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(Reuters) – The U.S. Internal Revenue Service risks losing a blunt weapon in its years-long campaign to collect income taxes from cryptocurrency investors after a ruling from the 1st U.S. Circuit Court of Appeals.
The 1st Circuit’s decision Thursday in Harper v. Rettig revives a challenge by crypto trader (and former in-house lawyer for the Bitcoin Foundation) James Harper to the IRS’s use of so-called John Doe summonses to obtain trading records from cryptocurrency exchanges. The appellate panel – Judges William Kayatta, Kermit Lipez and Gustavo Gelpí – said in an opinion by Lipez that under U.S. Supreme Court precedent from 2021’s CIC Services LLC v. IRS, taxpayers are entitled to sue the IRS over its information-gathering tactics, despite a statutory injunction on taxpayer challenges to tax assessment and collection.
The IRS had argued that Harper’s suit ran afoul of the Anti-Injunction Act of the Internal Revenue Code because his ultimate aim was to block the government from collecting taxes based on his crypto trades. But the 1st Circuit focused on Harper’s framing of the case, in which he demanded that the IRS expunge trading records that, in Harper’s view, were obtained in violation of his Fourth and Fifth Amendment rights. Under CIC precedent, the appeals court said, Harper is entitled to sue over IRS tactics, even if those tactics would eventually enable the government to assess and collect taxes.
To be sure, Thursday’s decision merely allows Harper, a New Hampshire resident and a fellow at the American Enterprise Institute, to go back to the trial court to argue that the IRS’s use of a John Doe summons to grab hold of his trading records was unconstitutional. The 1st Circuit did not rule on the merits of Harper’s constitutional arguments. It simply reversed the 2021 dismissal of his suit on sovereign immunity grounds.
The U.S. Justice Department, which represented the IRS in the Harper appeal, did not respond to a request for comment. Harper’s lead counsel, Richard Samp of the New Civil Liberties Alliance, said the ruling upholds the basic principle that people are entitled to go to court to protect their constitutional privacy rights.
The IRS has relied heavily on John Doe summonses to wrest information about crypto traders from U.S. platforms such as Coinbase, Inc and Circle Internet Financial. Most recently, the IRS won an Aug. 15 ruling that requires SFOX, a cryptocurrency broker, to produce trading records for users who conducted trades totaling at least $20,000, pursuant to a John Doe summons.
The DOJ press release on the SFOX decision shows just how powerful a device these John Doe summonses have been for the government. Crypto trades are often anonymous and difficult to trace, DOJ said, so it’s hard for the government to evaluate whether investors are reporting all taxable income from their transactions. The IRS has been able to persuade several federal district courts that there’s good reason to suspect that unknown clients of crypto exchanges are evading income taxes – and that the government is entitled to the records that will show such evasion.
“The John Doe summons remains a highly valuable enforcement tool that the U.S. government will use again and again to catch tax cheats,” IRS Commissioner Chuck Rettig said in the SFOX release. The IRS has said previously that after it sent warning letters to Coinbase customers identified through John Doe summonses, those crypto investors coughed up at least $25 million in unpaid taxes.
Harper, of course, is hoping that his revived suit restricts the IRS’s ability to obtain trading records without even notifying taxpayers that the government is seeking information about them. Harper counsel Samp told me in a phone interview that taxpayers have a constitutional right to oppose the disclosure of their trading records. Samp said the IRS may be authorized to use John Doe summonses to learn the names and addresses of crypto platform users. But the government should not be allowed, he said, to obtain their trading records en masse, without affording individual taxpayers an opportunity to contest IRS demands.
Harper believes the IRS obtained information about his trades from Coinbase and Abra, another U.S.-based crypto platform. He received a letter from the IRS in August 2019, notifying him that the agency “has information that you have or had one or more accounts containing virtual currency but may not have properly reported your transactions involving virtual currency.” Harper contends that, in fact, he paid the requisite taxes on all of his crypto trades and the 2019 IRS notification seems to have been a form letter. The government, said Harper counsel Samp, has never taken any action against Harper after sending that initial letter.
On remand, the IRS will surely point to its successful litigation with Coinbase over a 2016 John Doe summons. Coinbase opposed the summons, which sought information on all of its users. The IRS subsequently narrowed the demand to users who traded significant sums. Over protests by Coinbase and an anonymous user, U.S. Magistrate Judge Jacqueline Corley sided with the IRS on the enforceability of the narrowed summons.
Samp said he’s confident that the Coinbase ruling is distinguishable from Harper’s claims because Coinbase was a third party, not a taxpayer alleging a violation of constitutional rights.
It’s notable that the government used a John Doe summons to obtain users’ trading information from SFOX even after the 1st Circuit hinted pretty strongly at oral arguments in the Harper case last December that it would allow Harper to proceed with his constitutional challenge. Harper’s revived case looks like it will be quite a showdown.
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