Bitcoin, poetry and taxes

Link to case

One of my favorite poems is John Berryman's “Dream Song 14”, which begins with the poet's proclamation that "Life, friends, is boring. We must not say so. After all, the sky flashes, the great sea yearns, we ourselves flash and yearn, and moreover my mother told me as a boy (repeatingly) 'Ever to confess you’re bored means you have no Inner Resources.'" It’s a nice poem to memorize and it works well recited out loud after a bourbon or two following pecan pie. (Protip: many poems do).

What does John Berryman have to do with Bitcoin? Perhaps it’s my literary education, which preceded the law, but I confess that Berryman flashes through my mind sometimes when I read new crypto caselaw. For technology that has been in mainstream consciousness for such a short period of time, the fact that the cases are starting to become prosaic is perhaps notable in and of itself. We see the law adapting in real time to new tech. With that said, sometimes there is an interesting flash of newness and I saw a glimpse of that in a new case involving an IRS summons to a cryptocurrency exchange. I refer, in particular, to a new case called Zietke v. United States, 2019 U.S. Dist LEXIS 204274 (D. Wash., 11/25/2019).  It involves bitcoin account records and an SEC summons. 

Here's what happened, per the court: 

The Petitioner [Mr. Zietzke] attempted to navigate the tax consequences of cryptocurrency transactions when he self-prepared his 2016 tax return using Turbo Tax. In his 2016 return, Petitioner reported Schedule D long-term capital gains of $104,482. Petitioner calculated the $104,482 figure by including two Bitcoin transactions that he listed as having occurred in 2016. According to Petitioner, these transactions did not actually occur in 2016. However, Petitioner claims that he realized his mistake only after his Certified Public Accountant David Rumsey, whom Petitioner hired in 2017 to help him prepare for retirement, reviewed his tax returns and caught Petitioner’s error. Petitioner subsequently filed an amended return on August 14, 2017, that omitted the two transactions and thereby reduced his long-term capital gains in 2016 from $104,482 to $410. If correct, this reduction would entitle Petitioner to a $15,475 refund. Petitioner’s refund request caught the IRS’s attention, and on June 25, 2018, IRS Revenue Agent Amanda Snow sent Petitioner a letter informing him that the IRS was examining his 2016 tax return.

In the course of complying with IRS information requests, the IRS learned that Petitioner used the Bitstamp exchange for a 2016 transaction. This happened not because he told the IRS that he had a Bitstamp account -- he had disclosed that he had bitcoin in a wallet, with Coinbase and with purse.io. When the IRS learned of the Bitstamp account, it issued a summons to that exchange, directing it to "produce for examination books, records, papers, and other data relating to Petitioner's holdings with Bitstamp." The request included public addresses but not private keys. 

The petitioner moved to quash the summons the IRS served on Bitstamp. The Court began the analysis by pointing out that the IRS has a ridiculously huge amount of power and a summons is enforceable if issued for a legitimate purposes, the data is relevant to that purposes, the IRS doesn't have the data already, and IRS follow the legal steps necessary for issuing and serving the subpoena. The Court notes that "[t]he government's burden at this stage is slight."

For the most part, the IRS won, but with one notable exception. The petitioner argued "the summons [was] overbroad because it lacks a temporal limitation."  Here, even though the only tax year in question was 2016, the IRS asked for pre-2016 information including "[a]ll account history information (on-chain and off-chain) for transactions or events related to any Covered Accounts." Because the pre-2016 information was "irrelevant to the IRS's stated purpose of auditing Petitioner's 2016 amended return" this part of the summons was over broad. 

There's an interesting gloss here as well on Fourth Amendment protections for bitcoin transactional records. The Petitioner had objected, among other things, that a requirement that "public keys or addresses" be provided to the IRS would violate his privacy interests and that the IRS wouldn't be able to adequately secure the information. 

