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Cryptocurrency and Shifting IRS Enforcement Model

2018年9月21日 15:39

Reference: Dashiell C. Shapiro, Cryptocurrency and the Shifting IRS

Enforcement Model

CodeX Stanford Journal of Blockchain Law & Policy (2018)


“The world’s tax authorities might be facing enforcement hurdles as cryptocurrency and digital assets have become increasingly common and share diverse and borderless attributes. On September 28, 2018, the U.S. sets to end Offshore Voluntary Disclosure Program (OVDP), which focuses on customer service and procedurally fair carrot-and-stick principle. This deserves our attention and consideration when we seek to develop regulatory control over cryptocurrency trading and taxation in the near future.”

This article reviews the IRS’s previous enforcement model and considers how these have changed in recent decades. Obviously, the IRS has increasingly moved away from a purely punitive system towards one that focuses on customer service, the theory being that a procedurally fair system will increase taxpayer satisfaction and voluntary compliance. Given the IRS’s steady shift to a more holistic tax enforcement approach, we think that the IRS is likely to take a broad-based approach to cryptocurrency tax enforcement. The IRS’s future cryptocurrency tax enforcement can be characterized as the following:


  1. Carrot and Stick Principle

Due to the difficulty of tracing cryptocurrency transactions and the amount of tax revenue at stake, the IRS’s previous enforcement models have shifted, moving away from criminal prosecution. The recent experience of the IRS’s Swiss Bank efforts can give some helpful clues as to how the IRS intends to approach cryptocurrency evasion. Indeed, IRS criminal tax prosecutions have actually been in steady decline over the past decade. Besides, in previous cases dealing with Swiss offshore accounts, the IRS successfully convinced many offshore account holders to come forward file back tax returns and Foreign Bank Account Reports and even pay substantial fines, which makes the account holders believe there are other options other than prosecution. To accomplish this, the IRS has used large-scale “John Doe” summons efforts coupled with general threats of prosecution, to steer people to comply with these offshore voluntary disclosure regimes.

Using the recent example of this IRS Swiss Bank enforcement effort, we might find a similar enforcement model applicable to narrow the tax gap with respect to cryptocurrency tax collection.


  1. The IRS Strategy for Cryptocurrency Enforcement on Coinbase

Seeking to start an effective feedback loop for cryptocurrency tax enforcement like Swiss Bank case, in 2016 the IRS served a “John Doe” summons to Coinbase, hoping to gather past transaction data to identify individuals behind otherwise anonymous transfers of cryptocurrency. After the summons was served, Coinbase and its customers fought back. Coinbase protested the summons, arguing that it was overly broad and that the IRS cannot use the summons power to conduct “general research” absent an investigation. Besides, Coinbase filed a motion in the District Court to block the IRS from enforcing its summons for information on the site’s users.

After meeting with Coinbase’s representative, the DOJ had already agreed to narrow the scope of the summons, to include only users who had sent or received at least $20,000 worth of bitcoin in a given year. The District Court of California authorized the IRS to serve the summons although it noted that the summons should be “no broader than necessary to achieve its purpose.”

However, the Court ruled that even the narrowed summons sought more information than was needed. The Court stated that although all the IRS needed was the user’s transaction records and the account holder’s identity, the summons had sought all wallet addresses, all public keys for all accounts/wallets/vaults, Know-Your-Customer records, and correspondence between Coinbase and the account holder. Hence, the Court further limited the scope of the summons and held that if the Government later determines that if it needs more detailed records, it can issue a summons directly to the taxpayer, or to Coinbase with notice to a named user. But otherwise with its limited authority, the IRS enforced its summons and obtained transaction information on more than 10,000 Coinbase account holders.

Another point worth remembering is that the IRS did not merely gather information from foreign banks. It also issued “John Doe” summonses to FedEx, DHL, and UPS, to see which Americans were corresponding with foreign banks. The IRS may make a similar push to creatively triangulate data on cryptocurrency transactions, perhaps with summonses to Internet Service Providers (“ISPs”), social media platforms like Facebook, Google, and Twitter, or other technology service providers that do not expressly work with cryptocurrencies.


