Technology
ComplianceOctober 16, 2020

Strashny, Zietzke, and Virtual Currency: The More Technology Changes, the More Enforcement Stays the Same

By: Stevie D. ConlonAnna VayserRobert Schwaba

Originally published in the JOURNAL OF TAX PRACTICE & PROCEDURE on September 11, 2020

Stevie D. Conlon, Anna Vayser, and Robert Schwaba examine recent tax-related court decisions that demonstrate a pattern of IRS success in enforcement actions against taxpayers holding virtual currencies.

Recent tax-related court decisions demonstrate a pattern of IRS success in enforcement actions against taxpayers holding virtual currencies.1 Among others, Zietzke I, Zietzke II, and Strashny are broadly consistent with the notion that for enforcement purposes, despite technological details and differences, virtual currencies are simply one more asset class to which existing tax principles are generally applicable. These decisions hold that this is the case in the context of IRS investigation and summons activity and in the context of a settlement officer’s assessment of whether a taxpayer has sufficient assets to satisfy their total tax obligation.2 Although these principles are relatively easy to apply in the context of more traditional virtual currencies such as Bitcoin and Ethereum (which currently have the largest market shares), technologies are always changing. Newer, more privacy-focused coins are likely to present additional challenges and provide taxpayers, advisors and counsel with alternative arguments in favor of exceptional treatment in tax-related controversies. Zietzke, Strashny and related topics are discussed in more detail below. 

New Technological Challenges

Although virtual currencies such as Bitcoin and Ethereum offer some amount of privacy to users, in many cases they are far from untraceable. Every transaction is recorded individually and publicly on the blockchain, so once investigators have even a single thread to tug on, an entire network of a user’s transactions often becomes apparent.3 

Similarly, it is uncertain to what extent the IRS is able to garner information about non-U.S. transactions or atomic swaps. Lacking such transaction information can be problematic, but even if the IRS has some knowledge of the transaction, non-U.S. transactions and atomic swaps can present relatively unique valuation challenge.

More privacy-focused virtual currencies, such as Monero or Zcash, however, do not appear as traceable with the IRS’s current technology.4 The virtual currency industry seems confident that this type of tracing isn’t just a problem for the IRS, but is substantially more difficult due to the use of different cryptography that can allow for hiding sending addresses or seamlessly aggregating multiple unrelated transactions.5 Even Bitcoin itself may upgrade its cryptography in a way that would make tracing a single user’s transactions and holdings more difficult; Bitcoin Cash already has.6 Note, however, that since the conviction of Al Capone on October 17, 1931, it has been abundantly clear that the IRS will attempt to use various means to identify tax evasion regardless of the difficulty in tracing various types of taxpayer income and activity.7 Just because a transaction is difficult to find doesn’t mean that it is exempt from U.S. income taxation. In addition, although the Tax Cuts and Jobs Act of 2017 established modified territorial taxation for U.S. corporations, U.S. resident individuals remain subject to income taxation on their global income.

Similarly, it is uncertain to what extent the IRS is able to garner information about non-U.S. transactions or atomic swaps. Lacking such transaction information can be problematic, but even if the IRS has some knowledge of the transaction, non-U.S. transactions and atomic swaps can present relatively unique valuation challenges.8

Locating Virtual Currency: Technology or the Courts?

The IRS has seen success in obtaining virtual currency information using a combination of technological means and litigation. Specifically, the IRS has had success in litigation regarding a summons issued to one of the largest virtual currency exchanges in the United States, Coinbase, concerning the virtual currency activities of the exchange’s customers. Between 2013 and 2015, the IRS noted that less than 1,000 persons filed Forms 8949 including virtual currencies such as Bitcoin.9 Therefore, seeking further information, the IRS served a “John Doe” summons on Coinbase, which originally refused to comply and led to a petition to enforce the summons.10 Eventually the IRS narrowed the information requested in its summons to only include information regarding those accounts with a total of at least $20,000 in a single transaction type in any single year for the period requested.11 Although Coinbase still refused to comply with the summons, it did admit that the information requested by the IRS would require it to disclose information about nearly nine million transactions involving over 14,000 of its users.12 The Court upheld most of the summons: the summons met the hurdle of a legitimate investigative purpose13; while certain of the information sought for each “John Doe” user was sufficiently relevant, some of the information requested was overbroad14; and Coinbase failed to substantiate any abuse of process with respect to the summons.15

