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How the IRS Uses John Doe Summons to Identify Cryptocurrency Tax Cheats

 

How the IRS Uses John Doe Summons to Identify Cryptocurrency Tax Cheats

The IRS has been ramping up efforts to crack down on cryptocurrency tax evasion in recent years. One of their key tools for identifying non-compliant taxpayers is the John Doe summons. This allows the IRS to obtain information from third parties about a group of unnamed taxpayers who may have failed to properly report cryptocurrency transactions on their tax returns.

In this article, we’ll break down exactly what a John Doe summons is, how the IRS has used them to target crypto tax cheats, and what it means for investors in digital currencies.

What is a John Doe Summons?

A John Doe summons is a tool the IRS can use to obtain information and records about a group of taxpayers whose identities are unknown (hence the name “John Doe”). The IRS must first get approval from a federal district court judge before serving one of these summonses.

Once approved, the John Doe summons compels a third party that possesses relevant information about the targeted taxpayers to turn over those records to the IRS. This allows the tax agency to obtain data like names, addresses, and account details that can help them identify non-compliant taxpayers.

The IRS has used John Doe summonses for decades to gather information in various tax enforcement initiatives. But in recent years, they’ve become a prime weapon for targeting cryptocurrency tax evasion.

How the IRS Uses John Doe Summons for Crypto Taxes

In the past few years, the IRS has gotten federal courts to approve John Doe summonses for several major cryptocurrency exchanges and platforms:

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  • Coinbase – the IRS sought records on all Coinbase customers who conducted crypto transactions between 2013-2015.
  • Circle Internet Financial – the summons covered records of customers who made $20,000+ in crypto transactions from 2016-2021.
  • Kraken – the IRS obtained a summons for information on Kraken customers with $20,000+ in crypto transactions from 2016-2020.
  • SFOX – a summons was approved for records of customers with $20,000+ in crypto transactions from 2016-2021.

As you can see, the IRS has consistently used the $20,000 transaction threshold in these summonses. This allows them to focus on taxpayers who appear to have significant cryptocurrency activity and are most likely to have potential tax liabilities.

The summonses have compelled the crypto platforms to hand over detailed transaction records, account info, and other identifying data about the customers meeting that $20,000+ transaction standard.

Armed with this information, the IRS can piece together which taxpayers own the accounts and determine if they properly reported crypto transactions on their tax returns. Any taxpayer who received the summons has the right to legally contest it if they desire.

Why the IRS is Targeting Crypto Tax Evaders

The IRS considers cryptocurrency an investment property for tax purposes. This means capital gains and losses from trading, selling, or exchanging virtual currencies are taxable events that must be reported on your tax return.

However, because crypto is still relatively new compared to other asset classes, many users aren’t aware of the tax rules. Others know the requirements but try to avoid paying taxes on crypto gains through underreporting or non-reporting.

Some key reasons the IRS is worried about cryptocurrency tax evasion include:

  • Billions in unpaid taxes – The IRS estimates there is over $25 billion in unpaid cryptocurrency taxes.
  • Anonymity – The pseudo-anonymous nature of crypto makes it appealing for hiding assets and evading taxes.
  • Lack of third-party reporting – Unlike stock brokers, crypto exchanges don’t automatically report transactions to the IRS, allowing easier tax evasion.
  • Growth of crypto – With adoption booming, the IRS is worried about more and more unreported crypto transactions each year.

John Doe summonses give the IRS a powerful tool to obtain crypto transaction data directly from exchanges and identify non-compliant taxpayers. Expect to see expanded use of these summonses as crypto continues growing.

Recent Crypto Tax Prosecutions Linked to John Doe Summons

The data obtained from John Doe summonses has aided the IRS in identifying and prosecuting cryptocurrency tax evaders over the past few years.

For example, tax attorney James Kole was arrested in 2022 for allegedly helping clients hide over $100 million in capital gains from crypto transactions. According to a Justice Department release, the IRS used evidence from a John Doe summons served on a crypto exchange to catch Kole and his clients.

In another 2022 case, the IRS used a John Doe summons to obtain data that helped indict Robert and Larissa Morgan for tax evasion. The couple allegedly failed to report $5.6 million in capital gains from crypto trading between 2013-2017 according to the indictment.

These cases illustrate how the IRS leverages John Doe summons information to build substantial tax evasion and fraud cases against cryptocurrency holders. Expect to see more such prosecutions in coming years as the IRS receives additional data.

What This Means for Crypto Investors and Taxpayers

The IRS’s ramped up use of John Doe summonses sends a clear signal – crypto tax compliance is being taken very seriously.

For investors in Bitcoin, Ethereum, and other virtual currencies, here are some steps you can take to stay on the right side of the taxman:

  • Accurately report all crypto transactions on your tax return using Form 8949.
  • Maintain detailed records of your cost basis, sale price, and other details for each taxable event.
  • Consider using crypto-specific tax software to generate Form 8949 and calculate gains/losses.
  • Disclose all crypto income – failing to report is worse than reporting accurately.
  • Avoid obvious tax evasion schemes, as the IRS is cracking down.

The bottom line is that crypto is a taxable asset class – taxpayers need to take this seriously. Those who fail to report income or capital gains from virtual currency transactions are at growing risk of severe penalties, prosecution, and criminal tax fraud charges as the IRS expands its cryptocurrency compliance efforts.

Following the tax rules for digital currency is strongly advised in light of the IRS’s powerful tools like John Doe summonses. Don’t lose your crypto gains to interest, fees, and potential legal consequences – take crypto tax reporting seriously.

References

Here are some references cited in this article:

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