On the one hand, the Supreme Court held in 1976 in United States v. Miller that there's no Fourth Amendment reasonable expectation of privacy in bank records (because, among other things, they are not the account holder's records, but owned by the bank). A request for those records under the Bank Secrecy Act was (per the Court) constitutional, and not a Fourth Amendment violation. You can hear the Court’s announcement and explanation of this opinion in an old recording, thanks to the genius of the interwebs, here.

On the other hand, the U.S. Supreme Court in its 2018 opinion in Carpenter v. the United States held that a person does have a reasonable expectation of privacy in historical cell-site location information produced by their cell phones, notwithstanding the fact that the data is owned by cell phone carriers. The majority opinion concludes by observing that advances in science that make surveillance easier make the Court’s role in protecting privacy even more important:

As Justice Brandeis explained in his famous dissent, the Court is obligated—as “[s]ubtler and more far-reaching means of invading privacy have become available to the Government”—to ensure that the “progress of science” does not erode Fourth Amendment protections. Olmstead v. United States, 277 U. S. 438, 473–474 (1928). Here the progress of science has afforded law enforcement a powerful new tool to carry out its important responsibilities. At the same time, this tool risks Government encroachment of the sort the Framers, “after consulting the lessons of history,” drafted the Fourth Amendment to prevent. Di Re, 332 U. S., at 595.

We decline to grant the state unrestricted access to a wireless carrier’s database of physical location information. In light of the deeply revealing nature of CSLI, its depth, breadth, and comprehensive reach, and the inescapable and automatic nature of its collection, the fact that such information is gathered by a third party does not make it any less deserving of Fourth Amendment protection. The Government’s acquisition of the cell-site records here was a search under that Amendment.

So, to rule on privacy with respect to bitcoin transactional records, the Court had to decide which case was more applicable -- the bank records case or the cell phone case. Perhaps it’s not a great surprise, but the Court ruled that this particular issue was more like one involving bank records. First, there was "no surveillance" of any kind at issue and the financial records at issue "were exposed to and revealed to a third party." Furthermore, the Court said that the records don't implicate an "anticipation of privacy" related to one's physical location or movements, which was an important factor in the cell phone case. "At most", the Court said, "the records might reveal Petitioner's buying and spending history [and] his wealth."  But this was also true of bank records that the Court said were not protected under the 4th amendment. Bottom line -- the Court said that the IRS was entitled to the Bitstamp records, and no Fourth Amendment protection would be extended to them.

Is this a "life, friends, is boring" case or is there something new here?  The Court, being a court, is constrained by precedent. It's a reasonably careful analysis and we see the Court balancing between two competing lines of precedent. We also see that the IRS has enormous power in connection with tax collection and audits and probably knows more about your finances that you think it does (thus it was aware of the taxpayer's Bitstamp account without the existence of the account being dislcosed by the taxpayer). 

The interesting thing about the cell phone case is that the majority there could have fallen back on the bank records privacy precedent but didn't – the same logic arguably applies. That case showed the common law adopting to new technology and extending privacy protections even though an argument could have been made that those protections shouldn’t apply. This Court, in contrast, didn't see or treat bitcoin as something so unique that (in its view) constitutional protections should be afforded transactional records held by third party intermediaries. Now, the IRS may have made it easier for the Court to so rule by not requesting private keys -- requiring production of private key information in connection with an IRS summons might trigger Fourth Amendment protection, as it would be tantamount to seizure of the asset itself.

I'm skeptical that U.S. courts will extent Fourth Amendment privacy protection to bitcoin transactional records without legislative support of some kind. This is a heavy lift, under current precedent, if bitcoin is a financial asset and transaction records are seen as the functional equivalent as bank records, it's tough to move away from the bank record line of cases without. Sympathetic as the Supreme Court might have been in the cell phone records case, I suspect we are unlikely to see similar sympathy in cases involving bitcoin transaction records without a change in the law.  Another difference to consider is that all of the Supreme Court justices certainly have cell phones.  I suspect none of them own a single bit of crypto. If that changes, maybe sentiment on the bench will too.

Happy Thanksgiving!