As the Coinbase litigation demonstrated, the tax judiciary had little difficulty applying relevant law to the surrounding procedure in spite of the technological complexities relating to virtual currencies. Just as if it were any other financial institution, Coinbase was required to comply with the IRS summons, provided that summons met the standards generally applicable to such action, requiring that the IRS is, for a legitimate purpose, seeking relevant information not already in its possession and satisfying the administrative steps the Internal Revenue Code requires.16 Note, however, that some individuals with virtual currency transactions have continued to fight sometimes protracted battles against further disclosure in the courts.17

Zietzke I is one such dispute. The decision by the Federal District Court for the Western District of the Washington opens (as many virtual currency decisions do) with a basic discussion of how virtual currencies work, but then turns to a wonderfully pithy statement; “[a]s with many things in life, cryptocurrency transactions have tax consequences.”18 Taxpayer Zietzke had originally prepared and filed his own tax return for 2016; however, he claimed to have classified two of the largest Bitcoin transactions in the wrong year, which he later realized upon the advice of his CPA.19 An amended return reduced his long-term capital gains for the year from $104,482 to $410, which caught the attention of the IRS.20 Although Zietzke disclosed transactions on two virtual currency trading platforms, the IRS later discovered other transactions on other platforms, resulting in a summons issued to one of the platforms, Bitstamp.21

Much like the arguments raised by the taxpayer in the Coinbase litigation referenced above, Zietzke argued that the IRS did not issue the summons for a proper purpose and that the information sought was both irrelevant and already in the IRS possession.22 Additionally, Zietzke argued that the summons violated his reasonable expectation of privacy with respect to the Bitstamp records and that the IRS would not be able to properly secure any records Bitstamp provided.23

The Zietzke I court handled each of the first four arguments swiftly. The purpose of the summons was straightforward; the IRS is both allowed and “required by Congress to investigate persons who may owe taxesregardless of the amount.”24 A summons must merely seek records that may be relevant to the summons’s purpose; however, the initial summons lacked a time constraint, which was overbroad.25 The court observed further that a taxpayer’s statement that he has already provided all necessary records does not prevent the IRS from investigating further.26

With regard to Zietzke’s privacy concerns, the court noted the difference under the 4th Amendment between active surveillance and a request for final records already in the possession of a third party outside his own physical locale in distinguishing certain 4th Amendment decisions.27 Similarly, the court noted that the premise that the government is unable to properly secure records is not a legal one, and therefore should more properly be directed to Congress and the Executive.28 The bottom line is that the IRS prevailed against the taxpayer in Zietzke I. 

Zietzke II was a subsequent Tax Court decision involving the taxpayer’s second challenge to a similar summons served upon a different entity, which fared little better than the first.29 Although taxpayer Zietzke advanced a variety of additional concerns regarding relevance, the Tax Court merely ruled that some of the requested pieces of information were overbroad.30 The majority of the summons was once again upheld.31

Zietzke and Strashny suggest that taxpayers, their advisors and their counsel, should consider Bitcoin, Ethereum, or other virtual currencies as one more type of asset and that virtual currency holdings are generally subject to IRS summonses and collections rules.

In conjunction, the Zietzke decisions support the conclusion that the federal district courts and tax courts appear to understand digital accounts and are comfortable applying the law to summonses served on more traditional types of financial institutions or in search of more traditional assets. Analysis of the IRS summons proceeded without difficulty, along identical lines to those laid out well before virtual currency or virtual currency exchanges (or, indeed, before many of those owning or trading in virtual currencies themselves) existed.32

Strashny—Facts and Procedure

The Strashnys filed their Federal income tax returns on time for tax year 2017; however, they did not pay the amount of tax due on the return.33 The IRS assessed the Strashnys for the amount listed, plus additional amounts for failure to pay, subject to interest.34 In July 2017, the Strashnys mailed in Form 9465, an Installment Agreement Request, and a Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals.35 By December 2018, including interest, the Strashnys assessed 2017 tax liability was more than $1.1 million.36

