This Article reviews the IRS’s previous enforcement models, and considers how these have shifted in recent decades. The IRS has increasingly moved away from a purely punitive system towards one that focuses on customer service, the theory being that a procedurally fair system will increase taxpayer satisfaction and voluntary compliance. Given the IRS’s steady shift to a more holistic tax enforcement approach, the Author believes that the IRS is likely to take a broad-based approach to cryptocurrency tax enforcement.

Rather than a world of increasingly aggressive tax law enforcement, as Davidson and Rees-Mogg suggest, we may instead witness a continued strategic shift in resources deployment by the IRS away from criminal prosecutions as the IRS ramps up its cryptocurrency enforcement efforts.

The recent experience of the IRS’s Swiss Bank efforts can give some helpful clues as to how the IRS intends to approach cryptocurrency evasion. Indeed, IRS criminal tax prosecutions have actually been in steady decline over the past decade. Yet the IRS successfully convinced tens of thousands of offshore account holders to come forward, file back tax returns and Foreign Bank Account Reports, and even pay substantial fines. To accomplish this, the IRS has used large-scale “John Doe” summons efforts coupled with general threats of prosecution, to steer people to enter these offshore voluntary disclosure regimes. Using the recent example of this IRS Swiss Bank enforcement effort, we ask how a similar enforcement model might, and might not, work to close the tax gap with respect to cryptocurrency tax collection.


Back in 1999, before bitcoin or other cryptocurrencies had even been conceived,

Satoshi Nakamoto, Bitcoin: A Peer-to-Peer Electronic Cash System, BITCOIN (Nov. 8, 2008), https://bitcoin.org/bitcoin.pdf.
Milton Friedman predicted the rise of virtual currencies which would allow people to transfer funds without going through financial intermediaries.
Steve H. Hanke, Friedman and Hanke on Bitcoin, CATO AT LIBERTY, https://www.cato.org/blog/friedman-hanke-bitcoin (quoting Interview by John Berthoud with Milton Friedman, in San Francisco, Cal. (1999)) (“I think that the Internet is going to be one of the major forces for reducing the role of government…. The one thing that's missing, but that will soon be developed, is a reliable e-cash, a method whereby on the Internet you can transfer funds from A to B, without A knowing B or B knowing A.”).
“I think that the Internet is going to be one of the major forces for reducing the role of government,” he told the National Taxpayers Union. But two years before, James Dale Davidson—the founder of the Taxpayers Union—had also envisioned the future of virtual currency. Unlike Friedman, his vision included a remarkably bleak view of how world governments would respond to the adoption of new financial technologies.

In The Sovereign Individual: Mastering the Transition to the Information Age,

Davidson and William Rees-Mogg wrote about a future world rife with offshore tax evasion and fiat currency debasement, leading to an economic flight to “cyberspace.”
Id. at 23.
Here is how they put it:

When the state finds itself unable to meet its committed expenditure by raising tax revenues, it will resort to other, more desperate measures. Among them is printing money…. In almost every competitive area, including most of the world's multitrillion dollar investment activity, the migration of transactions into cyberspace will be driven by an almost hydraulic pressure-the impetus to avoid predatory taxation, including the tax that inflation places upon everyone who holds his wealth in a national currency.

Id. at 24.

Davidson and Rees-Mogg described a future in which western governments will “turn nasty” and “seek to suppress the cybereconomy by totalitarian means.”

Id. at 25.

One might argue that we are already there. Anyone who has been audited by the IRS for cryptocurrency transactions might indeed feel that way. Or maybe this future is just around the corner. But are we truly in store for massive totalitarian imposition of tax on cryptocurrency transactions or even the outlawing of such transactions, as some countries have sought to do?

See, e.g., J.P. Buntix, Reserve Bank of India Faces lawsuit Over Attempt to Ban Cryptocurrency Trading, NULL TX (Apr. 28, 2018), https://nulltx.com/reserve-bank-of-india-faces-lawsuit-over-attempt-to-ban-cryptocurrency-trading; Kevin Helms, Iran Continues to Develop State Cryptocurrency Despite Central Bank Ban, BITCOIN.COM NEWS (Apr. 30, 2018), https://news.bitcoin.com/iran-develop-cryptocurrency-central-bank-ban.

We could be, but it is also worth looking at what Davidson and Rees-Mogg got wrong. For example, they predicted that governments will find themselves virtually unable to track cyberspace transactions, especially those that end up in offshore banks. They write:

Widespread adoption of public-key/private-key encryption technologies will soon allow many economic activities to be completed anywhere you please…. Once the next logical steps have been taken, and offshore banking locations offer the services of communication in hard RSA-encrypted electronic mail using account numbers derived from public-key systems, financial transactions will be almost impossible to monitor at the bank or in communications. Even if the tax authorities were to plant a mole in the offshore bank, or burglarize the bank records, they would not be able to identify depositors.

DAVIDSON & REES-MOGG, supra note 3, at 212.

Moles in offshore banks? Burglarizing the bank records? Hardly. The authors underestimated the power of Western governments to ferret out tax evasion even in a global and increasingly mobile economy.

Nowadays, IRS tax collectors do not need to burglarize any offshore bank to obtain their records. Swiss banks (and almost every other country’s banks) regularly open their books to U.S. and other Western tax collectors.

Robert W. Wood, IRS Reads Swiss Bankers Like an Open Book, FORBES (May 2, 2012), https://www.forbes.com/sites/robertwood/2012/05/02/irs-reads-swiss-bankers-like-an-open-book/#327085405e82.
The question remains, though, whether despite increased banking transparency, cryptocurrencies will still prove to be such financial game-changers as to realize Davidson and Rees-Mogg’s prediction of a government war on cyberspace.

Certainly Western governments have proven more adept at tracking offshore banking transactions than the authors envisioned. Davidson and Rees-Mogg did not foresee the United States’ offshore enforcement efforts over the past decade,

The U.S. Department of Justice announced its “Swiss Bank Program” on August 29, 2013. The announcement stated that the Program “will encourage Swiss banks to cooperate in the department’s ongoing investigations of the use of foreign bank accounts to commit tax evasion. The department also released a joint statement with the Swiss Federal Department of Finance, stating that Switzerland will encourage its banks to participate in the program.” U.S. DEP’T OF JUSTICE: OFFICE OF PUBLIC AFFAIRS, UNITED STATES AND SWITZERLAND ISSUE JOINT STATEMENT REGARDING TAX EVASION INVESTIGATIONS (Aug. 29, 2013), available at http://www.justice.gov/opa/pr/united-states-and-switzerland-issue-joint-statement-regarding-taxevasion-investigations.
nor Congress’s passage of the Foreign Account Tax Compliance Act (“FATCA”).
Foreign Account Tax Compliance Act of 2009, H.R. REP. NO. 111-3933 (2009); see Nirav (Jonathan) Dhanawade, I Got 99 Problems and They’re All FATCA, 35 NW. J. INT'L L. & BUS. 139 (2014) (describing FATCA’s structure of increased information reporting from individuals as well as requirements on foreign financial institutions, noting that it was designed to prevent tax evasion by U.S. taxpayers with offshore accounts).

And how could they have? It seemed almost impossible that the Swiss would just abandon their long-held bank secrecy tradition when the U.S. came knocking.

