Zietzke v. United States, CASE NO. C19-1234-JCC

• Decision Date: 25 November 2019
• Docket Number: CASE NO. C19-1234-JCC
• Citation: 426 F.Supp.3d 758
• Parties: William A. ZIETZKE, Petitioner, v. UNITED STATES of America, Respondent.
• Court: U.S. District Court — Western District of Washington

426 F.Supp.3d 758

William A. ZIETZKE, Petitioner,

v.UNITED STATES of America, Respondent.

CASE NO. C19-1234-JCC

United States District Court, W.D. Washington, At Seattle.

Signed November 25, 2019

Cory L. Johnson, Jason A. Harn, Colvin & Hallett, Seattle, WA, John Michael McWilliams, Joseph P. Wilson, Pro Hac Vice, Richard G. Stack, Pro Hac Vice, Wilson Tax Law Group APLC, Yorba Linda, CA, for Petitioner.

Amy Matchison, US Department of Justice, Washington, DC, for Respondent.

ORDER

John C. Coughenour, UNITED STATES DISTRICT JUDGE

This matter comes before the Court on Petitioner's petition to quash an Internal Revenue Service summons (Dkt. No. 1) and on the Government's motion to enforce that summons (Dkt. No. 12). Having considered the parties' briefing and the relevant record, the Court finds oral argument unnecessary and DENIES Petitioner's petition. However, because the Court finds the summons overbroad, the Court ORDERS the Government to file a proposed amended summons that complies with this order. Until the Court approves an amended summons, the Court postpones ruling on the Government's motion to enforce.

I. BACKGROUND

Bitcoin¹ is a decentralized cryptocurrency that uses a distributed ledger system, or "blockchain," to ensure the cryptocurrency's security and integrity. To use a blockchain system, a user first creates a wallet, which contains information used to move units of a cryptocurrency on a blockchain. When the user downloads or purchases a wallet, software in the wallet generates a private key (a large integer number). That private key is then used to mathematically generate a public key (also a large integer number), which is used to create an address (a mix of numbers and symbols). This address functions as the name suggests: it is the destination for a cryptocurrency payment.

When two people agree for one person to send cryptocurrency to the other, the two reveal their public addresses to one another. Because the transferor's address is associated with their public and private keys, the transferee can confirm the transferor's ownership of the transferred cryptocurrency by verifying that the transferor's private key, public key, and address correspond. And once the cryptocurrency is transferred, the transferee can spend or withdraw the cryptocurrency with their own private key, which will now be associated with that cryptocurrency.

Although cryptocurrency transactions can occur directly between individuals, those transactions are often handled through digital currency exchanges. Digital currency exchanges are businesses that hold large amounts of traditional and cryptocurrency, allowing them to facilitate third-party transactions of traditional currency for cryptocurrency. To help facilitate such transactions, these businesses also provide hosted wallet services.

As with many things in life, cryptocurrency transactions have tax consequences. In 2014, the IRS set forth its position on those consequences in IRS Notice 2014-21, 2014-16 I.R.B. 938. Notice 2014-21 states, "virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency." Cryptocurrency is, therefore, taxed according to the gain or loss a taxpayer realizes when they sell or exchange cryptocurrency. Id. A taxpayer's gain or loss is determined by looking at the difference between the cryptocurrency's basis and the amount the taxpayer receives in exchange for the currency. Id. The basis, in turn, "is the fair market value of the currency in U.S. dollars as of the date of receipt." Id. And the cryptocurrency's fair market value is usually determined by the price at which the taxpayer purchases the cryptocurrency. Id.

Petitioner attempted to navigate the tax consequences of cryptocurrency transactions when he self-prepared his 2016 tax return using Turbo Tax. (Dkt. No. 23 at 2.) In his 2016 return, Petitioner reported Schedule D long-term capital gains of $104,482. (Dkt. No. 19 at 2–3.) Petitioner calculated the $104,482 figure by including two Bitcoin transactions that he listed as having occurred in 2016. (Id. ) According to Petitioner, these transactions did not actually occur in 2016. (Id. at 3.) 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. (Id. ) 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. (Id. ) If correct, this reduction would entitle Petitioner to a $15,475 refund. (Id. )