The IRS followed up by sending the Strashnys a Notice CP90, Intent to Seize Your Assets and Notice of Your Right to a Hearing.37 The Strashnys responded by requesting a hearing and attaching copies of their previously mailed Forms 9465 and 433-A.38 The Strashnys’ Forms did not contest the underlying amount of 2017 tax liability; similarly, the opinion notes that the Strashnys did not “check the box indicating that they could not pay the balance ….”39 The IRS Settlement Officer (“SO”) conducting the Strashnys’ requested a hearing (related to the requested Installment Agreement, “IA”) verified the Strashnys’ 2017 tax liability, confirmed all procedural requirements had been met, and, finally, noted the extensive virtual currency assets listed on Form 433-A.40 Prior to the conference, the SO also received documents including a copy of the Strashnys’ 2018 tax return, noting wages of over $200,000, and investment statements valuing the Strashnys’ virtual currency assets at over $7 million.41 Furthermore, the SO noted that the Strashnys “were currently withdrawing $19,000 per month from their cryptocurrency account.”42 This led the SO to question why the Strashnys had not liquidated these assets to pay their tax liability in full; if the Strashnys had the ability to do so, they would not qualify for an installment agreement.43 Although the Strashnys’ representative at the conference raised a minor procedural issue, he did not directly address why the Strashnys’ were unwilling to liquidate assets to fully satisfy their tax liability.44 In a follow-up call, the Strashnys’ representative similarly did not provide any reason why the Strashnys were unable to liquidate their virtual currency assets to pay the entire liability at once.45 The SO denied the Strashnys’ IA request, issuing a notice of determination which supported the SO’s proposed levy set for 30 days later.46 Following an assessment of tax liability and denial of the Strashnys’ request for an installment agreement, the IRS determined that action to collect their outstanding tax liability was appropriate. The Strashnys responded by proceeding with a Collections Due Process (“CDP”) case.47 The parties filed cross-motions for summary judgment, and the court agreed the case did not present a dispute of any material fact.48 As the parties did not dispute the amount of the underlying tax liability, the Tax Court reviewed the IRS collection decision for abuse of discretion, and finding none, granted the government’s motion for summary judgment.49

Strashny—Law

The Tax Court restated the general rule of applicable law that summary judgment is appropriate where no material facts are in dispute and a judgment based purely on the law suffices.50 As noted above, the Strashnys and the government disputed none of the relevant facts, including the amount of underlying tax liability, the Strashnys’ possession of substantial virtual currency holdings, and the Strashnys’ monthly income from wages and from the virtual currency holdings.51 As Code Sec. 6330(d)(1) provides no judicial standard of review for a CDP hearing, prior Tax Court decisions delineate an abuse of discretion standard (“arbitrary, capricious, or without sound basis in fact or law”) in cases without dispute as to the underlying tax liability.52

Law governing these hearings requires: first, verification of whether requirements under applicable law or administrative procedure have been met; second, consideration of any issues presented relevant to the unpaid tax or proposed levy; and third, a balance between the concerns of efficient collection activity and intrusion caused by collection action.53 Although installment agreements such as the one sought by the Strashnys are permitted under statute,54 subject to the Commissioner’s discretion,55 the Internal Revenue Manual (“IRM”) notes generally that unless a special circumstance applies, assets must be liquidated before such agreement is appropriate.56 In general, the Tax Court agreed with prior law that following the IRM guidelines when determining whether a taxpayer is eligible for an IA is not abuse of discretion.57

Here, the Strashnys volunteered the relevant information concerning their virtual currency holdings.58 The Strashnys also failed to provide any reason why it might be difficult or impractical to liquidate some or all of the virtual currency, and made no representations of any special circumstances that might make an IA more appropriate.59 The SO made the requisite procedural verifications, considered any issues the Strashnys raised, followed the IRM guidelines in requesting that assets be liquidated and attempted to determine whether some special set of circumstances might have prevented the Strashnys from liquidating their virtual currency holdings.60 The Tax Court, therefore, found no abuse of discretion under Code Sec. 6330(c).61 Similarly, the Tax Court held that denial of the Strashnys’ request for an installment agreement did not constitute abuse of discretion.62

The key takeaway from this summary proceeding is that the IRS (and the SO) treated the Strashnys’ virtual currency holdings just like any other asset.63 Absent special circumstances, reliance on the IRM requirement that most types of assets (presumably including virtual currencies) must be liquidated before a taxpayer can qualify for an IA was not an abuse of the SO’s discretion.64

The Strashnys’ assets were comprised primarily of considerable virtual currency holdings, which the Strashnys valued substantially in excess of their total tax liability. Although the record is unclear as to why the Strashnys believed an IA was appropriate despite these assets, it seems plausible that the novel nature of the assets caused either the Strashnys or their advisors to believe virtual currency could be treated differently. As demonstrated by the Tax Court’s memo opinion, it is relatively settled law that in most circumstances where a taxpayer has sufficient assets to satisfy their total tax liability, an IA simply isn’t an option.

