Tax Lawyer Blog

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The Summons

The Coinbase "John Doe" Summons: Has the IRS Overtaxed Its Authority?

Coinbase is a San Francisco-based cryptocurrency exchange company that operates bitcoin and other digital asset transactions and storage for over one million users in 190 countries.

This past November, a “John Doe” summons was issued on all U.S. Coinbase customers who utilized convertible virtual currency between 2013 and 2015. A "John Doe" summons is issued when the IRS cannot specifically identify an individual but knows that they may be ascertained by virtue of their activities.

Justification for the Summons

The Department of Justice’s justification for issuing the summons on behalf of the IRS is the agency’s need to:

  • Identify Coinbase users and whether or not they are U.S. persons
  • Determine whether or not they used an alias or nominee, or employed another tactic to disguise their identity after the initial account setup
  • Gather information on their transaction activity
  • Identify sources of funds that may have been undisclosed for tax purposes, and
  • Determine the correct U.S. federal tax liability of Coinbase users.

Note that the IRS has broad authority to request this data under 26 U.S. Code § 7602, in order to determine the tax liability of U.S. persons. However, as we will discuss in Part II, challenges are being made claiming that the scope of the information requested in this particular summons is too broad.

Scope of the summons

To accomplish its objectives, the IRS is demanding that Coinbase provide it with the following information:

  • Account/wallet/vault registration, aka account records for every account owned or controlled by the Coinbase user, and their complete user profile
  • History of changes to the user profile from the time of the account’s inception
  • User preferences, user history and security settings, including confirmed devices utilized
  • Records associated with Coinbase’s "Know-Your-Customer" (KYC) compliance program, which has in itself been criticized by some users as an invasion of privacy
  • Powers of attorney, corporate minutes, and other agreements or instructions given by Coinbase users that provide third party access and/or control over their account
  • Records of account activity, including transaction logs and other records that reflect the particulars of a transaction such as dates, amounts, type of transaction, account balances, bitcoin purchases and sales, and names of counterparties
  • List of all merchants for which Coinbase acts as Payment Service Provider, including records identifying the user of the wallet charged for every payment that has been processed by that merchant
  • Copies of all correspondence between Coinbase and its users, including any third party with access to the user’s account
  • Periodic statements of accounts or invoices, or the equivalent
  • Records of payments to and from the Coinbase account user, and
  • All exception reports produced by Coinbase’s Anti-Money Laundering (AML) System and all records related to investigations of those reports.

In Part II, we will discuss a Coinbase user’s recent challenge to this summons and Coinbase’s public explanation for its refusal to comply.

Jimmy Chen Seminar Attendees and Clients at Risk of Being Investigated for Tax Evasion

This past summer, Jimmy J. Chen, accountant and promoter of private charitable foundations, was charged with six felony counts of tax evasion. From 2009 through 2011, Mr. Chen apparently used his tax-exempt ChenSung Family Foundation to make only a single $250 contribution – and spent the rest of the money on himself.

Mr. Chen, through his office Jimmy J. Chen & Associates, Inc., used to conduct seminars throughout Northern California for individuals and families. Many of the attendees hired Chen to help them set up their own private foundations and advise them regarding his "tax saving" methods. The Franchise Tax Board (FTB) is now investigating Chen’s contacts for potential tax violations. Anyone who worked with Mr. Chen is at risk of being investigated and charged with civil or criminal tax evasion. (also see)

The Purpose and Function of a Private Charitable Foundation

Private Charitable Foundations are 501(c)(3) tax-exempt organizations that are funded by one or a small number of sources (usually an individual, family or business) that gift large amounts for charitable activities. Following are the two main types of private charitable foundations:

  •  Private Nonoperating Foundations make grants to other charitable organizations. They have their own list of pre-selected charities to which they donate and/or they run a competitive grants cycle.
  • Private Operating Foundations spend substantially all of their income and assets actively conducting their own charitable activities. For example, the Gates Foundation, established by Bill and Melinda Gates with a sizeable contribution from Warren Buffett, actively works to further the main philanthropic goals of their trustees, namely, expanding educational opportunities in the U.S., and enhancing healthcare and reducing extreme poverty worldwide.

Private foundations may not be used for buying yourself a luxury condominium with a karaoke room and an indoor golf range, or for buying life insurance for your spouse, as Chen’s apparently did.

Private Foundation Requirements

Private Charitable Foundations are required to pay only a small excise tax (1-2%) on their investment earnings, but under 26 U.S. Code § 4942(e) must spend at least 5% of the average fair market value of their assets each year on grants and other charitable activities. The failure to make that minimum distribution by the end of the following fiscal year subjects a foundation to a 30% excise tax on any undistributed amount 26 U.S. Code § 4942(a), and if the amounts continue to remain unpaid at the close of the next taxable period, the excise tax increases to 100% of any undistributed amount 26 U.S. Code § 4942(b).

The minimum distribution keeps the trustees from trying to use the foundation to hold their investments in a low-tax environment, but also makes the establishment of a private foundation not financially feasible for small donations. The starting contribution to establish a private foundation is generally around $5 million.

Consequences of using private foundations for tax avoidance

Chen used his private charitable foundation to avoid roughly $60,000 in taxes and is now facing hefty penalties and criminal charges. Felony tax evasion is punishable by up to five years in prison and/or up to $250,000 in fines ($500,000 in the case of corporations), as well as possible civil tax fraud penalties.

San Francisco tax lawyers

Those utilizing Chen’s methods may be subject to severe penalties and should obtain immediate legal assistance from an experienced tax attorney. For over 30 years, the Moskowitz, LLP tax team has worked diligently to achieve exceptional outcomes for the firm’s clients and our lawyers have successfully defended tax litigation cases throughout the United States.