See, e.g., Beckett G. Cantley, The UBS Case: The U.S. Attack on Swiss Banking Sovereignty, 7 BYU INT’L L. & MGMT. REV. 1 (2011) (“Thus, the [Swiss] government will likely continue to strengthen its bank secrecy violation penalties on the one hand, while on the other doing as little as possible to placate the United States with respect to U.S. citizens with unreported Swiss accounts.”).
Indeed, even when the IRS first issued summonses to Swiss banks, the immediate reaction of commentators was not to wonder about criminal charges for the banks (which were in fact coming), but to question whether the IRS even had the right to make these requests in the first place.
Before the Senate Permanent Subcommittee on Investigations issued its report on July 17, 2008, the discussion regarding the IRS’s offshore information gathering efforts largely centered around whether UBS would comply with the summons. See U.S. SENATE, PERMANENT SUBCOMMITTEE ON INVESTIGATIONS, TAX HAVEN BANKS AND U.S. TAX COMPLIANCE (July 17, 2008). Whether or not UBS would be prosecuted for having facilitated tax evasion was not a focus of the Senate inquiry. See, e.g., Kristen A. Parillo, Federal Court Grants Request for Info from Swiss Bank, TAX NOTES (July 2, 2008) (“Under Swiss law, disclosure without the consent of the account party would result in a criminal violation to the disclosing bank and/or its bankers. On the other hand, UBS AG may find itself between a rock and a hard place regarding making such disclosures, because failure to honor the “John Doe” summons could result in severe fines and penalties, a suspension of all U.S. activities of UBS, or even worse, legal action.”).

But never say never. As the IRS looks to increase tax compliance amongst cryptocurrency users, it is confronting similar issues—of how to obtain information on transactions that are in many ways currently beyond the reach of its information reporting rules, and how to manage resources effectively when there are many more non-compliant taxpayers than there are IRS Agents. The IRS’s Swiss Bank program was so extraordinarily successful that it is likely to serve as a model for the Agency’s efforts to curb cryptocurrency tax evasion. But will it suffice? This is the multi-billion dollar question.

See, e.g., Faizan Raza, Cryptocurrency Market Surges, $454 Billion-Plus, INVESTING.COM (May 10, 2018), https://www.investing.com/analysis/the-market-cap-of-cryptocurrencies-has-surged-over-454-billion-200315002.

Despite their underestimation of the IRS’s agility in responding to offshore tax evasion, Davidson and Rees-Mogg were right to have predicted an increasing tension between government regulators and new financial technologies.

The IRS has already bristled at the lack of reporting of cryptocurrency gains,

Michael Cohn, IRS tells taxpayers to report cryptocurrency transactions or face penalties, ACCOUNTING TODAY (Mar. 23, 2018), available at https://www.accountingtoday.com/news/irs-tells-taxpayers-to-report-cryptocurrency-transactions-or-else-face-tax-penalties.
and has taken the opening shots (by enforcing a summons against Coinbase, the leading bitcoin trading exchange)
Jeff John Roberts, IRS Wins Bitcoin Fight, Gets Access to 14,000 Coinbase Accounts, FORTUNE (Nov. 30, 2017), available at http://fortune.com/2017/11/29/irs-coinbase; Dashiell Shapiro, IRS Targets Bitcoin Users, But Is Coinbase the Next UBS?, 154 TAX NOTES 13, 129 (Mar. 27, 2017).
in what is likely to be part of a larger and more wide-scale enforcement effort.

Due to the difficulty of tracing cryptocurrency transactions

See, e.g., David Voreacos, IRS Cops Are Scouring Crypto Accounts to Build Tax Evasion Cases, BLOOMBERG (Feb. 8, 2018), available at https://www.bloomberg.com/news/articles/2018-02-08/irs-cops-scouring-crypto-accounts-to-build-tax-evasion-cases (noting that the IRS has formed a team of 10 Criminal Investigators to pursue tax evasion cases) (quoting Lisa Zarlenga as warning that “The biggest challenge for the IRS is this really new technology… They need to educate themselves on what is a blockchain, how do we learn what’s on the blockchain, and how do we follow it?”). The article also notes that because blockchains are online ledgers that record transactions in virtual currencies, they “can be public or private. Because there’s no central authority in the blockchain, people can often store wealth secretly and serve as their own bankers.” See also Omri Marian, Are Cryptocurrencies Super Tax Havens? 112 MICH L. REV., FIRST IMPRESSIONS, 38, 42 (2013); Sarah Jane Hughes & Stephen T. Middlebrook, Advancing A Framework for Regulating Cryptocurrency Payments Intermediaries, 32 YALE J. REG., 495, 533–34 (2015).
and the amount of tax revenue at stake, we can certainly expect more heavy artillery strikes from the IRS following their opening salvos. But what form will they take, and what issues might arise as the IRS tries to close the cryptocurrency tax gap?

This Article reviews the IRS’s previous enforcement models, and considers how these have shifted in recent decades. The IRS has increasingly moved away from a purely punitive system towards one that focuses on customer service, the theory being that a procedurally fair system will increase taxpayer satisfaction and voluntary compliance.

See Leandra Lederman, Tax Compliance and the Reformed IRS, 51 KANS. L. REV. 974-75 (2003).
Given the IRS’s steady shift to a more holistic tax enforcement approach, we think that the IRS is likely to take a broad-based approach to cryptocurrency tax enforcement.

Rather than a world of increasingly aggressive tax law enforcement, as Davidson and Rees-Mogg suggest, we may instead witness a continued strategic shift in resources deployment by the IRS away from criminal prosecutions as the IRS ramps up its cryptocurrency enforcement efforts.

The recent experience of the IRS’s Swiss Bank efforts can give some helpful clues as to how the IRS intends to approach cryptocurrency evasion. Indeed, IRS criminal tax prosecutions have actually been in steady decline over the past decade.

See Transactional Records Access Clearinghouse [hereinafter “TRAC”], Taxpayers Referred for Criminal Prosecution by IRS Reach New Low (Mar. 26, 2018), available at http://trac.syr.edu/tracreports/crim/502. The report shows a steady decline in IRS referrals for criminal prosecution from 2013 (when the Swiss Bank Program began) to the present. The report notes: “The latest available data from the Justice Department show that during January 2018 the government reported receiving 135 new referrals for prosecution from the Internal Revenue Service. According to referral-by-referral data obtained by the Transactional Records Access Clearinghouse (TRAC), this number was down substantially from its peak four years ago. For the most recent twelve month period this meant that IRS referred only 1,824 taxpayers for criminal prosecution, compared with the same twelve month period four years ago when it had referred more than twice that number (3,896).”
Yet the IRS successfully convinced tens of thousands of offshore account holders to come forward, file back tax returns and Foreign Bank Account Reports, and even pay substantial fines.
See, e.g., Jay R. Nanavati & Justin A. Thornton, DOJ and IRS Use “Carrot ‘n Stick” to Enforce Global Tax Laws, 29 CRIMINAL JUSTICE 2 (Summer 2014) (noting that the IRS’s voluntary disclosure programs have induced 43,000 taxpayers to report their foreign bank accounts and to pay taxes, penalties, and interest to the IRS of approximately $6 billion).
To accomplish this, the IRS has used large-scale “John Doe” summons efforts coupled with general threats of prosecution, to steer people to enter these offshore voluntary disclosure regimes.
See David Voreacos, Secret Swiss Accounts Said No Longer Safe for Tax Dodging, BLOOMBERG (Sept. 8, 2013), available at https://www.bloomberg.com/news/articles/2013-09-08/secret-swiss-accounts-said-no-longer-safe-for-tax-dodging (“If someone had an account in Switzerland, it is beyond foolish to think that that account is going to remain secret. . . . In the last five years, we’ve seen a remarkable change in our ability to get information concerning Swiss bank accounts. It’s extraordinary. Switzerland is no longer a good place to hide assets for tax reasons.”) (quoting Assistant Attorney General Kathryn Keneally).
Using the recent example of this IRS Swiss Bank enforcement effort, we ask how a similar enforcement model might, and might not, work to close the tax gap with respect to cryptocurrency tax collection.

U.S. Tax Enforcement Policy’s Recent Shifts

In the 1980s the IRS began explicitly working towards closing the “income tax gap.”

