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IRS Quest for Coinbase Data Sets Dangerous Precedent

Millions of Americans are at risk of losing their financial privacy because of the agency's flimsy assumption that all Bitcoin users are tax cheats.  This article originally appeared in American Banker.

It is understood and accepted that, if someone is investigated for tax evasion, a bank or brokerage may be required to turn over private financial records to the government. However, Americans would be shocked if the IRS asked a financial institution in good regulatory standing to turn over the names, addresses and shopping histories of millions of customers just because the IRS thought there might be some tax cheats among them. But that’s exactly what the IRS did in a recent court filing against the bitcoin exchange Coinbase.

The IRS has petitioned a court to let it serve what is known as a “John Doe” summons, which requires a business to turn over information about any of its customers that match specific criteria. The summons applies as long as the government can’t get the information elsewhere and has “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 the tax laws.”

In this case, the specific criteria are not very specific at all. The government is seeking the information on every U.S. customer who used the exchange between 2013 and 2015 – a class so broad that it encompasses millions. And what is the “reasonable” basis? In its filing, the IRS notes the fact that some people have indeed used bitcoin to evade taxes, as well as “a public perception that tax evasion is possible with virtual currency.” But all the IRS cites to back up that point is a Huffington Post article. This is an incredibly weak foundation to support breaching the privacy of millions of Americans. It’s possible to use cash to evade taxes, so by this standard the IRS should be able to access the private records of everyone who uses cash with a single court order.

The IRS is embarking on a fishing expedition, and this overreach should concern Americans whether they use bitcoin or not.

The Fourth Amendment to our Constitution protects “the right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures[.]” It aims to accomplish that, in part, by prohibiting general warrants that give government agents broad authority to search unspecified places or persons. While the courts have weakened Fourth Amendment protections when a third party like a bank or business keeps your information, the tide has begun to turn back. Courts have begun to recognize that there must be some limits as more and more of our private data is stored not in our homes, but in “the cloud.” If the IRS can get a summons to search all users of bitcoin, it may only be a matter of time before it can get one targeting all video gamers or all eBay shoppers and sellers.

The move by the IRS also undermines our country’s image as the home of innovation. If we set a precedent that merely dealing in bitcoin could result in a firm’s customers easily losing their financial privacy, it would have severe consequences for bitcoin and the related blockchain ecosystem – cutting-edge technologies that promise to revolutionize business. By creating an environment in which developers and entrepreneurs think twice before using such technologies for fear of being labeled a potential tax evader, we risk driving that innovation into the arms of foreign competitors.

Finally, it is shortsighted of the government to be so aggressive toward firms like Coinbase that so diligently comply with regulation and routinely cooperate with law enforcement requests. Respected companies like Coinbase and its millions of law-abiding customers are the government’s best bet to find bad guys using bitcoin. If the government’s actions drive away legitimate actors from the bitcoin ecosystem, it will only have succeeded in reducing transparency and helping criminals.

The government should reconsider its petition. If it doesn’t, Coinbase has stated that it will fight vigorously in court, and it will doubtlessly have the support of technologists, privacy advocates and Americans who know government overreach when they see it.