III. Challenges for IRS Cryptocurrency Enforcement

Simply selling or buying cryptocurrency does not necessarily mean someone owes additional tax, even if large quantities of cryptocurrency have changed hands. Besides, despite the fact that the IRS has all Coinbase users’ data, many cryptocurrency transactions did not pass through Coinbase, and instead took place in private peer-to-peer transactions or on foreign exchanges. This means IRS needs a critical mass of intermediaries and/or individuals to report cryptocurrency trade information, or it is going to have a near-impossible task of making significant headway in its enforcement efforts. That is, in short, the IRS needs a “feedback loop” of information reporting regarding blockchain transactions, as it developed through its Swiss Bank enforcement efforts.

Also, the IRS faces a potential problem it did not face in its offshore account enforcement efforts: namely that the IRS OVDP primarily targets those speculative investors and many early adopters of cryptocurrency, who are now among some of the wealthiest, are fiercely libertarian and anti-government in their political leanings. With cryptocurrency enforcement, the IRS may be facing large groups of politically motivated individuals who are acting on political principles, rather than merely trying to grab a buck.

Complicating matters, the IRS also faces widespread confusion about how exactly to report cryptocurrency profits. The IRS issued a Notice in 2014, stating that bitcoin is property, not currency, but significant questions remain among practitioners. For example, how are bitcoin derivatives and loan agreements to be taxed? Can exchanges of one cryptocurrency for another qualify as like-kind exchanges under Code Section 1031, and thus avoid current taxation? Additional confusion stems from the fact that cryptocurrency users have been deploying cryptocurrencies as though they were currencies, using them as a cash substitute to make purchases online. Yet the IRS position that cryptocurrencies are in fact property could mean that each of these transactions is a taxable event, similar to a stock sale. The reporting burden, and the confusion regarding what tracking methods to use, can be overwhelming for taxpayers. And it may make voluntary compliance efforts even more challenging, especially since many cryptocurrency investors are already ideologically disposed against government enforcement.

Yet the IRS might want to take extra care not to adopt too combative a stance, given that it cannot rely solely on third-party reporting to ensure cryptocurrency compliance, which makes promoting voluntary compliance imperative. This means perhaps both more carrots and more sticks than with its offshore enforcement efforts. Perhaps more worrying for the IRS is its lack of resources to prosecute most instances of cryptocurrency tax evasion. This, combined with significant anti-government backlash in the cryptocurrency community, makes it possible that the government enforcement efforts might be undermined.


  1. Economics of Crime or Taxpayer-Friendly IRS?

As the IRS approaches cryptocurrency enforcement, it would be wise to keep both models in mind. Perceived fairness will surely be a key metric to evaluate any IRS response. Given the current confusion regarding tax reporting requirements for cryptocurrency, the IRS may be on increasingly shaky ground if it takes too combative an approach. Prosecuting individuals for cryptocurrency tax “crimes” when those tax rules are not even clearly stated could run the risk of jury nullification, negative judicial precedent, or even public backlash.

However, there are some problems lie in the IRS’s previous offshore account holder voluntary disclosure program – taxpayer friendly model. Any large-scale voluntary disclosure regime should probably be coupled with increased clarity regarding cryptocurrency reporting rules, as well as some relief for innocent taxpayers trapped by honest mistakes. The IRS itself may even bear some of the brunt of confusing and burdensome reporting rules, once it begins slogging through audits involving high volumes of cryptocurrency transactions.

At the same time, the IRS views its Swiss Bank enforcement efforts as a success, and is likely to stick to the script for the time being. This means some will be prosecuted, “John Doe” summons will be enforced to gather data on cryptocurrency transactions, and some large institutions and advisory firms will be charged as well, for facilitating tax evasion transaction using cryptocurrencies. This could be too stringent.

But whatever approach the IRS takes, it should take into account the political views and cultural considerations of the cryptocurrency community to anticipate possible responses. It is becoming increasingly clear that group dynamics can be at play in responses to government enforcement efforts.

(Compiled by Prof. Fan Chien-Te & Liu Jing-Tang, ARRS Center of Blockchain Law & Policy, National Tsing Hua University)



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