District Court Rules IRS's John Doe Summons on Coinbase Was Not Unconstitutional

(Parker Tax Publishing June 2023)

A district court held that the IRS did not violate a taxpayer's rights under the Fourth and Fifth Amendments when it used a John Doe summons obtain his account information from Coinbase, a virtual currency exchange. The court found that the taxpayer did not have protectable Fourth or Fifth Amendment interests in the records produced by Coinbase in response to the John Doe summons and that even if he did, the IRS's actions were reasonable and provided the taxpayer with constitutionally adequate due process. Harper v. Rettig, 2023 PTC 144 (D. N.H. 2023).

Background

In 2013, James Harper opened an account with Coinbase, an entity that facilitates transactions in virtual currencies such as bitcoin. The terms of agreement stated that Coinbase would take reasonable precautions to protect users' personal information but warned users that Coinbase may share their personal information with law enforcement, government officials, or other third parties when it is compelled to do so by a subpoena, court order, or similar legal procedure.

In 2013 and 2014, Harper deposited bitcoin into his Coinbase account. He primarily received the bitcoin as income from consulting work. Harper claimed that he reported all of his bitcoin on his tax returns and paid taxes on all income from bitcoin payments. Harper began liquidating his holdings in the Coinbase account in 2015. By 2016, Harper no longer held any bitcoin in the Coinbase account.

In 2016, the IRS petitioned a district court under Code Sec. 7609(f) and (h)(2) for leave to serve a John Doe summons on Coinbase. "A 'John Doe' summons is, in essence, direction to a third party to surrender information concerning taxpayers whose identity is currently unknown to the IRS. Under Code Sec. 7609(f), the IRS may only serve a John Doe summons after a court proceeding in which the IRS establishes that: (1) the summons relates to the investigation of a particular person or ascertainable group of persons; (2) there is a reasonable basis for believing that such persons may fail or may have failed to comply with any provision of any internal revenue law; and (3) the information sought to be obtained, and the identity of the subject persons, is not readily available from other sources. The district court found that the IRS established these three requirements and granted its petition.

The IRS served the summons on Coinbase, which did not comply. The IRS agreed to narrow the scope of its summons. In U.S. v. Coinbase, Inc., 2017 PTC 536 (N.D. Cal. 2017), a district court ordered Coinbase to comply with the narrowed version of the summons after finding that the IRS complied with the requirements of Code Sec. 7609(f) and U.S. v. Powell, 379 U.S. 48 (1964). The court ultimately ordered Coinbase to produce, for a limited group of account holders, the following information to the IRS: (1) the taxpayer ID number; (2) name; (3) birth date; (4) address; (5) records of account activity including transaction logs, and (6) all periodic statements of account or invoices.

Coinbase produced account holder documents and information to the IRS in response to the narrowed summons, including information about Harper's Coinbase account from 2013 to 2015. Following its receipt of Harper's Coinbase account information, the IRS sent Harper a letter in 2019 entitled "Reporting Virtual Currency Transactions." In the letter, the IRS stated that it had information that Harper had a virtual currency account but may not have properly reported his virtual currency transactions. The IRS warned that if Harper had failed to properly report his transactions, he could be subject to future civil and criminal enforcement activity.

Harper filed suit in August 2020 against the IRS in a district court. His complaint contained three counts: (1) violation of the Fourth Amendment; (2) violation of the Fifth Amendment; and (3) violation of Code Sec. 7609(f). Harper first contended that the IRS's acquisition of his Coinbase records through a John Doe summons was an unreasonable seizure and search that violated the Fourth Amendment. Under longstanding Supreme Court precedent, a person has no legitimate expectation of privacy in information he voluntarily turns over to third parties (the third-party doctrine). However, in Carpenter v. U.S., 138 S.Ct. 2206 (2018), the Supreme Court held that the third-party doctrine did not apply to location information maintained by wireless telephone carriers because such information "provides an intimate window into a person's life, revealing not only his particular movements, but also his familial, political, professional, religious, and sexual associations." Harper argued that, like the location data in Carpenter, the account information held by a virtual currency exchange provides an intimate window into a person's life. He also argued that he had a property interest in the Coinbase records because they were his personal or "private papers."

Harper further contended that under the Due Process Clause of the Fifth Amendment, he had a right to be notified before the IRS attempted to deprive him of his property and privacy interests. Instead of the ex parte procedure the IRS used in issuing the John Doe summons, Harper asserted that the IRS should have first sought a John Doe summons to Coinbase for account holder names only. Presuming it obtained his name from this summons, Harper said the IRS should have then sent summonses to the individual account holders with notice, providing them an opportunity to contest the summons. Finally, Harper attempted to argue that the IRS violated Code Sec. 7609(f) by failing to satisfy several prerequisites for issuance of a John Doe summons.

In a motion to dismiss, the IRS argued that Harper had no protected interests in the Coinbase records and that even if he did, it used a constitutionally adequate process to deprive him of those interests. The IRS further argued that the Coinbase court's unappealed Code Sec. 7609(f) determination was not subject to later challenges.

Analysis

The district court granted the IRS's motion to dismiss Harper's case. The court found that the IRS has broad latitude to issue summonses and the IRS's actions at issue in this case fell squarely within that broad latitude.

The court rejected Harper's argument that his Coinbase account information was protected under Carpenter. Rather, the court found that virtual currency records are more akin to bank records. The court reasoned that while the information in Carpenter was collected by the wireless carrier (perhaps without the user even realizing it) as soon as a user turned his phone on, a customer opening a bank account - or a Coinbase account - must provide his personal information to the third party. By electing to buy, sell, and store virtual currency through Coinbase, and providing personal information to Coinbase, the court said that users like Harper sacrifice any privacy interest in such information. The court also disagreed with Harper's characterization of his Coinbase account information as akin to his personal or private papers. Rather, the court said the records the IRS obtained from Coinbase are analogous to a customer's account records with a bank - routine business records in which the customer has neither a property interest nor a reasonable expectation of privacy. While Harper may have had a proprietary interest in the bitcoin itself, the court noted that the IRS did not seek to dispossess him of that property; it did not seize or search anything over which Harper could assert ownership or control. Thus, the court concluded that Harper had no protectable Fourth Amendment interest in the records Coinbase produced in response to the IRS summons.

With respect to Harper's Fifth Amendment argument, the court responded that Harper did not have a protectable interest in records belonging to Coinbase and that no court has recognized a protectable liberty interest in maintaining the privacy of financial records held and created by a third-party financial institution. The court also found that whether to utilize Harper's proposed procedure was discretionary to the IRS and due process did not compel the IRS to undertake the that procedure.

The court also agreed with the IRS's argument that Harper could not challenge the John Doe summons under Code Sec. 7609(f) because the Coinbase court already determined that the summons met the statutory requirements. The court also noted that neither Harper nor any party, intervenor, or amici appealed that court's orders, moved for relief from judgment, or moved to reopen that case. Even if Harper had a private right of action to assert a violation of Code Sec. 7609(f), the court found that there was no violation because the IRS made the required showing under the statute and followed the required procedures.

For a discussion of the IRS's summons authority, see Parker Tax ¶263,120. For a discussion of virtual currency transactions, see Parker Tax ¶119,600.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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