A few weeks ago the IRS sent Coinbase a subpoena asking us to disclose records on all U.S. customers over a three year period (this covers millions of customer accounts). Since then, we’ve spoken with the IRS, outside legal counsel, and various industry bodies. I wanted to share a few thoughts to provide better visibility into how we’re thinking about it.
First, it’s important to understand how Coinbase thinks about regulation and compliance in the digital currency space. As an exchange, we view compliance as key to digital currency’s success. Building an easy way for people to exchange their local currency into and out of digital currency requires that we work closely with governments in every country where we operate. We’ve invested heavily in compliance since the inception of the company, and today about 20% of the people in our 130 person company work on compliance in some way.
Tax policy is no exception. We have worked to comply with all IRS guidance in our space, beginning with the March 2014 guidance on virtual currency. Specifically, we began filing 1099s for merchants who accept digital currency through Coinbase, responded to numerous subpoenas for specific cases, and even proactively created a cost basis report for our customers to assist them in reporting their taxes.
Earlier this year, the Inspector General for Tax Administration (who oversees the IRS) wrote a report stating “Virtual currencies offer potential benefits over traditional currencies, including lower transaction fees and faster transfer of funds”, however, “there has been little evidence of coordination between the responsible functions to identify and address…potential taxpayer noncompliance issues for transactions involving virtual currencies”.
I believe Coinbase and the IRS fundamentally want the same thing: for all U.S. users of virtual currency to pay their taxes. And I believe our prior actions demonstrate that we are committed to making this happen. I also feel that the IRS sending us a John Doe summons on all customer accounts is not the best way for us to mutually accomplish this objective.
In the past, Coinbase has complied with a number of IRS subpoenas that are specific to individuals and meet appropriate standards. However, their most recent subpoena asks us to turn over records on all customers (including transaction history, IP addresses, transcripts with customer support, etc). Suffice to say, we feel the IRS’s subpoena is overly broad and incorrectly implies that all users of virtual currency are evading taxes. Asking for detailed transaction information on so many people, simply for using digital currency, is a violation of their privacy, and is not the best way for us to accomplish our mutual objective.
If the IRS were to approach Citibank, Fidelity, or Paypal and ask them to turn over all customer records, they would rightfully push back. And I feel we have the same obligation to do so.
I also feel that this subpoena unfairly punishes Coinbase, one of the few digital currency companies that is both located in the United States and committed to compliance. We will likely incur a legal cost of between $100,000 and $1,000,000 in the process of defending our customers from this overly broad subpoena; funds which could be put to better use building innovative products or hiring more employees. This heavy handed approach by the IRS punishes one of the good guys. Other digital currency exchanges operating abroad (while still serving U.S. customers) are unlikely to demonstrate a similar commitment to working with the IRS, yet we were the only company (as far as I know) to receive a subpoena for all customer records. I believe this is one of those situations that could have been resolved with a phone call instead of a subpoena, given our amicable interactions with the IRS in the past. My hope is that we can move toward that type of relationship in the future.
A path forward
As I mentioned above, Coinbase and the IRS have (I believe) a shared goal to ensure all U.S. customers pay their taxes. I believe a good option would be to use the same third party reporting mechanism that brokerage firms like Fidelity and Charles Schwab use today: the 1099-B form. We’d ideally like to see that structure applied evenly to all companies in the industry, but even if we’re required to go first, we’re ready to implement 1099-B reporting.
With this potential solution, Coinbase (and other virtual currency exchanges) would issue a 1099-B at the end of the year to all U.S. customers, and send a copy to the IRS. This would make it easy for users of virtual currency to pay their taxes without violating their privacy. 1099 forms provide a simple summary of gains or losses on trading activity, instead of full transaction records, transcripts with customer support, IP addresses, etc.
Since the IRS routinely processes 1099 forms, I suspect that this data would be easier to ingest compared to hundreds of gigabytes of unstructured data turned over in a subpoena. We’d be happy to do the work of structuring this data into a standard format to make it easier to use.
Finally, I think the IRS guidance that treats virtual currency as property (instead of currency) may make this 1099 reporting inefficient (not just for us, but for the IRS and citizens). For tax purposes, gains on property do not have a de minimis exemption like currency. This would mean that even the sale of a small amount of digital currency (say to purchase a cup of coffee) would generate a 1099 form. A de minimis exemption could be introduced to eliminate the long tail of paperwork. Alternatively, virtual currency could be treated as an actual currency for tax purposes (which already has a de minimis exemption built in). This would be a nice optimization of the reporting process.
I think there is a reasonable path forward for both the IRS and Coinbase to accomplish our shared objectives. My belief is that the vast majority of people using digital currency today are not seeking to evade taxes. They are simply investors seeking returns, and people interested in a nascent new technology. If we make it easy for them to pay their taxes with clear reporting, they will.
Sadly, given the overly broad subpoena, it appears we will be forced to contest it in court to protect our customers’ privacy, at great expense. My hope is that the IRS is willing to work with us to establish a sensible reporting mechanism, like the 1099 reporting that all brokerage services like Fidelity and Charles Schwab use. A protracted legal battle, seeking to reveal private information from people who are not evading taxes, would be bad for Coinbase, the IRS, and many U.S. citizens.