Vito Tanzi & Parthasarathi Shorne, A Primer on Tax Evasion (1994), at 17.
IRS Commissioner Roscoe Egger reported in 1982 that this gap in the legal sector grew from $29 billion in 1973 to $87 billion in 1981,
and he projected it would grow to $120 billion by 1985.
The gap in the illegal sector was projected to be much larger, and more broadly the income tax gap was increasingly viewed as a threat to the income tax itself.
Michael J. Graetz & Barbara McDowell, Tax Reform 1985: The Quest for a Fairer, More Efficient and Simpler Income Tax, 3 YALE L. & POL. REV. 5, 16-23 (1984); Thomas G. Vitez, Information Reporting and Withholding as Stimulants of Voluntary Compliance, in INCOME TAX COMPLIANCE (American Bar Association) (1983) (noting that “the dramatic deterioration in compliance levels witnessed thus far, if not reversed quickly and forcefully, will gain further momentum and eventually erode, beyond repair, the integrity of our present income tax system.”).

The economic model informing policymaking at the time was heavily based on economics of crime analysis, first introduced by Gary Becker in 1968.

Gary S. Becker, Crime and Punishment: An Economic Approach, 76 J. POL. ECON. 1 69-217 (1968).
In the 1970s, this economics of crime model was applied to taxation by Michael Allingham and Agnar Sandmo.
Michael G. Allingham & Agnar Sandmo, Income Tax Evasion, A Theoretical Analysis, 1 J. PUB. ECON. 323-28 (1972).

The economics of crime approach generally treats criminal activity as a rational individual decision that depends upon probabilities of detection and conviction and levels of punishment. Becker explicitly suggested that this methodology was applicable to tax evasion and avoidance.

Becker, supra note 26, at 170, 172.
Allingham and Sandmo were able to derive conditions under which an increase in the penalty rate (or the probability of imposition of sanctions) increases the reported taxable income of a rational maximizing taxpayer.
Allingham & Sandmo, supra note 27, at 330.
The model assumes a proportional tax schedule and certainty about both the penalty schedule and the probability of sanction imposition.

With this economic model, the U.S. responded to the perceived tax compliance “crisis” in 1982 by increasing penalties and expanding information reporting, in order to increase both the probability of detection and the cost of punishment. This included legislation that provided penalties for substantial understatements of tax liabilities,

TAX EQUITY AND FISCAL RESPONSIBILITY ACT OF 1982, Pub L. No. 97-248, 96 Stat. 324, 614 (1982). See Alan Plumley & C. Eugene Steuerle, Ultimate Objectives for the IRS: Balancing Revenue and Service, in THE CRISIS IN TAX ADMINISTRATION (Henry J. Aaron & Joel Slemrod eds., 2003) (“The Tax Equity and Fiscal Responsibility Act of 1982 (‘TEFRA’) initiated a period in which policymakers became willing to impose greater burdens on taxpayers in order to harvest the revenues from improved tax compliance. Faced with the need to restore fiscal stability after what they perceived as the excessive 1981 tax cuts, . . . drafters of TEFRA reviewed numerous potential ways to raise revenue and concluded that improved tax compliance was a relatively attractive option.”). I.R.C. §§ 6653, 6661, 7206.
for aiding and abetting understatements of tax liabilities,
Id. at 615. I.R.C. § 6701.
for the filing of frivolous returns,
Id. at 617. I.R.C. § 6702.
for failure to file information returns,
Id. at 605. I.R.C. § 6721.
and for extended failure to file tax returns.
Id. at 610. I.R.C. § 6651.

Congress also increased the penalty for failure to supply taxpayer identification numbers,

Id. at 607.
increased criminal fines,
Id. at 588-589. I.R.C. §§ 7201, 7206.
and implemented new requirements for registering tax shelters with the IRS and for maintaining lists of tax shelter investors.
I.R.C. § 6111.
Congress even gave the IRS authority to seek injunctive relief against the promoters of abusive tax shelters, seeking to head off tax evasion in some cases before it had even taken place.
Id. at 612. I.R.C. § 6700.

This legislative history illustrates Congress’s belief that increased penalties and information reporting would help to narrow the income tax gap. The Congressional Committee Reports on the 1982 Act describe the tax collection process as an “audit lottery,” and presumes that citizens endeavor to maximize their own narrowly perceived financial self-interests.

S. REP. NO. 97-494, at 74, 277 (1982), as reprinted in 1982 U.S.C.C.A.N. 781 (“These advisors frequently emphasize the lack of any penalty when sufficient tax has been withheld from wages and encourage others to play the ‘audit lottery.’ The committee believes that an immediately assessable penalty on the filing of protest returns will help deter the filing of such returns, and will demonstrate the determination of the Congress to maintain the integrity of the income tax system.”).
Most analysis at the time involved a fairly straightforward model which pits a single taxpayer (who is attempting to maximize personal gain and weighing this against the risk of detection and penalties for non-compliance) against the IRS.
Graetz & Barbara McDowell, supra note 25; Allingham & Sandmo, supra note 27, at 330.
The idea is that if risk of detection and penalties increase, so should compliance.
Allingham & Sandmo, supra note 27, at 330-31.

However, some early critics noted that there may not be a linear relationship between increased penalties and increased compliance. In the mid-1980s, Jackson and Milliron argued that the cost of increased sanctions could outweigh the benefits.

Betty R. Jackson & Valerie C. Milliron, Tax Compliance Research: Findings, Problems & Prospects, 5 J. ACCOUNTING LITERATURE 1 (1986).
They suggested taxpayers may become alienated if sanctions are perceived as too severe, resulting in general antagonism and disrespect for the law.

Some commentators have argued that the economic model should be expanded to include the IRS as a strategic actor in a game-theoretic approach.

Michael J. Graetz, The Tax Compliance Game: Toward an Interactive Theory of Law Enforcement, 2 J. LAW, ECON & ORG. 1 (Spring 1986).
Even with this change, the model would still generally have the structure of a single rational taxpayer’s decision-making pitted against the IRS.

It is also worth asking whether it is a failing of the model that its analysis envisions a single taxpayer, rather than groups of similarly situated taxpayers who are forced to make game-theoretic decisions in response to enforcement efforts.

Recent experience with the IRS’s offshore compliance efforts suggest that there are group dynamics in play as well which are worth considering in any economics of crime model. See James Alm, Expanding the Theory of Tax Compliance from Individual to Group Motivations, A HANDBOOK OF ALTERNATIVE THEORIES OF PUBLIC ECONOMICS (2014), 260. The IRS has limited resources and is not able to audit everyone with an offshore account. The IRS’s Offshore Voluntary Disclosure programs have offered decreasingly favorable “deals” to taxpayers who waited longer to come forward. The first taxpayers to take the IRS up on its offer of a voluntary disclosure paid the least penalties, and also arguably reduced the burden on the IRS of auditing those who came forward later (or not at all). Leandra Lederman, The Use of Voluntary Disclosure Initiatives in the Battle Against Offshore Tax Evasion 57 VILL. L. REV. 499, 527 (2012) (“The IRS has wisely increased the general penalty each time, rather than offering the same or more attractive terms, which would encourage non-compliers to wait for a better deal, as well as undermining taxpayers’ perceptions of the fairness of the federal income tax system generally and the offshore compliance effort in particular.”).
For example, cryptocurrency investors, as dispersed as they are, may in some instances respond to perceived IRS enforcement policies as a group and look to each other’s behavior as a guide for informing their tax compliance postures.
One example is the move to Puerto Rico that many cryptocurrency investors have undertaken, due to perceived favorable tax treatment for cryptocurrency gains. See, e.g., Sean King, I’m Moving to Paradise on Jan 1 and Will Legally Pay No Tax on Cryptocurrency Gains! True Story, STEEMIT (June 2017), https://steemit.com/anarchocapitalism/@sean-king/i-m-moving-to-paradise-on-jan-1-to-legally-pay-no-tax-on-cryptocurrency-gains-true-story; Drew Crawford, Why Puerto Rico is becoming a Crypto-Utopia for U.S. Investors, MEDIUM (March 3, 2018), https://medium.com/@drewcrawford/why-puerto-rico-is-becoming-a-crypto-utopia-for-u-s-investors-c35029a5ab0d; Nellie Bowles, Making a Crypto Utopia in Puerto Rico, NEW YORK TIMES (Feb. 2, 2018), available at https://www.nytimes.com/2018/02/02/technology/cryptocurrency-puerto-rico.html; but see Dashiell Shapiro, Is Puerto Rico a Crypto Tax Paradise? Expert Take, COINTELEGRAPH (February 10, 2018), https://cointelegraph.com/news/is-puerto-rico-a-crypto-tax-paradise-expert-take.

