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(Reuters) – It’s no secret that the Internal Revenue Service suspects thousands of cryptocurrency users of underreporting their tax liability.
In 2017, the IRS won a decision which granted the government access to transaction records belonging to more than 10,000 customers of the virtual currency exchange Coinbase Inc. Last April, the government secured a similar deal decision to view the records of Circle Internet Financial Inc.
The IRS used a so-called John Doe summons to get hold of the crypto exchanges’ records, claiming that while the government does not know the identity of Coinbase and Circle account holders, it had good reason to suspect them of not declaring the income taxable. IRS suspicions, at least with respect to the Coinbase summons, appear to have been justified: the government said Coinbase customers shelled out an additional $ 25 million after the IRS sent letters warning them to pay what they owed for crypto transactions.
One of those John Does, a New Hampshire man named James Harper, claims the IRS violated his constitutional rights when he obtained records of his transactions. If he’s right, his lawsuit will certainly make the IRS crackdown on crypto more difficult. But first, he has to persuade the 1st US Court of Appeals that he even has the right to bring the case.
According to the 1st Circuit briefing, which ended on Tuesday when Harper’s lawyers at the New Civil Liberties Alliance filed his brief response, this question will come down to an interpretation of the decision of the Supreme Court of the United States last May in CIC Services LLC v. IRS. Harpist supports that the Supreme Court’s decision opens the way for him to challenge what he considers to be an unconstitutional seizure of his files. Theirs maintains that, contrary to Harper’s assertions, the Supreme Court has in fact emphasized that prosecutions like Harper’s cannot proceed.
The case of Harper, which seeks to force the IRS to erase its crypto account records and ban the government from collecting them in the future, has been dismissed last March by U.S. District Judge Joseph DiClerico of Concord, New Hampshire. (In the original lawsuit, Harper sought monetary compensation for the alleged constitutional violations, but he dropped those claims on appeal.) The judge ruled that the sovereign immunity of the United States precluded the Harper trial.
In particular, DiClerico invoked the anti-injunction law, which prohibits prosecution “for the purpose of restricting the assessment or collection of any tax.” Harper had attempted to present his complaint as a challenge to the IRS’s collection of his transaction records, not as an attempt to avoid paying additional taxes. He argued that he had already paid all required taxes on his crypto transactions, despite a 2019 letter from the IRS warning of potential penalties if he had not accurately reported that income.
The trial judge rejected Harper’s framing. Since the 2019 IRS letter referred to a potential tax liability, DiClerico said, Harper’s lawsuit was an attempt to interfere with tax collection.
The Supreme Court issued its opinion on CIC services two months later, ruling that the Anti-Injunction Act did not prohibit a tax shelter advisor from pre-challenge an IRS reporting requirement that included sanctions in the event of non-compliance. The IRS had argued that the reporting requirement fell within the scope of the anti-injunction law because of the monetary penalty, but the judges unanimously ruled that the case was not intended to interfere with collecting taxes but canceling the reporting requirement.
According to Harper’s briefs to Circuit 1, the same logic applies in his challenge to the IRS’s collection of crypto transaction records. The government has not demanded payment of additional taxes from Harper, he said, so his lawsuit cannot be interpreted as an attempt to impose a tax assessment or a tax levy. The CIC decision, argued Harper’s lawyer, directs the courts to review the purpose of the lawsuits against the IRS and the relief seekers sought. Harper argued that his case challenges the government’s “illegal collection of information”, so under CIC this is not prohibited by the Anti-Injunction Act.
The IRS, represented by the Justice Department’s tax division, responded with key differences between the CIC case and the Harper trial. In the CIC case, the Justice Department said, the challenge was limited to a reporting requirement (although it comes with a monetary penalty for non-compliance). Harper’s lawsuit, the government said, is ultimately about tax liability: it sues to prevent the IRS from collecting documents that would allow the agency to assess whether it has paid enough taxes.
“Harper’s claim that the IRS has yet to decide to assess additional taxes does not change the fact that the purpose of the taxpayer’s lawsuit is to delay or prevent the IRS from using its financial information to do it, ”said DOJ’s brief.
Of course, going beyond the Anti-Injunction Act – as well as the Declaratory Judgment Act’s broad prohibition on declaratory judgments “in matters of federal taxes” – is only the first hurdle for Harper. Even if he was allowed to sue, he would still have to demonstrate the unconstitutionality of the IRS’s use of John Doe’s statutory summons process, which included a heated dispute with Coinbase over the scope of the information that would be released. (Harper said it’s also possible that the 2019 IRS letter he received was based on records the IRS could have obtained from another virtual bureau de change without any subpoena. )
But be careful if Harper wins one way or another. His briefs on Circuit 1 insisted he was not seeking a “system-wide injunction” to force the IRS to remove transaction records from all crypto exchange clients. “Perhaps other people in a similar situation could seek a similar remedy; maybe not, ”his lawyers said. Their next sentence, however, made it clear that Harper’s case is indeed destined to have systemic implications: a victory for him, they said, “would likely deter (the) IRS from also collecting illegal information at the ‘to come up “.
It’s a bugle for crypto users and exchanges.
IRS Comes for Crypto Traders: Judge Approves IRS Request for Circle Records
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