On September 21, 2022, the U.S. District Court for the Southern District of New York granted the IRS’s ex-parte motion for leave to serve a John Doe summons to M.Y. Safra Bank after the IRS’s investigation into digital asset trading platform SFOX. The court’s order requires M.Y. Safra Bank to produce records on U.S. customers of SFOX who may owe tax on unreported cryptocurrency transactions. This follows similar IRS’s John Doe summonses against Coinbase, Inc., Circle Internet Financial, and Payward Ventures, Inc. d/b/a Kraken.
John Doe summonses are a powerful tool for the government to find unreported and underreported income from digital asset transactions. After the United States District Court for the Northern District of California permitted the IRS to serve a John Doe summons on Coinbase, Inc. the IRS sent notification letters to more than 10,000 taxpayers, advising them to file amended returns and pay back taxes. The IRS said those notifications resulted in nearly $17.6 million in assessments against taxpayers. The M.Y. Safra Bank John Doe summons is the latest attack by the IRS to find taxpayers that have unreported or underreported income from cryptocurrency transactions.
M.Y. Safra Bank John Doe Summons
The IRS filed the ex-parte motion on August 8, 2022. The memorandum of law in support of the motion explained the grounds for the IRS’s belief that virtual currency transactions were not being properly reported by SFOX platform users that had accounts with M.Y. Safra Bank. According to the government’s Memorandum of Law in Support of the Ex-parte Petition for Leave to Serve a John Doe Summons (the “Memorandum”), SFOX partnered with M.Y. Safra Bank to offer SFOX users access to cash deposit bank accounts. SFOX users who signed up for this service held interests in pooled accounts at M.Y. Safra and certain users were eligible to open standard commercial accounts at the bank. All users with access to M.Y. Safra account services were required to complete M.Y. Safra’s customer onboarding process, including its “Know Your Customer” process, which involves providing the bank with user identifying information. SFOX users were able to use the bank to buy and sell positions in digital currency from SFOX. When SFOX users initiated funds-transfers to buy or sell cryptocurrency, SFOX served as an intermediary to provide M.Y. Safra with transaction instructions and M.Y. Safra would then initial the funds transfer. SFOX does not make reports to the IRS of cryptocurrency transactions that occur on its platforms.
The IRS stated it expected that in response to the John Doe summons, M.Y. Safra will be able to provide information about the identities and cryptocurrency transactions of SFOX users that also used M.Y. Safra’s services, which the IRS will then be able to use with other information to examine whether the users complied with the Code. The IRS sought information from M.Y. Safra of any U.S. person, who directly or indirect had authority of any accounts held with SFOX with at least the equivalent of $20,000 in value of transactions (regardless of type) in cryptocurrency in any one year from January 1, 2016, through December 31, 2021.
In the Memorandum, the IRS provided information from an IRS investigation that identified specific individuals who held accounts with SFOX and failed to comply with their tax and reporting obligations under the Code. The IRS presented the court with specific information with respect to these ten individuals that indicated they transferred or received funds through M.Y. Safra accounts. In granting the order, the court agreed that there was a “reasonable basis for believing” at least 10 individuals may have failed to disclose and pay tax on cryptocurrency transactions conducted by the taxpayers via SFOX, which uses M.Y. Safra’s banking services.
According to the Memorandum, SFOX is a “cryptocurrency prime dealer and trading platform that connects exchanges, over-the-counter brokers, and liquidity providers globally” and that it “has over 175,000 registered users, and users have undertaken more than $12 billion in transactions since 2015.” As with the earlier John Doe summonses noted above, the M.Y. Safra John Doe summons may result in the IRS identifying a large number of taxpayers that have underreported or unreported income from cryptocurrency transactions.
IRS Voluntary Disclosure Practice
Taxpayers who have engaged in cryptocurrency transactions should discuss the transactions with their advisors and assess the potential tax and criminal implications. On February 15, 2022, the IRS announced that Form 14457, Voluntary Disclosure Practice Preclearance Request and Application (the “Voluntary Disclosure Practice”) was revised to include the voluntary disclosure of cryptocurrency transactions. The Voluntary Disclosure Practice is primarily for taxpayers that are concerned about criminal prosecution. It is important to note that taxpayers that are already under audit are not eligible to participate in the program. If a taxpayer decides to proceed with the Voluntary Disclosure Practice, the taxpayer must report to the IRS:
- information for all non-compliant virtual currency the taxpayer owned, controlled, or was the beneficial owner of, either direct or indirectly, for the entire disclosure period of 6 years,
- information about where the cryptocurrency is stored, and
- whether a “mixer” or “tumbler” was used, along with the reason it was used.
Additionally, in exchange for a decreased risk of criminal prosecution, the taxpayer must be prepared to:
- pay in full all tax and interest on the past 6 years of tax deficiencies, and
- pay a civil fraud penalty under section 6663 of 75 percent on the year with the highest tax liability.
The Voluntary Disclosure Practice may be an option for taxpayers who are concerned about criminal exposure if the taxpayer can satisfy the conditions set forth above. Another proactive option that may be available to the taxpayer is to file amended returns disclosing the cryptocurrency transaction and the taxpayer’s gain from the transaction. In either case, the best practice is to proactively disclose any cryptocurrency transactions with the IRS rather than waiting for an IRS enforcement action.
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Freeman Law International Tax Symposium
Readers may be interested in the Freeman Law International Tax Symposium scheduled to take place virtually on October 20 and 21, 2022. Attendees will qualify for CLE, CPE, and CE and the slate of presenters includes well-recognized speakers and panelists, such as the IRS Commissioner, a prior Chief Counsel of the IRS, a former Acting Assistant Attorney General of the U.S. Department of Justice Tax Division, and many others in government and private practice.
 These terms refer to services utilized to further increase the anonymity of crypto currency transactions and holdings.