In the 1990s, other critiques noted that the traditional economic model fails to explain high voluntary tax compliance rates given low audit rates, and suggests that in addition to enforcement and information gathering by the IRS, psychological or cultural factors should be considered as well.

See, e.g., Eric Posner, Law and Social Norms: The Case of Tax Compliance, 86 VIRG. L. REV. 1781, 1782 (2000) (“A widespread view among tax scholars holds that law enforcement does not explain why people pay taxes.”). Others have suggested that a tax system that combines both penalties and rewards is more effective in maximizing compliance. Josef Falkinger & Herbert Walther, Rewards Versus Penalties: on a New Policy against Tax Evasion, 19 PUB. FIN. Q. 72. (1991); James Alm, Isabel Sanchez, Ana De Juan, Economic and Noneconomic Factors in Tax Compliance, 48 INT’L REV. SOC. SCIENCES 1, 3-18 (February 1995); JOHN S. CARROLL, HOW TAXPAYERS THINK ABOUT THEIR TAXES: FRAMES AND VALUES (1990).
There were also studies conducted outside the tax context which suggest that perceptions of procedural fairness can promote voluntary compliance.
See, e.g., TOM R. TYLER, WHY PEOPLE OBEY THE LAW, 40, 64–68, 172–73 (1990); GARY E. BOLTON ET AL., FAIR PROCEDURES: EVIDENCE FROM GAMES INVOLVING LOTTERIES (2000); Toni Makkai & John Braithwaite, Trust and Compliance, J. POLICING & SOCIETY (1994) (evaluating nursing home regulation and inspection, and reporting that inspection teams which used purely negative and punitive approaches actually increased non-compliance); See also Ercan Sirakaya and Muzaffer Uysal, Can Sanctions and Rewards Explain Conformance Behavior of Tour Operators with Ecotourism Guidelines, 5 J. SUSTAINABLE TOURISM 4 (1997) (examining compliance with ecotourism guidelines).

This academic shift to a focus on non-economic factors coincided with a public backlash against the more punitive approach the IRS had taken in the 1980s.

See, e.g., CHARLES O. ROSSOTTI, MODERNIZING AMERICA’S TAX AGENCY, INTERNAL REVENUE SERVICE, DEP’T OF TREASURY (1999), at 1195 (“Historically, the IRS placed great emphasis on direct enforcement revenue…. However, there are many techniques other than direct enforcement that increased compliance at the IRS and elsewhere, such as better and more targeted taxpayer education, better reporting, voluntary agreements, improved regulations, and earlier intervention through notices and phone calls.”); David Cay Johnston, Tax Professionals See Pitfalls in the New I.R.S., NEW YORK TIMES, July 18, 1999, at 21 (“Joel A. Goverman, who is in charge of revising I.R.S. collection strategies, said: ‘We are emphasizing customer service and working with the taxpayer to come to the proper resolution. . . . [W]e believe that taking hard immediate action will result in our ending up collecting less money.’”), available at https://www.nytimes.com/1999/07/18/us/tax-professionals-see-pitfalls-in-the-new-irs.html; Oral History Interview of Commissioner Mortimer Caplin, 14 VA. TAX REV. 429, 453 (1994) (quoting former Commissioner Mortimer Caplin, “[W]e were saying, ‘How can we show that we’re getting better compliance by this more cooperative and softer approach, this courteous approach?’”); AMERICAN BAR ASSOCIATION COMMISSION ON TAXPAYER COMPLIANCE, supra note 23 (“To improve taxpayers’ cooperation with the Internal Revenue Service and increase their willingness to comply, we recommend that the Service take a more active role in educating taxpayers and providing assistance to those who need it. The recently announced reorganization of the Internal Revenue Service’s structure to place greater emphasis on taxpayer service is a promising step in this direction.”).
After Congressional hearings focusing on IRS overzealousness, where “horror stories” of IRS misdeeds were recounted,
Joe Spellman, Conference Panel Ponders Finance Hearing Horror Stories, 83 TAX NOTES 1854, 1854 (1999).
Congress in 1998 passed the Internal Revenue Service Restructuring and Reform Act of 1998 (the “1998 Act”). The 1998 Act sought to promote a renewed focus on “taxpayer rights” and “customer service.”
Lederman, supra note 18, at 981.

The 1998 Act included a Taxpayer Bill of Rights, a changed mission statement for the IRS that did not mention the collection of taxes, and restrictions on enforcement activity.

It even called for termination of an IRS Agent’s employment where the employee has violated taxpayers’ rights.
Martha A. Sobol, Taxpayers Benefit From Bipartisan Focus on Taxpayers’ Rights: The IRS Restructuring and Reform Act, 10 LOY. CONSUMER L. REV. 4, 265 (1999) (“The Reform Act holds all IRS employees and managers accountable for their actions in collection cases, and provides that all IRS correspondence to taxpayers must contain a contact name and phone number for questions or concerns regarding the correspondence.”).
The 1998 Act also shifted the burden of proof in some civil matters from taxpayers to the IRS, and established a public review board overseeing IRS administration.
Ralph Vartabedian & Jonathan Peterson, Clinton Signs Bill that Aims to Reform IRS, LOS ANGELES TIMES (July 23, 1998), available at http://articles.latimes.com/1998/jul/23/news/mn-6415.

After Congress enacted the 1998 Act, the IRS shifted significant resources from enforcement to taxpayer service.

Lederman, supra note 18, at 982.
Some data suggests that this move may have been a strategic success. As Leandra Lederman notes, total federal revenue actually increased between 1997 and 2001, outpacing inflation, despite the decline in IRS enforcement activity, and even despite a decline in revenue generated from enforcement.
Id. at 983-85.

While Lederman concedes that there is no direct link between a kinder, gentler IRS and increased revenue, there is at least theoretical support for such a link in the literature on regulatory enforcement.

Id. at 1010-1011.
It is also worth asking to what extent budget surpluses in the late 1990s (compared with budget deficits in the 1980s),
may have informed the shift in Congressional thinking about IRS enforcement.

IRS’s Offshore Enforcement Efforts: A New Enforcement Model

On the heels of the 1998 Act and the push towards a more taxpayer-friendly IRS, the IRS was also ramping up its efforts to go after offshore tax evasion. Its approach was a mix of the economic model of the 1980s and the more holistic model of the 1990s. The strategy involved increased sanctions and information gathering, as well as some high-profile prosecutions. However, it also involved extending carrots to noncompliant taxpayers in the form of amnesty for those who came clean about their offshore accounts through the IRS’s Offshore Voluntary Disclosure initiatives.

Nanavati &Thornton, supra note 20, at 5 (noting that the Offshore Voluntary Disclosure Program [hereinafter “OVDP”] was “the closest thing to a ‘carrot’ that the government has offered taxpayers to induce compliance) (explaining that the first OVDP was available for a limited time in 2009, and allowed taxpayer to come clean regarding their foreign account holdings by disclosing their accounts, paying back taxes, and paying a 20% penalty on their highest annual account balance).

