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The Internal Revenue Service (IRS) has made its intentions regarding cryptocurrency clear. The agency expects taxpayers to report these transactions. A failure to do so can result in allegations of tax crimes. But how does the IRS even know if a taxpayer has digital assets and is failing to report them? Isn’t one of the benefits of this type of asset its secrecy?

Apparently digital currency is not as secret as some thought, as was highlighted in a recent tax case.

What were the takeaways from the case?

The case questioned how agency can get information from a third-party. Examples of third parties in these cases would be the cryptocurrency holder, for example Coinbase.

Taxpayers who use cryptocurrency argued that information held by third parties like Coinbase was protected by the Fourth Amendment. Specifically, they stated the IRS would need a warrant to get the information. A failure to do so would result in an illegal search and seizure. The IRS countered that it was within their right to request the information. They further argued that if the third party would not provide the information they would need to comply with a subpoena, not a warrant. This is an important distinction as it requires less evidence to get a subpoena compared to a warrant.

Ultimately, the court agreed with the IRS. In order for the Fourth Amendment protection against illegal search and seizure argument to stand, the taxpayer needed to establish a reasonable expectation of privacy. Instead, the court stated the IRS provided more convincing evidence that the information should not fall within these protections. One of their arguments involved pointing to previous cases had held that bank records of financial transactions were not covered by these protections. The court further supported this reasoning by stating that users of Coinbase and similar platforms are aware that information that is actually stored within the blockchain is publicly available.

What does this mean for taxpayers?

This holding is important as it establishes the IRS will likely be successful in gathering information from a public blockchain. As a result, taxpayers are wise to proactively disclose applicable information. Those were unsure of how to do so are wise to seek legal counsel.