No, I’m not referring to Laurence Olivier’s (or Liam Neeson’s) quote as Zeus in Clash of the Titans. The “Kraken” is actually a reference to Payward, Inc. dba Kraken—a digital currency exchange and trading platform. In one of its more recent investigations in the digital currency realm, the Internal Revenue Service is seeking information on cryptocurrency transactions (and the associated taxpayers) related to Kraken. Currently, the United States is seeking to serve John Doe summonses on Kraken to uncover helpful information as a part of its ongoing cryptocurrency investigation. However, such summonses are not without limit, as a federal court in California is currently evaluating whether the summons at issue conforms with the requirements of Section 7609(f).
Section 7609, Generally
The Internal Revenue Service (“IRS”), in an effort to ensure U.S. citizens comply with their federal tax obligations, has certain tools at its disposal. One of those tools is the third-party summons. Under Section 7609 of the Internal Revenue Code, the IRS must follow certain special procedures, including the notice requirements under Section 7609(a). Moreover, Section 7609 provides certain procedures related to John Doe summonses—summonses that do not identify the person with respect to whose liability the summons is issued.
Notably, John Doe summonses should not be used for “fishing expeditions.”[1] Such summonses must follow additional requirements pursuant to Section 7609(f):
(f) Additional requirement in the case of a John Doe summons.–Any summons described in subsection (c)(1) which does not identify the person with respect to whose liability the summons is issued may be served only after a court proceeding in which the Secretary establishes that—
(1) the summons relates to the investigation of a particular person or ascertainable group or class of persons,
(2) there is a reasonable basis for believing that such person or group or class of 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 from the examination of the records or testimony (and the identity of the person or persons with respect to whose liability the summons is issued) is not readily available from other sources.
The Secretary shall not issue any summons described in the preceding sentence unless the information sought to be obtained is narrowly tailored to information that pertains to the failure (or potential failure) of the person or group or class of persons referred to in paragraph (2) to comply with one or more provisions of the internal revenue law which have been identified for purposes of such paragraph.[2]
Taxpayers may petition a court to quash the enforcement of IRS summonses. However, in United States v. Powell, the U.S. Supreme Court ultimately favored the IRS by making it extremely difficult for taxpayers to stop the enforcement of IRS summonses.[3] Specifically, the Supreme Court held that the taxpayer has the burden of proof to show that the IRS failed on one of the following four requirements: (1) that the investigation will be conducted pursuant to a legitimate purpose, (2) that the inquiry may be relevant to the purpose, (3) that the information sought is not already within the Commissioner’s possession, and (4) that the administrative steps required by the Code have been followed.[4]
In re Tax Liability of John Does[5]
On March 30, 2021, the United States filed a petition in the Northern District of California, petitioning the Court for an order authorizing service of an Internal Revenue Service “John Doe” summons to Payward Ventures, Inc. and Subsidiaries for information related to transactions in cryptocurrency. The United States argued that its petition was filed, in part, pursuant to Section 7609(f) and, therefore, met the three listed requirements of subsection (f). Uncomfortable with the scope of the summons, the Court express the following concerns:
In addition to basic registration, identification, and transaction information, the proposed summons seeks broad categories of information such as “complete user preferences,” “[a]ny other records of Know-Your-Customer due diligence,” and “[a]ll correspondence between Kraken and the User or any third party with access to the account pertaining to the account,” among other similarly expansive requests. The IRS relies on Supervisory Internal Revenue Agent Karen Cincotta’s declaration to support its request. Although Cincotta addresses each category of information sought, her explanations for some of them rest on conclusory assertions that such information “may be relevant in determining, and verifying, the identity of the account user” or “revealing other accounts controlled by the same user.”
Addressing the analogous standard of whether information sought is “relevant” in a post-issuance challenge under United States v. Powell, 379 U.S. 48 (1964), to enforcement of an IRS summons issued to another cryptocurrency exchange, the Honorable Jacqueline Scott Corley rejected the IRS’s position that similarly broad categories of information were relevant, and held that the IRS should first review basic user information and transaction histories before determining whether further subpoenas—either to the cryptocurrency exchange or to individual users—were necessary.[6]
Conclusion
Based on the Court’s review of the John Doe summons and related petition, the Court ordered the United States to “show cause” and explain why its petition should not be denied for failure to meet the “narrowly tailored” requirement of Section 7609(f). The Court stated the United States must address each category of information sought, delineating between information that is needed presently and that can be deferred.
The United States, in turn, filed its response on April 14, 2021. Its response noted that the “narrowly tailored” requirement of Section 7609(f) was added to ensure that “the information sought in the summons [is] at least potentially relevant to the tax liability of an ascertainable group.”[7] Further, the United States argued that the phased investigatory approach outlined by the Court (and by United States v. Coinbase) is not supported by Powell. Whether the Court sees the issue the same way is a different discussion. Regardless, it appears federal courts continue to wrestle with how to deal with Section 7609, in general, and Section 7609(f), in particular, and how to reconcile the provisions with Powell.
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[1] I.R.M. 25.5.7.4.
[2] I.R.C. § 7609(f).
[3] See generally United States v. Powell, 379 U.S. 48 (1964).
[4] Id. at 57-58.
[5] In re Does, No. 21-CV-02201-JCS, 2021 WL 1222862, at *1 (N.D. Cal. Mar. 31, 2021).
[6] Id. at *1 (internal citations omitted).
[7] H.R. Rep. No. 116-39, 116th Cong. 1st Sess., at 41 (April 9, 2019).
