This article was written by Betty Williams, the founder of Williams & Associates.
As quickly as digital wallets are opened and electronic exchanges of virtual currencies are made, opportunities for tax evasion arises. The IRS has pledged to thwart such illegal activity, limiting the time for taxpayers who may not have reported their undisclosed income from cryptocurrency to come forward and remedy past years.
In November 2016, the District Court for the Northern District of California authorized the IRS to serve a John Doe summons to Coinbase, Inc., a U.S. based digital currency exchange,  ultimately limiting the enforcement to information related to documents involving at least $20,000 in any one transaction in any one year from 2013 through 2015.  At that time in 2017, this amounted to a disclosure of 13,000 of Coinbase’s customers.  The IRS determined that for 2013 through 2015 no more than 900 taxpayers filed returns each year reporting virtual currency, even though Coinbase had serviced nearly 6 million customers and handled over $6 billion in transactions during that period. 
Fast forward to the present day, where on March 30, 2021, the IRS asked the same court for similar information and more, from a second digital currency exchange, Payward Ventures, Inc., d/b/a Kraken or Kraken.com. 
This time, the IRS comes armed with additional information it obtained following the Coinbase summons, and from its own Virtual Currency Compliance campaign announced on July 2, 2018. The IRS has long recognized that people who obtain income illegally, also do not report the ill-gotten gains on their tax returns. Similarly, there is a direct correlation between the rate of underreporting income when the income is not subject to third-party information reporting, such as with Forms W-2 or 1099. In a study published in September 2019, the IRS found that the overall rate of underreporting income that was not subject to third-party information reporting was 55 percent, compared to 1 percent for amounts subject to information reporting and withholding. 
Couple this information with the purposeful and inherent anonymity associated with cryptocurrency, and a breeding ground for illegal activity is born.
Ultimately, the IRS wants information regarding individual customers and their cryptocurrency transactions that can be used with other blockchain information to determine whether the individuals are complying with the federal tax laws. In addition, the government wants to determine whether a digital currency exchange such as Kraken is meeting its internal recordkeeping and reporting obligations, including the Know-Your-Customer rules. In the recent Declaration to support the application for the John Doe summons for Kraken, IRS Supervisory Revenue Agent provided five examples of the type of taxpayer for whom the IRS seeks information. Two of the taxpayer examples are U.S. citizens; three are U.S. residents. The first four taxpayer examples either filed no tax returns or reported very little income on the returns that were filed. Yet they each have one or more accounts at Kraken, engaging in transactions ranging from $5 to $56 million in transactions during the period of review. Some used multiple accounts and had unusual activity including moving currency to multiple locations without any obvious economic reason. Similarly, activity such as converting U.S. dollars to bitcoin and then immediately back to U.S. dollars for withdraw, is suspicious.
The fifth taxpayer example is one who participated in the IRS’ Domestic Voluntary Disclosure Program. He submitted late returns for 2015 and 2016 reporting his previously undeclared cryptocurrency income. The total for 2015 was $189,000; 2016 was $2,300,000. Additionally, this taxpayer submitted delinquent returns for 2017 and 2018 reporting more than $2,000,000 in income each year with activity involving more than $23,000,000 in deposits and withdrawals at multiple digital currency exchanges, like Kraken.
It is easy to see why the IRS is paying close attention to cryptocurrency activity and is seeking summonses from the digital currency exchanges for information. On April 1, 2021 another application for a John Doe summons was authorized, this time by a federal court in the District of Massachusetts, on Circle Internet Financial, Inc.
The IRS is committed to catching those involved in tax fraud and tax evasion. If you have unreported income involving cryptocurrency, now is the time to contact a tax attorney to discuss your compliance options.