Should the IRS be able to monitor a taxpayer’s finances without restriction?  Should the IRS have access to all a taxpayer’s data, including stubs, receipts, bank statements, and more?.

This question becomes very relevant in the case of bitcoin user William Zietke, reported reason.com. The IRS audited Zietke after he amended his 2016 tax return. According to the IRS, Mr. Zietke was uncooperative. As a result, the IRS summonsed Zietke as well as the crypto exchanges Coinbase and Bitstamp for more information. The ramifications of these summonses are that by its very nature, it allows for the permanent surveillance of Mr. Zietke’s cryptocurrency finances.

Mr. Zietke is opposing the IRS on the basis that the summonses are unnecessary, unwarranted, and a violation of his fourth amendment rights.  The outcome will affect every bitcoin user.

The Zietke Case: Facts

⇒ Zietke mined coins with an average value of $10 each (at the time).

⇒ By 2017, his bitcoins were worth $1,000 each.

⇒ Zietke decided to cash out a part of his bitcoin position to retire.

⇒ Zietke tried to avoid a rising marginal tax rate (resulting from a substantial capital gain in a single year), Zietke (wrongly) assumed that it was perfectly legal to spread his gains over more than one year.

⇒ Zietke claimed his gains over two years, 2016 and 2017.

⇒ “I made a mistake,” Zietke insists. This was the first time I faced this type of situation. I became aware of my errors when I appointed an accountant for the first time in 2017.

⇒ When my accountant told me that all gains claimed in a given year had to be backed by same year transactions, I did the right thing: I amended my return, removed a gain of $104,482, and this triggered a $15,475 refund.

By correcting his return, one could argue that Zietke was over-compliant. He was one of only 807 Americans even to report bitcoin income for 2013, keeping in mind that the IRS did not even issue any guidelines on bitcoin taxation before 2014.

Complexities hamper Bitcoin reporting.  Users send and receive cryptocurrencies electronically without any participation by third-party institutions (banks). To make matters worse, the US Tax Code designates bitcoin to be property. Once you receive bitcoin in exchange for goods and services, you have to claim its fair market value as income.

Similarly, if your bitcoin appreciates in value, you have to report your capital gains when you sell or trade it.  Since no institutions are involved, crypto users must keep track of their bitcoin value (upon receipt and sale).

However, since Bitcoin is also a currency, things become even more complicated.  As it stands, the law requires bitcoin users to report as a taxable event, any transaction where cryptocurrency is traded for goods and services, even when you buy a sandwich and a cup of coffee.

The Zietke Case: IRS

⇒ During the audit, the IRS issued two document requests to Zietke.

⇒ Zietke provided an accounting of his taxable 2016 bitcoin transactions, including screenshots of his activity on Purse.io and Coinbase. He also provided an activity log from Armory (software), showing that he made no transactions during 2016, and provided bank statements as a basis for the cost of the bitcoin he acquired through Coinbase.

⇒ Zietke redacted the random strings of numbers and letters that identify his digital wallets ( his public addresses) because of its sensitive nature.

⇒ Satoshi Nakamoto’s original bitcoin white paper, wich ‘founded crypto, explained that privacy in cryptocurrency, had to be maintained by keeping public keys private.

⇒ If Zietke offered his public addresses to the IRS, they would be able to surveil his finances forever. Therefore Zietke requested the IRS to accept alternative verification that he fully paid his 2016 taxes.