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K&F News Brief: DOJ Uses John Doe Summons On Crypto Dealer To Remind Taxpayers To Report Crypto Transactions

On August 16, 2022, the Department of Justice published a press release announcing that a federal court in the Central District of California has authorized the IRS to serve a John Doe summons on the cryptocurrency prime dealer SFOX. That summons directs SFOX to identify and produce records relating to taxpayers who, between 2016 and 2021, engaged in cryptocurrency transactions on its platform that totaled at least the equivalent of $20,000. The press release noted that “There is no allegation in this suit that SFOX has engaged in any wrongdoing in connection with its digital currency business.” The DOJ explained the utility of John Doe summonses in enforcing cryptocurrency tax compliance, and emphasized that taxpayers who transact in virtual currencies should ensure that they comply with tax laws and regulations.

The IRS uses John Doe summonses as a means of obtaining information about possible violations of federal tax laws by individuals whose identities are not known. In accordance with Section 7609(f) of the Internal Revenue Code, the IRS may only issue a John Doe summons that “does not identify the person with respect to whose liability the summons is issued” after a court proceeding in which the IRS must first establish that 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 federal tax 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. Section 7609(f) also specifies that the IRS may not issue a John Doe summons “unless the information sought to be obtained is narrowly tailored to information that pertains to the failure (or potential failure) of the [relevant] person or group or class of persons…to comply with one or more provisions of the internal revenue law.” A John Doe summons to a cryptocurrency trading platform is not new; the IRS has previously issued similar John Doe summonses to other cryptocurrency exchanges including Kraken, Circle, and Coinbase.

The DOJ noted that some taxpayers may be using cryptocurrency to hide taxable income from the IRS, as transactions in cryptocurrency “can be difficult to trace and have an inherently pseudo-anonymous aspect.” IRS Notice 2014-21, which contains guidance from the Service on the tax consequences of the use of virtual currencies, notes that virtual currencies that can be converted into traditional currency are to be considered property for tax purposes, and that a taxpayer may have a gain or loss on the sale or exchange of a virtual currency depending on the taxpayer’s tax basis in that currency. The IRS’s commitment to ensuring cryptocurrency tax compliance is underscored by the presence of a question at the top of the 2022 Form 1040 income tax return, as well as the 2022 Form 1040-SR income tax return for seniors, asking about virtual currency transactions. Anyone who transacts in virtual currencies is well advised to review the IRS’s guidance to ensure compliance before filing their 2022 tax returns.

More information on the taxation of cryptocurrency is available on the IRS’s webpage on Virtual Currency.