Curiously, neither the SO nor the Strashnys raised any valuation concerns. Virtual currency assets are notoriously volatile, and the end of 2017 through the beginning of 2018 was a period of relatively drastic downward correction.65 On the other hand, from a purely procedural standpoint, the Strashnys themselves placed a value on the virtual currency of several multiples of their tax liability, so presumably the SO was more than willing to accept such a valuation.

The IRS demonstrably had no difficulties here understanding and accepting that in spite of the differences, virtual currency holdings were governed by its existing framework of analysis. The Strashnys had a certain outstanding liability, and, just as if their holdings consisted of other readily tradable assets such as publicly traded stocks, bonds, or commodities futures, before they could qualify for an IA these assets needed to be liquidated or borrowed against. Without any mitigating circumstances or arguments about why liquidation was inappropriate, the Strashnys (and presumably any other taxpayers with significant virtual currency holdings, regardless of whether they clearly disclose those holdings as the Strashnys did) simply did not qualify for repayment of their liability through an IA. Over time, the IRS has demonstrated its ability to locate these holdings and apply existing rules tax rules by analogy. Zietzke and Strashny suggest that taxpayers, their advisors and their counsel, should consider Bitcoin, Ethereum, or other virtual currencies as one more type of asset and that virtual currency holdings are generally subject to IRS summonses and collections rules.

*The authors have previously written articles on virtual currency tax issues.

1 See, e.g., Zietzke, 426 FSupp3d 758 (W.D. Wash. 2019) (“Zietzke I”); Zietzke, Case No. 19-cv03761-HSG (N.D. Cal. Jan. 17, 2020) (“Zietzke II”) (collectively, Zietzke I and Zietzke II shall be referenced as “Zietzke”); A. Strashny, 119 TCM 1565, Dec. 61,694(M), TC Memo. 2020-82 (2020).

2 See, e.g., Zietzke, 426 FSupp3d 758 (W.D. Wash. 2019) (“Zietzke I”); Zietzke, Case No. 19-cv03761-HSG (N.D. Cal. Jan. 17, 2020) (“Zietzke II”); Strashny, TC Memo. 2020-82 (2020).

3 This is clear given public IRS statements and mailings. See, e.g., Conlon, Vayser and Schwaba, New IRS Rev. Rul. 2019-24 & Related FAQ: Not the Bitcoin Tax Guidance Taxpayers Were Looking for, J. Taxation of Financial Products, Jan. 21, 2020; Conlon, Vayser and Schwaba, If a Crypto Tree Falls in a Digital Forest, Can It Give Rise to Tax Evasion, 161 Tax Notes 701 (Nov. 5, 2018), 2018 TNT 225-8.

4 Allyson Versprille, IRS Challenged to Find Tech for Tracing Private Crypto Deals, Bloomberg Tax, July 7, 2020, https://news.bloombergtax.com/ daily-tax-report/irs-challenged-to-find-techfor-tracing-private-crypto-deals.

5 Id.

6 Jamie Redman, Bitcoin Cash Protocol Successfully Upgrades—Schnorr Signatures Are Here, Bitcoin. com, May 15, 2019, https://news.bitcoin.com/ bitcoin-cash-protocol-successfully-upgradesschnorr-signatures-are-here/.

7 See https://en.wikipedia.org/wiki/Al_Capone.

8 Such challenges are discussed more in-depth in the author’s previous articles: If a CryptoTree Falls in a Digital Forest, Can It Give Rise to Tax Evasion, 161 Tax Notes 701 (Nov. 5, 2018); Valuation of Cryptocurrencies and ICO Tokes for Tax Purposes, 12 Estate Planning & Community Property Law Journal 25.

9 Coinbase, Inc., at 7. No. 17-cv-01431-JSC (N.D. Cal. Nov. 28, 2017).

10 Coinbase at 1.

11 Coinbase at 3.

12 Coinbase at 6–7.

13 To wit, explaining the large gap between transactions and tax filings concerning virtual currency. Coinbase at 9.

14 Certain Know-Your-Customer records, certain information about third-party accesses and controls, and other information related to contact between third-parties and Coinbase were all deemed not relevant at this stage. Coinbase at 11.