These carrots are perhaps the greatest success of the IRS’s strategy. The message was clear: if you hide funds offshore, we will find you. But if you come forward and pay penalties and back taxes (in the Offshore Voluntary Disclosure Program or another disclosure program),

See id. In addition to the IRS’s OVDP Programs, it has also offered a 2012 OVDP Streamlined Procedure, which was initially available only to U.S. taxpayers living abroad who represent a low risk of tax evasion. Participants in the Streamlined Procedure had to pay a penalty of 5% of their highest account balance, and file tax returns for the prior 3 years, and FBARs for the past 6 years, as well as pay income tax and interest for each tax year.
we will work with you. And many taxpayers happily grabbed the carrots. Offshore account collections have topped $10 billion, and are still coming in.
Robert W. Wood, IRS Offshore Account Collections Top $10 Billion, FATCA Hunt Continues, FORBES (Oct. 24, 2016), available at https://www.forbes.com/sites/robertwood/2016/10/24/irs-offshore-account-collections-top-10-billion-fatca-hunt-continues/#5925628b3250.
These efforts to find untaxed funds hidden in offshore accounts proved wildly successful, and are arguably a model for future IRS enforcement efforts aimed at groups of similarly situated taxpayers, such as cryptocurrency investors.

Many of those who came forward and fixed their offshore account filings sooner faced lower penalties and no criminal charges.

Andrew Velarde, Practitioners Debate Fairness of Lack of IRS OVDP Retroactivity, TAX NOTES 669 (Aug. 11, 2014) (noting “consistent penalty rate increases in the programs rolled out between 2009 and 2012, from 20 percent to 25 percent to 27.5 percent”).
However, the longer taxpayers waited to come forward, the larger their penalties turned out to be. Penalties started at 20% of a taxpayer’s largest offshore account balance, then rose to 25%, then 27.5%, and finally to 50% for some who waited too long to enter the program.
See Stephan Michael Brown, One-Size-Fits-Small: A Look at the History of the FBAR Requirement, the Offshore Voluntary Disclosure Programs, and Suggestions for Increased Participation and Future Compliance, 18 CHAP. L. REV. 18, 243 (2014) (“In response [to FBAR noncompliance], the government has drastically increased the penalties for noncompliance.”).
The IRS finally announced in March of 2018 that it was closing the Offshore Voluntary Disclosure Program effective September 28, 2018, and issued a press release warning, “Taxpayers with undisclosed foreign assets urged to come forward now.”
IRS News Release, IR-2018-52 (Mar. 13, 2018).

Finally, the IRS put the screws to both foreign governments

Pascal Fletcher & Jane Sutton, U.S./UBS deal ramps up pressure on tax havens, REUTERS (Aug. 19, 2009), available at https://www.reuters.com/article/us-ubs-taxhavens-analysis-sb/u-s-ubs-deal-ramps-up-pressure-on-tax-havens-idUSTRE57I5QJ20090819.
and foreign banks
Robert W. Wood, 100 Swiss Banks Get Ultimatum: Hand Over Americans Or Face U.S. Prosecution, FORBES (Oct. 13, 2014), available at https://www.forbes.com/sites/robertwood/2014/10/13/100-swiss-banks-get-ultimatum-hand-over-americans-or-face-u-s-prosecution/#2efab47f2eb2.
to make them cough up more data about U.S. taxpayers holding accounts overseas. Through the use of “John Doe” summonses, the IRS was able to enforce wholescale records requests to foreign banks for client records that could lead to accounts held by Americans.
Nanavati & Thornton, supra note 20, at 5-6.

The IRS also prosecuted many large foreign banks who had helped Americans stash money overseas, and obtained hefty settlements in these cases.  UBS, one of the prime offenders in the offshore banking scandal, agreed to pay a fine of $780 million in its Deferred Prosecution Agreement with the Department of Justice (“DOJ”).

David S. Hilzenrath & Zachary A. Goldfarb, UBS to Pay $780 Million Over U.S. Tax Charges, WASHINGTON POST (Feb. 19, 2009), available at http://www.washingtonpost.com/wp-dyn/content/article/2009/02/18/AR2009021802541.html.
Credit Suisse paid even more.
Christie Smythe, Credit Suisse Judge Accepts $2.6 Billion Tax Plea Deal, BLOOMBERG (Nov. 21, 2014), available at https://www.bloomberg.com/news/articles/2014-11-21/credit-suisse-judge-accepts-2-6-billion-tax-plea-deal.
Some banks were literally driven out of business.
Rupert Neate, Oldest Swiss bank Wegelin to close after admitting aiding US tax evasion, THE GUARDIAN (Jan. 4, 2013), available at https://www.theguardian.com/world/2013/jan/04/swiss-bank-wegelin-close-tax-evasion.
The IRS also prosecuted high-profile individual taxpayers for hiding their money in offshore accounts.
Robert W. Wood, Beanie Babies Founder Ty Warner To Pay $53M For Offshore Tax Evasion, FORBES (Sept. 18, 2013), available at https://www.forbes.com/sites/robertwood/2013/09/18/beanie-babies-founder-ty-warner-to-pay-53m-for-offshore-tax-evasion/#202009c74830.

The IRS’s combination of increased data collection, threat of penalties and criminal prosecutions, and the carrot of the voluntary disclosure program, proved extraordinarily successful with respect to offshore tax evasion, and is likely a model for future enforcement efforts.

See Paul Marcotte, IRS Winning Game of Offshore Hide and Seek Update on FBARs, 46 MD BJ 5, 7 (2013) (describing Overseas Voluntary Disclosure Initiative programs).


Decline of Criminal Prosecutions

However, perhaps the most interesting aspect of this story is that as the IRS’s offshore voluntary disclosure programs increasingly raked in billions of dollars, IRS criminal referrals have actually been in a steady decline. A recent study from Syracuse University shows that the IRS has drastically reduced the number of cases it refers for criminal prosecution.

See TRAC, supra note 19.
The decline started after 2013, which is the same year the IRS announced its “Swiss Bank Program.”

The Syracuse University report in March of 2018 shows that the IRS had only referred 1,824 cases for criminal prosecution during the most recent 12-month period, compared with 3,896 during the same period four years ago.

That is more than a 50% reduction in criminal referrals to the DOJ.

Some of this reduction in criminal referrals may be due to budget cuts.

See Chuck Marr & Cecile Murray, IRS Funding Cuts Compromise Taxpayer Service and Weaken Enforcement, Center on Budget and Policy Priorities, CENTER ON BUDGET AND POLICY PRIORITIES (Apr. 4, 2016).
Indeed, IRS Criminal Investigation (“CI”) Agents have seen their ranks decline from 2,749 to 2,153 in the same time period.
See TRAC, supra note 19.
But the reduction in criminal referrals is proportionately much greater than these cuts would indicate, so something else seems to be unfolding.

Donald Fort, the head of IRS Criminal Investigations who has manned the post since 2017, has been vocal about the fact that the Agency is focusing on new types of enforcement, namely international and cryptocurrency cases.

Voreacos, supra note 17.
There will surely be some criminal prosecutions to come out of the IRS’s current cryptocurrency enforcement push. But instead of focusing primarily on prosecutions, a large-scale disclosure effort may also be in the works, modeled after the IRS’s Offshore Voluntary Disclosure programs.
Manoi Viswanathan, Tax Compliance in a Decentralizing Economy, 34 GA. ST. UNIV. L. REV. 2 (Winter 2017-2018).

It is therefore important to understand how IRS CI Agents have already shifted their focus in recent years. Specifically, the IRS’s CI Agents have played a key role in administering the IRS’s Voluntary Disclosure initiatives as part of the Swiss Bank Program.

