdown “the first major tax case for the industry.”

“[I]t will have a huge impact well beyond just Coinbase and its customers,” said Klein, the organizer of the Digital Currency & Ledger Defense Coalition. The group, which includes attorneys from Cooley; Orrick, Herrington & Sutcliffe; and Sidley Austin, plans to weigh in with an amicus brief backing Coinbase, Klein said.

The conflict began taking shape in November 2016 when U.S. Magistrate Judge Jacqueline Scott Corley of the Northern District of California issued a court order that would force the company to hand over three years’ worth of customer data. Lawyers for the IRS got the sign-off from Corley in ex parte proceedings on a so-called John Doe summons to identify the Coinbase customers.

On Jan. 11, lawyers for Coinbase forcefully objected with court papers calling the IRS’s request overly broad and complaining that it places an outsized burden on the company. Goodwin Procter’s Steven Ellis wrote that the agency had relied on a single declaration by an IRS agent which cited only three known failures to report income related to digital currency. The IRS, he wrote, hadn’t established grounds to ask for “information regarding every single transaction conducted by every single U.S.-based Coinbase account holder (no matter how large or small) for a three-year period.”

“The IRS did not suggest, and has never suggested, that Coinbase itself has engaged in any wrongdoing of any kind,” Ellis wrote.

Ellis referred a call to a company spokesman, who declined to comment.

Corley will hear arguments on Jan. 19 on a separate motion from Jeffrey Berns, a Los Angeles attorney and Coinbase customer, who is seeking to intervene in the lawsuit and block the IRS’s summons himself. Since Berns filed his motion, the IRS has dropped its request for Berns’ personal records and asked that the judge find his motion moot.

In an op-ed published Jan. 12 at the digital currency news website Coindesk, Berns wrote that the type of summons the IRS obtained from the court is more often used in cases involving tax shelters or offshore banking accounts, where the IRS has identified a practice that has no legitimate purpose other than evading taxes.

“The IRS’s characterization of all cryptocurrency users as potential tax evaders concerned me immediately when I first learned of the summons,” Berns wrote. “The federal government must not be allowed to trample on the rights of individuals and to stifle innovation due to an undisclosed political agenda,” he wrote.

Berns is being represented by Lee Weiss, his partner in the Berns Weiss law firm. Weiss wasn’t immediately available Thursday.

— Read Turning Cryptocurrency Into an Asset Class on ThinkAdvisor.