15 Coinbase at 13.

16 Coinbase at 5 citing Code Sec. 7602(a); see also J. Crystal, CA-9, 99-1 ustc ¶50,464, 172 F3d 1141, 1143.

17 Virtual currency holders have raised interesting constitutional arguments; one recent suit, for example, references a line of 19th century cases concerning seizure of “private papers.” See Individual Claims Digital Currency Exchange Subpoenas Violated Rights, 2020 TNTF 142-29 (July 24, 2020).

18 Zietzke I, 426 FSupp3d at 762.

19 Zietzke I, 426 FSupp3d at 762.

20 Zietzke I, 426 FSupp3d at 763.

21 Zietzke I, 426 FSupp3d at 763.

22 Zietzke I, 426 FSupp3d at 763.

23 Zietzke I, 426 FSupp3d at 763.

24 Zietzke I, 426 FSupp3d at 765.

25 This requirement was easily addressed by modifying the summons to limit it to information for the tax year in question. Zietzke I, 426 FSupp3d at 765.

26 Zietzke I, 426 FSupp3d at 766.

27 Zietzke I, 462 FSupp3d at 768–769.

28 Zietzke I, 462 FSupp3d at 769.

29 Zietzke II, No. 19-cv-03761-HSG.

30 For the most part, the additional restrictions were the removal of passwords, security settings, and account retrieval information, as well as a time constraint to 2016. Zietzke II, No. 19-cv-03761-HSG at 20.

31 Zietzke II, No. 19-cv-03761-HSG at 20.

32 The specific test is articulated in M. Powell, SCt, 64-2 ustc ¶9858, 379 US 48, 85 SCt 248.

33 Strashny at 2.

34 Strashny at 2.

35 Strashny at 2. Fall 2020 29

36 Strashny at 3.

37 Strashny at 3.

38 Strashny at 3.

39 Strashny at 3. Presumably, the box referred to is the box marked “I Cannot Pay Balance” on Form 12153, Request for a Collection Due Process or Equivalent Hearing, rather than any of the boxes on Forms 9465 or 433-A.

40 Strashny at 3.

41 Strashny at 3.

42 Strashny at 3–4.

43 Strashny at 4.

44 Strashny at 4. The representative did, however, raise some minor procedural issues specifically concerning issuance of an intent to levy despite the request for an installment agreement; however, until formal denial of the request, no levy action would be taken. Id.

45 Strashny at 4.

46 Strashny at 5.

47 Strashny at 2.

48 Strashny at 2.

49 Strashny at 1, 6.

50 Strashny at 5.

51 Strashny at 5.

52 Strashny at 5 citing H. Goza, 114 TC 176, 182, Dec.

53,803 (2000); see also E.F. Murphy, 125 TC 301, 320, Dec. 56,232 (2005) aff’d, CA-1, 2007-1 ustc ¶50,115, 469 F3d 27. 53 See Code Sec. 6330(c)(3).

54 Strashny at 6 citing G. Thompson, 140 TC 173, 179, Dec. 59,469 (2013).

55 Strashny at 6 citing W. Rebuck, 111 TCM 1010, Dec. 60,504(M), TC Memo. 2016-3.

56 Strashny at 6 citing IRM pt. 5.14.1.4(5) (Sept. 19, 2015).

57 Strashny at 7 citing Orum.

58 Strashny at 3.

59 Strashny at 7.

60 Strashny at 3–4.

61 Strashny at 6.

62 Strashny at 7.

63 Similarly, the IRS has recently focused on whether microtask compensation in virtual currency results in taxable income to the person performing the task and receiving virtual currency in exchange, and concluded that it was taxable income. IRS Chief Couns. Mem. 202035011 (Aug. 28, 2020).

64 Strashny at 7 citing IRM pt. 5.14.1.4(b) (Sept. 9, 2014); S. Hosie, 108 TCM 591, Dec. 60,091(M), TC Memo. 2014-246.

65 See Conlon, Vayser and Schwaba, Valuation of Cryptocurrencies and ICO Tokens for Tax Purposes, 12 Estate Planning & Community Property Law Journal 25

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