For the Defense - Vol. 6 Issue 3 - 39

Earlier this year, the IRS served additional John
Doe summonses on Circle Internet Financial
Inc., which administers Poloniex, and Payward
Ventures Inc. d/b/a Kraken.20
Each summons seeks
to identify cryptocurrency transactions. As noted,
Kraken and Poloniex conduct due diligence when
customers open their accounts because they are
registered MSBs. Therefore, like Coinbase, they
can identify the individuals making the underlying
trades.
John Doe summonses are an important tool
for the IRS because this type of summons is the
only way to identify U.S. persons with unreported
cryptocurrency transactions. The effect, however,
is a dragnet approach to identifying taxpayers
with potential liability. The summonses also
provide another advantage to the IRS: the normal
statute of limitations for assessment is three years,
which can be extended to six years if the IRS can
show a substantial understatement.21
However, if
it takes the IRS more than six months to collect
information in response to a John Doe summons,
the statute of limitations against the taxpayer is
tolled for any period over the six months.22
Once
the IRS possesses the information, it is free to
use the information to audit the taxpayer and/or
initiate a criminal investigation.
Taxpayers With Unreported Cryptocurrency
Transactions Have Options
Taxpayers who have failed to report
cryptocurrency need to come into compliance.
However, filing an amended tax return can easily
subject a taxpayer to substantial civil penalties
and, potentially, criminal penalties.
Taxpayers have the option of filing a " qualified
amended tax return. " Taxpayers who file a
qualified amended tax return can avoid the
accuracy-related penalties. Under IRS regulations,
a qualified amended tax return is one which is
filed unprompted by the IRS and before some
external event that would lead the taxpayer to
believe that s/he will be audited.23
For example,
a taxpayer cannot file a qualified amended tax
return if the return(s) will be reporting income
items from cryptocurrency transactions at an MSB
that received a John Doe summons.24
As an alternative, the IRS has the Voluntary
Disclosure Program.25
Under this program,
taxpayers agree to a full audit, file six years' worth
of tax returns, and agree to the accuracy penalty
for five years and fraud penalty for the year with
the highest balance. Individuals who participate
in the Voluntary Disclosure Program must also sit
for an on-the-record interview with the IRS. If the
IRS determines that the taxpayer is truthful, the
IRS will agree not to prosecute the taxpayer for
criminal violations. Individuals with unreported
income from an illegal source are not eligible for
the Voluntary Disclosure Program, which is not
open to individuals under audit or under criminal
investigation.
To participate in the Voluntary Disclosure
Program, a taxpayer submits his/her name and
Social Security number to CI. After CI " preclears "
the taxpayer, s/he is accepted into the program
and begins working with an auditor. The two-step
process affords some protection to a taxpayer who
might not be willing to cooperate as robustly if
s/he faced the specter of a criminal prosecution.
The role of an attorney cannot be understated.
Congress has enacted a statutory privilege for
communications between the taxpayer and his/her
return preparer, but this privilege is limited.26
This
privilege only applies to a federally authorized tax
practitioner relating to the preparation of a federal
tax return. Statements made to a return preparer
can be used in a criminal proceeding. Taxpayers
who need to amend their tax returns need to
speak with their lawyer - not their accountants.
Lawyers, however, may hire an accountant under
a Kovel agreement, wherein the lawyer retains an
accountant to work at the lawyer's direction and
thus the communications remain confidential.27
Under this arrangement, the taxpayer is assured
that the disclosure to a return preparer will remain
privileged.
Secret Cryptocurrency Accounts Will Become
Obsolete
The IRS has adopted a carrot and stick strategy
to bring taxpayers into compliance. However, the
Treasury Department has more powerful tools
that will make it more difficult for taxpayers
to conceal their cryptocurrency accounts. Most
significantly, in December 2020, FinCEN issued
a Notice of Proposed Rulemaking that would
require regulated entities like banks and MSBs to
file reports for anyone transferring cryptocurrency
Vol. 6, Issue 3 l For The Defense 39
For the Defense - Vol. 6 Issue 3

Table of Contents for the Digital Edition of For the Defense - Vol. 6 Issue 3