See IRS, Offshore Voluntary Disclosure Program Frequently Asked Questions 2014, FAQ #24 (“Once a taxpayer’s disclosure has been preliminarily accepted by CI as timely, the taxpayer must complete the submission and cooperate with the civil examiner in the resolution of the civil liability before the disclosure is considered complete.”), available at https://www.irs.gov/individuals/international-taxpayers/offshore-voluntary-disclosure-program-frequently-asked-questions-and-answers-2012-revised.
So, forget the typical picture of IRS CI Agents in the field, interrogating taxpayers and building criminal cases.  Rather, picture CI Agents sitting behind a desk, pushing papers to help the IRS take in large hauls of cash from taxpayers who would otherwise have been their targets in criminal investigations.

Of course, the threat of prosecution for those not accepted into the Offshore Voluntary Disclosure Program (“OVDP”) looms, so the CI Agent’s involvement obviously is not without possible consequences.  Denial of admission to the OVDP typically occurs when a taxpayer is already under criminal investigation at the time they submit their application.

Id. at FAQ #14 (“I’m currently under examination. May I participate in the OVDP? No. If the IRS has initiated a civil examination for any year, regardless of whether it relates to undisclosed OVDP assets (see FAQ 35), the taxpayer will not be eligible to participate in the OVDP. A taxpayer under criminal investigation by CI is also ineligible.”).
But even in these cases of denied entry, prosecution is rare, and many taxpayers initially denied entry to the OVDP have later been admitted to the program.
Ty Warner is one of the rare exceptions. See Scott D. Michel, Zhanna A. Ziering, and Young Ran Kim, U.S. Offshore Account Enforcement Issues, J. TAX PRAC. & PROC. (2014) (noting that Ty Warner was denied entrance to the OVDP and later criminally prosecuted).
Moreover, as a practical matter, even with an occasional offshore tax evasion prosecution, many CI Agents are now spending more time processing civil fine paperwork than developing criminal cases. 

This does not mean the IRS is switching to an entirely civil enforcement scheme.  Some commentators have suggested we might be better off under such a system, where tax crimes are treated the same way as parking in a red zone.

See, e.g., Stuart P. Green, Moral Ambiguity in White Collar Criminal Law, 18 NOTRE DAME J. L. ETHICS & PUB. POL’Y 2, 501 (2004); Sanford H. Kadish, Some Observations on the Use of Criminal Sanctions in Enforcing Economic Regulations, 30 U. CHI. L. REV. 423 (1962); Francis Bowes Sayre, Public Welfare Offenses, 33 COLUMBIA L. REV. 55, 78-88 (1933) (suggesting that excessive reliance on criminal prohibitions undermines the legitimacy of criminal sanctions, and that it should be invoked only for morally reprehensible conduct).
But while the IRS certainly is not giving up on criminal prosecutions, it also appears to be strategically shifting resources away from prosecuting individuals one case at a time, and towards collecting back taxes in large-scale data collection efforts and voluntary disclosure programs.  The IRS’s Swiss Bank efforts suggest that this is an effective and efficient shift in resource deployment.  Money talks, after all, even for the IRS.

Given that offshore collections will be slowing down over the next decade,

See IRS News Release, supra note 65.
a hungry IRS will likely be looking for new sources of untapped revenue. A significant number of U.S. taxpayers who hid funds overseas have already come forward, and the IRS will now be looking for the “next big thing.” Judging by recent events, the IRS seems to be hoping to find it in the new world of cryptocurrencies.


Coinbase Summons: The IRS Sets its Sights on Cryptocurrency


In order to be able to spend fewer resources on criminal prosecution and still improve taxpayer compliance, the IRS needs to be able to gather significant amounts of data on cryptocurrency transactions. Otherwise, it has few “sticks” to reinforce any carrots it is offering for taxpayer compliance.

See Leandra Lederman, Reducing Information Gaps to Reduce the Tax Gap: When Is Information Reporting Warranted?, 78 FORDHAM L. REV. 1733, 1736, 1742–52 (2010) (discussing three recently enacted information reporting provisions).

Eventually, the IRS is likely to implement regulations requiring wholescale information reporting from cryptocurrency exchanges.

See id. at 1733, 1735 (noting link between information gathering and tax gap).
But for the time being it needs to gather data on past transactions in order to compile sufficient information to piece together large and otherwise anonymous transactions, as well as to give it a credible threat of enforcement action.

Again, if we look at the Swiss Bank program as our example, the IRS did not merely extend an olive branch to taxpayers with unreported offshore accounts. It first began with data collection in the form of broad “John Doe” summonses to the banks that held those accounts.

See Lederman, supra note 46, at 504-09.
These sought to gather data on U.S. account holders who might owe back taxes, essentially targeting all Americans with foreign bank account holdings.

The IRS created an effective “feedback loop” of banks, bankers, and lawyers providing information on U.S. customers with offshore accounts, and in turn U.S. customers giving information on bankers and lawyers that had helped them establish offshore accounts.

See Nanavati & Thornton, supra note 20, at 5 (“Taxpayers who enter the [OVDP] program must not only declare their accounts and pay the penalty, but must also frequently submit to detailed questioning regarding the names of the bankers, lawyers, and other professionals who assisted them in opening and maintaining their secret accounts.”).

Seeking to start a similar feedback loop for cryptocurrency tax enforcement, in 2016 the IRS served a “John Doe” summons to Coinbase.

Ex Parte Petition for Leave to Serve “John Doe” Summons Against All Defendants, In re: Tax Liabilities of John Does, 3:16-cv-06658-JSC (N.D. Cal.) (Nov. 17, 2016), Pacer Docket 1.
Coinbase is an online platform and digital currency “wallet” that allows its users to exchange and transact with digital currencies such as bitcoin.
Robert W. Wood, Court Allows IRS John Doe Summons for Bitcoin, Other Virtual Currencies, FORBES (Nov. 30, 2016), available at https://www.forbes.com/sites/robertwood/2016/11/30/court-allows-irs-john-doe-summons-for-users-of-virtual-currency/#4f7be2066ac3.
The IRS was hoping to gather a treasure trove of data cataloging who was buying and selling bitcoin and other digital currencies. Some of these transactions, possibly most of them, had never been reported to the IRS.
The IRS’s summons enforcement request included a declaration noting that from 2013 to 2015, less than 1,000 tax returns out of the more than 120 million electronically filed individual returns in each year appear to have reported bitcoin transactions on Form 8949. See Declaration of David Utzke, Pacer Docket 1:1, No. 3:17-cv-01431 (N.D. Cal.) (Mar. 16, 2017).

As for the IRS’s summons to Coinbase, the more data the IRS accumulates, the more it might be able to identify transactions that many digital currency users assumed were anonymous.

See Nanavati & Thornton, supra note 20, at 5.
This is especially true given the nature of blockchain technology, which can record all transactions in a public ledger.
JAUME BARCELO, USER PRIVACY IN THE PUBLIC BITCOIN BLOCKCHAIN (2014) (noting that address reuse has negative consequences to the user’s privacy, and that “the public availability of all Bitcoin transactions poses privacy-related challenges on the network”), available at http://www.dtic.upf.edu/~jbarcelo/papers/20140704_User_Privacy_in_the_Public_Bitcoin_Blockchain/paper.pdf; Fergal Reid & Martin Harrigan, An Analysis of Anonymity in the Bitcoin system, in SECURITY AND PRIVACY IN SOCIAL NETWORKS 197–223 (2013) (“Using an appropriate network representation, it is possible to associate many public-keys with each other, and with external identifying information. With appropriate tools, activity of known users can be observed in detail. This can be performed using a passive analysis only. Active analyses, where an interested party can potentially deploy ‘marked’ Bitcoins and collaborating users can discover even more information. We also believe that large centralized services such as the exchanges and wallet services are capable of identifying and tracking considerable portions of user activity.”).
As the IRS begins gathering data on past transactions, it is able to make headway into discovering the identities of individuals behind otherwise anonymous transfers of cryptocurrency.

