As the number and variety of cryptocurrencies on the market continue to grow, so does the scrutiny by government regulators. As noted in my prior post, the Federal Bureau of Investigation, Securities and Exchange Commission, and the Commodities Futures Trading Commission have developed units focused on cyber-threats, as have numerous foreign governments. Most recently, the Internal Revenue Service has joined the mix by investigating the ways in which taxpayers do – and more importantly, do not – report virtual currency transactions. Now Congress has gotten in on the action by amending the tax code to close a loophole that allowed cryptocurrency owners to exchange digital currencies without reporting the transactions on their tax returns. 2018 is likely to be a year of uncertainty for owners of cryptocurrencies, which may account in part for the double digit decline in the value of Bitcoins at the end of December.
After announcing initiatives aimed at addressing misconduct in the cyber world, in December 2017, the relatively new Cyber Unit of the SEC brought its first enforcement action related to the sale of cryptocurrency through an initial coin offering (“ICO”). In the lawsuit filed in the Eastern District of New York, the SEC alleges that Dominic Lacroix, described by the government as a “recidivist securities law violator,” had undertaken a cryptocurrency ICO that fraudulently raised approximately $15 million from investors by falsely promising a 13-fold profit in less than a month. The complaint seeks permanent injunctions, disgorgement plus interest and penalties and bars from practice for Lacroix. According to Robert Cohen, Chief of the Cyber Unit, “This first Cyber Unit case hits all of the characteristics of a full-fledged cyber scam and is exactly the kind of misconduct the unit will be pursuing. We acted quickly to protect retail investors from this initial coin offering's false promises.”
The IRS also has initiated cryptocurrency-related litigation, filing a lawsuit in federal district court in San Francisco in March 2017 to obtain customer data, including customer accounts and transaction records, from Coinbase. Coinbase, a popular service for buying and selling bitcoins which – on a side note – recently announced that it was conducting an internal investigation into possible insider trading of Bitcoin Cash by its employees, refused to comply with the government’s summons claiming it was illegally broad.
Initially, the IRS sought records related to all of Coinbase’s more than one million customers. Its demand subsequently was limited to those accounts that conducted bitcoin transactions worth $20,000 or more, which applied to approximately 8.9 million transactions conducted by more than 14,000 Coinbase customers. The information sought all transactions where bitcoins were exchanged for dollars or where customers sent/received coins from another bitcoin user. In November 2017, United States Magistrate Judge Jacqueline Corley, sitting in the Northern District of California, ruled in favor of the IRS, finding that the narrowed summons “serves the IRS’s legitimate purpose of investigating Coinbase account holders who may not have paid federal taxes on their virtual currency profits.”
Magistrate Judge Corley ordered Coinbase to turn over the taxpayer ID number, name, date of birth, address, records of account activity and periodic statements of accounts in response to the subpoena, but found that the IRS’s request for account opening records, copies of passports or driver’s licenses, all wallet addresses, and all public keys for all accounts/wallets/vaults were not relevant at this stage of the government’s investigation.
The order covers the period from 2013 to 2015. Papers filed during the litigation revealed that the IRS’s investigation was prompted by the agency’s discovery that in those years, less than 900 individuals per year declared bitcoin related losses or gains despite the fact that the value of virtual currency soared from $13 to $1,100 during the same period. Since then, digital currencies, which offer a low-cost alternative to using banks, money transfer companies or brokers that charge hefty fees, have continued to explode. In 2017, trading of cryptocurrencies posted record numbers – over $10 billion – in trading volume.
The decision in the Coinbase case is particularly relevant given provisions included in the controversial 2017 Tax Cuts and Jobs Act that amend the tax code’s rules regarding “like kind exchanges.” Section 1031 of the Internal Revenue Code allows taxpayers to postpone the recognition of capital gains or losses for “like kind exchanges.” To qualify as “like kind,” both properties must be similar in nature, character or class. For example, real property and personal property can qualify, as long as they are exchanged for similar real or personal property. The statute explicitly excludes stocks, bonds, or notes, and other securities or debt.
From The Insider Blog: White Collar Defense & Securities Enforcement