Coinbase vs. the IRS: Is Virtual Currency Now Losing Its Appeal?

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Coinbase Inc., the world's largest digital currency broker, lost a bid to block an Internal Revenue Service investigation into whether some of the company’s customers haven’t reported their cryptocurrency gains.

U.S. Magistrate Judge Jacqueline Scott Corley in San Francisco ruled that the tax agency’s demand for information isn’t overly intrusive. The price of bitcoin has been soaring and crossed $10,000 Tuesday. 

With just 800 to 900 taxpayers reporting bitcoin gains from 2013 through 2015 in a period when more than 14,000 Coinbase users have either bought, sold, sent or received at least $20,000 worth of bitcoin, “many Coinbase users may not be reporting their bitcoin gains,” she wrote. “The IRS has a legitimate interest in investigating these taxpayers.”

Coinbase has been sparring since last year with the IRS over its summons -- and continued to resist turning over the information even after the agency scaled back its request in July. Coinbase and industry trade groups contend the government’s concerns about tax fraud are unfounded and that its sweeping demand for information is a threat to privacy.

The company said it’s glad that the government and the court narrowed the scope of the summons. Still, Coinbase -- and the cryptocurrency world in general -- is none-too-happy.

“Coinbase started this process more than 12 months ago, and while today’s result is not the complete victory we hoped for, it does represent a substantial and unprecedented victory for the industry and the hundreds of thousands of customers that would have been unfairly targeted if it weren’t for our action,” the company said in a statement posted on its blog.

Last year, analysts said similar demands could be made of other digital-currency companies if the IRS widens its investigation.

“The government has sensed a windfall -- any company that has a plethora of wealthy users might be in the sights,” Charles Hayter, CEO of market tracker CryptoCompare, said in an email. “If there is tax to be paid the government is going to go after it if it makes an example” or a return on investment.

The IRS persuaded Corley last year to order Coinbase to approve its summons for customer records from a three-year period for an investigation into whether taxpayers failed to report income.

Coinbase resisted, and negotiations between the company and the agency resulted in a narrowed request for information to about 8.9 million transactions and 14,355 account holders. Coinbase argued at a Nov. 9 hearing the inquiry remained unreasonably broad.

Corley ruled that the company must turn over basic identifying information, records of account activity and period statements for accounts with the equivalent of $20,000 in any one transaction type during any single year from 2013 to 2015. The judge said other data need not be disclosed at this time, including public keys for all accounts, wallets, and vaults.

The case is U.S. v. Coinbase, 17-01431, U.S. District Court, Northern District of California (San Francisco).