The IRS’s summons to Coinbase sought records on the site’s users whose identities were yet unknown to the IRS. This is a classic “John Doe” summons, of the type that the IRS used to masterful effect in its offshore account enforcement efforts.

See, e.g., U.S. Dep’t of Justice Press Release, Court Authorizes IRS to Issue Summonses to Discover U.S. Taxpayers with Offshore Bank Accounts at Belize Bank International Limited and Belize Bank Limited (Sept. 16, 2015), available at https://www.justice.gov/opa/pr/court-authorizes-irs-issue-summonses-discover-us-taxpayers-offshore-bank-accounts-belize-ba-0.
Section 7609(f) of the Internal Revenue Code authorizes such summonses, but the burden is slightly higher than that of a typical summons targeted at one individual.
I.R.C. § 7609(f).
For a “John Doe” summons to be allowed:

·       it must relate to the investigation of a particular person or ascertainable group or class of persons,

I.R.C. § 7609(f)(1).

·       there must be 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 law,

I.R.C. § 7609(f)(2).

·       the information sought to be obtained from the examination of the records or testimony (and the identity of the person or persons with respect to whose liability the summons is issued) must not be readily available from other sources.

I.R.C. § 7609(f)(3).

The IRS summons to Coinbase at first glance appeared to meet these criteria. The United States District Court for the Northern District of California initially entered an order authorizing the IRS to serve the summons on Coinbase.

U.S. Dep’t of Justice Press Release, Court Authorizes Service of John Doe Summons Seeking the Identities of U.S. Taxpayers Who Have Used Virtual Currency (Nov. 30, 2016), available at https://www.justice.gov/opa/pr/court-authorizes-service-john-doe-summons-seeking-identities-us-taxpayers-who-have-used.
Courts typically give the IRS wide latitude to enforce summonses that may uncover information regarding potential tax evasion.
See U.S. DEP’T OF JUSTICE TAX DIVISION SUMMONS ENFORCEMENT MANUAL 2 (Nov. 2014) (“The summons statutes, I.R.C. §§ 7602-7613, provide the IRS with an investigative device that is to be interpreted broadly in favor of the IRS”).
“John Doe” summonses have a higher bar than a regular summons,
See I.R.C. § 7609(a), (b). See also United States v. Powell, 379 U.S. 48 (1964).
but the bar is still relatively low.
I.R.C. § 7609(f).

However, Coinbase customers fought back. A Coinbase customer and attorney, Jeffrey K. Berns, filed a motion in the District Court on behalf of himself and other Coinbase users which sought to intervene in the federal case and block the IRS from enforcing its summons for information on the site’s users.

See Shapiro, supra note 16.
Coinbase had also protested the summons, arguing that it was overly broad, and that the IRS cannot use the summons power to conduct “general research” absent an investigation.
Order Re Petition to Enforce IRS Summons, Case 3:17-cv-01431-JSC (N.D. Cal.) (Nov. 28, 2017), Pacer Docket 78 at 8. See United States v. Humble Oil & Refining Co., 488 F.2d 953 (5th Cir. 1974).

The Court largely agreed with the IRS, although it noted that the summons should be “no broader than necessary to achieve its purpose.”

Id. at 10.
After meeting with Coinbase’s representative to discuss summons enforcement, the DOJ had already agreed to narrow the scope of the summons, to include only users who had sent or received at least $20,000 worth of bitcoin in a given year.
Id. at 3.

However, the Court ruled that even the narrowed summons sought more information than was needed. The Court stated that although all the IRS needed was the user’s transaction records and the account holder’s identity,

Id. at 10-11.
the summons had sought all wallet addresses, all public keys for all accounts/wallets/vaults, Know-Your-Customer records, agreements or instructions granting a third-party access, control, or transaction approval authority, and correspondence between Coinbase and the account holder.
Order Re Petition to Enforce IRS Summons, at 11.
The Court limited the scope of the summons further, and held that if the Government later determines that it needs more detailed records, it can issue a summons directly to the taxpayer, or to Coinbase with notice to a named user, which it stated was a “process preferable to a John Doe summons.”
Id. at 11.

But otherwise the Court permitted the IRS to enforce its summons and obtain transaction information on more than 10,000 Coinbase account holders.

On February 23, 2018, Coinbase sent an official notice to approximately 13,000 customers whose information it was turning over to the IRS in response to the summons, and urged them to seek counsel from attorney if they had any questions.
See Molly Jane Zuckerman, Coinbase Informs 13k Affected Customers of Imminent Data Handover to IRS, COINTELEGRAPH (Feb. 24, 2018), https://cointelegraph.com/news/coinbase-informs-13k-affected-customers-of-imminent-data-handover-to-irs.

The IRS’s (mostly) successful enforcement of its “John Doe” summons against Coinbase suggests more such summonses may be coming, in order to uncover information on cryptocurrency transactions. As with the early years of the IRS’s Swiss Bank enforcement efforts, “John Doe” summonses can help set the stage for future IRS enforcement actions.  

Another point worth remembering is that the IRS did not merely gather information from foreign banks. It also issued “John Doe” summonses to FedEx, DHL, and UPS, to see which Americans were corresponding with foreign banks.

See Robert W. Wood, IRS Issues John Doe Summons To FedEx, DHL, UPS, HSBC In Massive Offshore Account Hunt, FORBES (Dec. 20, 2014), available at https://www.forbes.com/sites/robertwood/2014/12/20/irs-issues-john-doe-summons-to-fedex-dhl-ups-hsbc-in-massive-offshore-account-hunt/#73d5a9b3eb10.
The IRS may make a similar push to creatively triangulate data on cryptocurrency transactions, perhaps with summonses to Internet Service Providers (“ISPs”), social media platforms like Facebook, Google, and Twitter, or other technology service providers that do not expressly work with cryptocurrencies.  

If the Swiss Bank efforts are an accurate guide, the IRS might also be considering whether to bring charges against cryptocurrency trading platforms or other way stations that facilitate cryptocurrency trades. It is not clear what such charges would be, but a decade ago few saw prosecutions of UBS and other well-heeled banks coming, either.

Before the Senate Permanent Subcommittee on Investigations issued its report on July 17, 2008, the discussion largely centered around whether UBS would comply with the summons. CARL LEVIN & NORM COLEMAN, TAX HAVEN BANKS AND US TAX COMPLIANCE, UNITED STATES SENATE: PERMANENT SUBCOMMITTEE ON INVESTIGATIONS (PSI) (July 17, 2008). Whether or not UBS would be prosecuted for facilitating tax evasion was not a focus of the Senate inquiry. See PARILLO, supra note 13 (“Under Swiss law, disclosure without the consent of the account party would result in a criminal violation to the disclosing bank and/or its bankers. On the other hand, UBS AG may find itself between a rock and a hard place regarding making such disclosures, because failure to honor the John Doe summons could result in severe fines and penalties, a suspension of all U.S. activities of UBS, or even worse, legal action.”).
Indeed, some observers commented that UBS might face legal troubles at home for breaking Swiss banking secrecy laws, if it complied with the IRS’s summons.
Randall Jackson, Switzerland Reacts to U.S. John Doe Summons, TAX NOTES (July 7, 2008) (“UBS may find itself in a precarious position because although tax evasion is not a crime in Switzerland, divulging bank customer information is illegal; hence, it may want to request that additional Swiss authorities become involved with the overall investigation, according to the Agence France-Presse report.”).
So the tides can change quickly.


Challenges for IRS Cryptocurrency Enforcement

Now that the IRS has the Coinbase data, what next? The vast amount of information will surely be time-consuming for the government to sort through. Simply selling or buying bitcoins does not necessarily mean someone owes additional tax, even if large quantities of bitcoin have changed hands.

