Taxpayers Cannot Claim Privacy Rights With The IRS Over Crypto Investment Holdings

Taxpayers Cannot Claim Privacy Rights With The IRS Over Crypto Investment Holdings

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 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 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.

So What Went Wrong?

What the IRS managed to piece together was that Zietke purchased a backpack on According to the IRS, Mr. Zietke informed them that all of the coins he disposed of during 2016 went through Coinbase.

What’s more, the IRS managed to link some of Mr. Zietke’s addresses to wallets linked to BTC-e and Bitstamp exchanges while Mr. Zietke informed the IRS that all his bitcoin holdings were split between his personal wallets and Coinbase.

Since Zietke did not satisfy the IRS information requests, the IRS informed him that summons would be issued for the requested information, and both Bitstamp and Coinbase would now be included in the effort.

Is The IRS Wrong?

For starters, the backpack was acquired using money from a Coinbase address. The IRS now admits this. According to Zoetke’s version, he never said or implied that his holdings were split between private wallets and Coinbase. Also, the IRS document requests asked only for information about his 2016 transaction activities and not for a full account of his actions. The BTC-e transactions occurred before 2016, while the Bitstamp transactions were merely transfers between his two accounts and did not trigger any tax events. Zietke says he offered these nontaxable transactions to the IRS during a conference call and was told they were irrelevant.

The IRS Goes For The Jugular

  1. Summonsed:
    • Coinbase
    • Bitstamp
    • Zietke
  2. The summonses demand access to all of the following information:
    • All account history information for any accounts affiliated with Mr. Zietke, including:
      • Digital wallet information
      • Blockchain addresses
      • Transaction IDs
      • Any other information related tothe parties involved.:
        • The identity
        • Location

Take Note

  • From Coinbase and Bitstamp, they demanded:
    • The IRS wanted all Mr. Zietke’s public addresses AND all the addresses of all the identities and wallets of anyone who transacted with Mr. Zietke.
  • From Zietke they demanded:
    • All documents and records related to all blockchain addresses and associated wallet IDs he owned during 2016.
    • All public addresses linked to any virtual currency he held during 2016 whether he used it that year or not.

Zietke’s Response

  1. Zietke filed motions to quash the summonses to Bitstamp and Coinbase.
  2. He refused to comply with the summons he received on the grounds that the IRS had no right to ‘perfect surveillance of his financial activity’ in the specific circumstances of his case.
  3. He would have to regain his privacy by selling all his bitcoin holdings, pay all the subsequent taxes, and then repurchase all the bitcoins with new wallets.

IRS Respond To Zietke

  1. Activity statements, according to the IRS, are insufficient. The IRS has no way to know whether it is a complete record.
  2. The IRS needs the transaction histories of all wallets Mr. Zietke owned during 2016 to check for themselves.
  3. Zietke’s privacy concern does not hold water. Public addresses are no different from bank account numbers, which the IRS regularly request for audit purposes.

Of course, account numbers are very different from public addresses. With public addresses, the IRS can monitor Mr. Zietke’s financial activities in real-time, forever. In 2016 when the IRS used a John Doe summons to Coinbase for the private information of users. It included wallet addresses. The court rejected the request for wallet addresses. It stated that the courts might grant permission for the same when they become necessary for specific users once the IRS reviewed the relevant records.

A Washington District Court Ruling In The Zietke Bitstamp Case

The court upheld the summons BUT:

  • Narrowed the scope to 2016 transactions
  • It granted the request for wallet addresses for those transactions
  • It dismissed Zietke’s privacy concerns based on the third-party doctrine (you do not have a reasonable expectation of privacy for information revealed to a third party and conveyed by the same to the government
  • The court still has to rule on the attempt to quash the Coinbase summons [a magistrate judge produced recommendations to the California district judge in line with the Bitstamp ruling].

If the Department Of Justice Allows The IRS To Enforce Zietke’s Individual Summons:

  • Hence the third-party doctrine cannot apply.
  • Zietke’s summons does not involve any third parties.

The outcome will affect thousands of US taxpayers. The IRS is intent on enforcing cryptocurrency taxation. No doubt, if the IRS gets its way with the Zietke summons, many Bitcoin users will be in serious trouble.

Readers should note that this article is only intended to convey general information on these issues and that FAS CPA & Consultants (FAS) in no way intends for the contents of this article to be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. This article cannot serve as a substitute for such professional services or advice. Any decision or action that may affect the reader’s business should not rely solely on the contents of this article, but should rather be consulted on with a qualified professional adviser. FAS shall not be responsible for any loss sustained by any person who relies on this presentation. This article is subject to change at any time and for any reason.

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Fulton Abraham Sanchez, CPA

Fulton Abraham Sánchez, CPA I am Certified Public Accountant, specialized in Tax Planning & Offshore Strategies for Real Estate, Hedge/Equity Funds, Fintech, Crypto, Expats, IRS Debt Resolution. You can email me and follow us on Facebook : FAS CPA & Consultants.

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