Depending on the particular branch of the U.S. government one is talking to, cryptocurrency can be property (IRS), a security (SEC) or a commodity (CFTC). On April 20, 2021, the U.S. House of Representatives passed a bill aimed at remedying this situation. The bipartisan Eliminate Barriers to Innovation Act will establish a digital asset working group to ensure collaboration between regulators and the private sector to foster innovation.

The new law will require the SEC and CFTC to establish a working group on digital assets, which will consist of appointees from each agency as well as representatives from financial technology companies, financial firms, and small businesses, among others. The working group will produce a report within a year that will include an analysis of the domestic regulatory framework and the developments in other countries relating to digital assets. The report also requests insight into best practices to reduce fraud, protect investors, and assist in compliance with obligations under the Bank Secrecy Act.

Congressman Patrick McHenry, Republican leader of the House Financial Services Committee made clear that the objective was for Washington to keep up with the innovations in the fintech industry and provide more regulatory clarity. Congressman Stephen F. Lynch, Democratic Chair of the Financial Technologies Task Force delivered a similar message, saying: “As this technology continues to develop and deploy, it is extremely important that we consider the possible vulnerabilities that the wider adoption of digital assets might present while addressing the lack of clarity in the regulation of these financial instruments to mitigate potential harms that may occur. This bill will create critical collaboration between the S.E.C., the C.F.T.C. and Congress that will ultimately help create fair and transparent markets.”

At the same, the Token Taxonomy Act ( H.R. 1628) has been reintroduced and is currently pending before the House. The sponsor of this bill, Warren Davidson, has explained that the purpose of the bill is also to improve regulatory clarity. But it more directly confronts the SEC, which has applied the Howey test to determining if tokens qualify as securities, concluding in almost every case that it does. This bill specifically excludes digital tokens from the definition of a security and directs the SEC to enact certain regulatory changes relate thereto.

In a previous post, we explained how the U.S. Internal Revenue Service had introduced a question on the 2020 tax form that asked, “at any time during 2020 did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency.” Along another path, the IRS’s Operation Hidden Treasure is a partnership between the civil office of fraud enforcement and the criminal investigation unit aimed at rooting out tax evasion from cryptocurrency owners. And, the IRS is also pursuing John Doe summonses against cryptocurrency exchanges.

On April 1, 2021, a federal court in the District of Massachusetts entered an order authorizing the IRS to serve a John Doe summons on Circle Internet Financial Inc. seeking information about U.S. taxpayers who conducted at least the equivalent of $20,000 in transactions in cryptocurrency during the years 2016 to 2020. The IRS is requesting that Circle produce records identifying such U.S. taxpayers, along with other documents relating to their cryptocurrency transactions. Circle is a digital currency exchanger headquartered in Boston.

A typical summons is issued when the IRS knows the name of the target and seeks information about that taxpayer. A John Doe summons allows the IRS to get the names of all taxpayers in a certain group. A John Doe Summons must be approved by a federal district court judge.

According to the Justice Department, the government’s petition does not allege that Circle has engaged in any wrongdoing in connection with its digital currency exchange business. Rather, according to the court’s order, the summons seeks information related to the IRS’s “investigation of an ascertainable group or class of persons” that the IRS has reasonable basis to believe “may have failed to comply with any provision of any internal revenue laws[.]”

The IRS is simultaneously pursuing authority to issue John Doe summonses against Kraken, a California cryptocurrency exchange. Once again, the government is asking about U.S. taxpayers who conducted at least the equivalent of $20,000 in transactions in cryptocurrency during the years 2016 to 2020. The IRS is not having as much luck there. On March 31, 2021, the federal court in the Northern District of California issued an Order to show Cause in which it said that the IRS had likely made a sufficient showing to satisfy the requirements of the statute for issuing a John Doe summons, but the court had concerns with respect to scope of the request (which the statute requires be “narrowly tailored”). The IRS does not allege that Kraken engaged in any wrongful conduct.

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 court therefore required the IRS to show cause why the petition should not be denied for failure to meet the “narrowly tailored” requirement of the statute. In doing so, the IRS must address specifically “ why each category of information sought is narrowly tailored to the IRS’s investigative needs, including whether requests for more invasive and all-encompassing categories of information could be deferred until after the IRS has reviewed basic account registration information and transaction histories.”

IRS guidance regarding the tax treatment of virtual currencies was first introduced in IRS Notice 2014-21. Under U.S tax law, virtual currency is treated as property for Federal income tax purposes. The IRS’s position is that receipt of virtual currency as payment for goods or services is treated as income and that a taxpayer can have a gain or loss on the sale or exchange of a virtual currency, including for when it is used to pay for goods.