See 26 U.S.C. § 1012.
There are still many dots to connect. The IRS in the meantime is hoping that many Coinbase users will come forward voluntarily to amend past filings, or to file returns if they had not filed.

But what if they do not? Many cryptocurrency transactions did not pass through Coinbase, and instead took place in private peer-to-peer transactions or on foreign exchanges.

Viswanathan, supra note 80, at 29; Shu-Yi Oei & Diane M. Ring, Can Sharing Be Taxed?, 93 WASH. U. L. REV. 989, 1034 (2016) (discussing regulatory challenges in peer-to-peer transactions).
The IRS needs a critical mass of intermediaries and/or individuals to report cryptocurrency trade information, or it is going to have a near-impossible task of making significant headway in its enforcement efforts.
Viswanathan, supra note 80, at 44 (“For some network participants, anonymity is a secondary concern relative to these other benefits. If these parties can be encouraged to shed the anonymity provided by the blockchain, the anonymity of the other parties is weakened.”).
It needs, in short, a “feedback loop” of information reporting regarding blockchain transactions, as it developed through its Swiss Bank enforcement efforts.
See Nanavati & Thornton, supra note 20, at 5.

Also, the IRS faces a potential problem it did not face in its offshore account enforcement efforts: namely that many early adopters of cryptocurrency, who are now among some of the wealthiest, are fiercely libertarian and anti-government in their political leanings.

See, e.g., Primavera De Filippi, Bitcoin: A Regulatory Nightmare to a Libertarian Dream, 3 INTERNET POL’Y REV. 2 (2014); Ittay Eval, Blockchain Technology: Transforming Libertarian Cryptocurrency Dreams to Finance and Banking Realities, COMPUTER (Sept. 2017).
The IRS’s offshore account enforcement efforts were largely targeted at individuals who were simply engaged in opportunistic tax evasion. With cryptocurrency enforcement, the IRS may be facing large groups of politically motivated individuals who are acting on political principles, rather than merely trying to grab a buck.

Complicating matters, the IRS also faces widespread confusion about how exactly to report cryptocurrency profits. The IRS issued a Notice in 2014, stating that bitcoin is property, not currency.

IRS NOTICE 2014-21, IRB 2014-16 (Apr. 14, 2014).
The Notice gave some detail about W-2 and 1099 reporting, but significant questions remain among practitioners.  For example, how are bitcoin derivatives and loan agreements to be taxed?
See Dashiell Shapiro, Bitcoin Loans and Other Cryptocurrency Tax Problems, 35 JOURNAL OF TAXATION OF INVESTMENTS 2, 33 (Winter 2018).
Can exchanges of one cryptocurrency for another qualify as like-kind exchanges under Code Section 1031, and thus avoid current taxation?
See Robert W. Wood, Tax Bills Doom Tax-Free 1031 Exchanges of Cryptocurrency, FORBES (Nov. 27, 2017) (noting that beginning in 2018, Congress expressly made like-kind exchanges unavailable for cryptocurrency transactions, but that in prior years the option remains “controversial”), available at https://www.forbes.com/sites/robertwood/2017/11/27/tax-bills-doom-tax-free-1031-exchanges-of-cryptocurrency/#29299a7cf58f.
What if a taxpayer receives a “fork” of cryptocurrency—is this a taxable event, and if so how is the tax to be determined?
See ABA Section of Taxation, Comments on the Tax Treatment of Hard Forks (March 19, 2018), TAX NOTES Doc. 2018-12249 (arguing for a safe harbor for 2017 hard forks of cryptocurrency, in light of the uncertainty).

Additional confusion stems from the fact that cryptocurrency users have been deploying cryptocurrencies as though they were currencies, using them as a cash substitute to make purchases online.

Yet the IRS position that cryptocurrencies are in fact property could mean that each of these transactions is a taxable event, similar to a stock sale. The reporting burden, and the confusion regarding what tracking methods to use, can be overwhelming for taxpayers. And it may make voluntary compliance efforts even more challenging, especially since many cryptocurrency investors are already ideologically disposed against government enforcement.

Given these issues, what would a cryptocurrency voluntary disclosure program look like? If the IRS’s Offshore Voluntary Disclosure initiatives are any guide, and the signs suggest they might be,

On November 8, 2016, the Treasury Inspector General for Tax Administration criticized the IRS for not taking coordinated action to ensure the IRS maintains a “strategic approach to the tax implications of virtual currencies.” See U.S. TREASURY INSPECTOR GENERAL FOR TAX ADMINISTRATION, RISING USE OF VIRTUAL CURRENCIES REQUIRES IRS TO TAKE ADDITIONAL ACTIONS TO ENSURE TAXPAYER COMPLIANCE, available at https://www.treasury.gov/tigta/press/press_tigta-2016-34.htm. For example, the report notes that, “Under authority of the Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN), the IRS has Bank Secrecy Act enforcement responsibilities for financial institutions not regulated by a Federal bank agency or another Federal regulator such as money service businesses.” This could indicate that a broad-based enforcement effort against unregulated exchanges could be coming, similar to the IRS’s enforcement efforts in its Swiss Bank program.
such a program might involve disclosures to IRS CI Agents, filing past returns, and paying back taxes and, critically, large penalties.

Yet the IRS might want to take extra care not to adopt too combative a stance, given that it cannot rely only on third-party reporting to ensure cryptocurrency compliance. Given that some cryptocurrency transactions pass through no intermediary at all, the IRS will need to promote voluntary compliance from large segments of the cryptocurrency community. This means perhaps both more carrots and more sticks than with its offshore enforcement efforts.

Perhaps more worrying for the IRS is its lack of resources to prosecute most instances of cryptocurrency tax evasion. Given the decline in the IRS’s CI Agent ranks, and budget cuts to enforcement, it may not have a credible threat that it will prosecute more than handfuls of cryptocurrency tax evaders. This, combined with significant anti-government backlash in the cryptocurrency community, makes it possible that the government enforcement efforts might be undermined.


Economics of Crime or Taxpayer-Friendly IRS?

The IRS’s coming cryptocurrency enforcement push may prove to be an interesting test of the principle competing theories of tax enforcement. Whereas the 1980s model used an economics of crime approach that viewed taxpayers as rationally responding to the possibility of detection and weighing sanctions that could be imposed, the 1990s saw a shift among academics towards a holistic model that saw taxpayer compliance as connected to perceptions of fairness in enforcement and regulation.

As the IRS approaches cryptocurrency enforcement, it would be wise to keep both models in mind. Perceived fairness will surely be a key metric to evaluate any IRS response. Given the current confusion regarding tax reporting requirements for cryptocurrency, the IRS may be on increasingly shaky ground if it takes too combative an approach. Prosecuting individuals for cryptocurrency tax “crimes” when those tax rules are not even clearly stated could run the risk of jury nullification, negative judicial precedent, or even public backlash.

Any large-scale voluntary disclosure regime should probably be coupled with increased clarity regarding cryptocurrency reporting rules, as well as some relief for innocent taxpayers trapped by honest mistakes. The IRS itself may even bear some of the brunt of confusing and burdensome reporting rules, once it begins slogging through audits involving high volumes of cryptocurrency transactions.

At the same time, the IRS views its Swiss Bank enforcement efforts as a success, and is likely to stick to the script for the time being. This means some will be prosecuted, “John Doe” summonses will be enforced to gather data on cryptocurrency transactions, and some large institutions and advisory firms will be charged as well, for facilitating tax evasion transactions using cryptocurrencies.

But whatever approach the IRS takes, it should take into account the political views and cultural considerations of the cryptocurrency community to anticipate likely responses. In other words, it should consider the cryptocurrency community as a strategic actor in its enforcement model. In contrast to the view of tax enforcement as “the government” versus “the taxpayer,” largely reflected in both the 1980s model and the 1990s models, it is increasingly clear that group dynamics can be at play in responses to government enforcement efforts.