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. (Dkt. No. 19-1 at 18.) In the months that followed, Petitioner provided the IRS with information about his Bitcoin holdings and transactions. (See Dkt. Nos. 13 at 3–5, 19 at 4–26.) Petitioner informed the IRS that he had two separate groups of Bitcoin holdings. (Dkt. No. 13 at 4–5.) The first group consisted of his personal holdings that he managed through Armory wallet software. (Id. ) The second group allegedly consisted of Bitcoins held in wallets hosted by Coinbase, a currency exchange, and Purse.io, a hosted wallet platform that operates as a Bitcoin-to-Amazon.com item exchange. (Id. ) Petitioner told the IRS that these latter holdings originated when Petitioner deposited U.S. dollars from a personal bank account into a Coinbase account and then transferred funds from that account to his Purse.io account. (Id. at 5.)

Although Petitioner initially told the IRS that he used only two hosted wallet platforms, the IRS discovered that Petitioner also used Bitstamp, another currency exchange. (Dkt. No. 13 at 5–6.) In addition, the IRS learned that Petitioner used Bitstamp to conduct at least one Bitcoin transaction in 2016. (Dkt. No. 23 at 2.) Upon learning of this transaction, the IRS issued a summons to Bitstamp. (Dkt. No. 1-1 at 3–15.) The summons directs Bitstamp to produce for examination books, records, papers, and other data relating to Petitioner's holdings with Bitstamp. (See id. at 12–15.) The requested data includes Petitioner's public keys and blockchain addresses. (Id. at 13.) It does not include Petitioner's private keys. (See id. at 12–15.)

On June 27, 2019, Petitioner filed a petition to quash the summons that the IRS served on Bitstamp. (Dkt. No. 1.) The IRS subsequently moved for the Court to enforce its summons and to deny the petition to quash. (Dkt. No. 12.)

II. DISCUSSION

Petitioner asks the Court to quash the Bitstamp summons for six reasons: (1) the IRS issued the summons in bad faith; (2) the IRS seeks information that is irrelevant to its audit of Petitioner's 2016 amended return; (3) the IRS already possesses the information that it seeks from Bitstamp; (4) the IRS failed to follow the administrative steps required by the United States Code for issuance and service of a summons; (5) the summons violates Petitioner's reasonable expectation of privacy in Bitstamp's records; and (6) the Government cannot guarantee the security of any records that it receives from Bitstamp. (See Dkt. No. 23 at 12–24.) Although five of Petitioner's arguments lack merit, he is correct that the summons is overbroad because it seeks both relevant and irrelevant material.

A. Legal Standard

Congress requires that the IRS investigate the tax liability of persons who may be liable to pay an internal revenue tax. 26 U.S.C. § 7601. To help the IRS conduct such investigations, Congress enacted 26 U.S.C. § 7602(a), which gives the IRS the power to issue administrative summons. "The § 7602 summons is critical to the investigative and enforcement functions of the IRS." United States v. Arthur Young & Co. , 465 U.S. 805, 814, 104 S.Ct. 1495, 79 L.Ed.2d 826 (1984). The IRS's power to issue summons has, therefore, been construed broadly in the IRS's favor. See United States v. Euge , 444 U.S. 707, 714–15, 100 S.Ct. 874, 63 L.Ed.2d 141 (1980).

The breadth of the IRS's power under § 7602(a) is reflected in the test for determining the validity of a summons. See United States v. Clarke , 573 U.S. 248, 254–55, 134 S.Ct. 2361, 189 L.Ed.2d 330 (2014). Under that test, the Government must first present a prima facie case for enforcement. United States v. Powell , 379 U.S. 48, 57–58, 85 S.Ct. 248, 13 L.Ed.2d 112 (1964). The Government establishes a prima facie case by showing that (1) the IRS issued the summons for a legitimate purpose; (2) the summoned data may be relevant to that purpose; (3) the IRS does not already possess the summoned data; and (4) the IRS followed the administrative steps required by the United States Code for issuance and service of a summons. Id. The Government's burden at this stage is "slight." Fortney v. United States , 59 F.3d 117, 120 (9th Cir. 1995). Consequently, the Government usually meets its burden by introducing a sworn declaration of the revenue agent who issued the summons stating that the prima facie case requirements have been met. Id.

If the Government establishes a prima facie case, then the burden shifts to the petitioning taxpayer to show that the IRS is attempting to abuse the court's process or is lacking in good faith. United States v. Dynavac, Inc. , 6 F.3d 1407, 1414 (9th Cir. 1993). The burden on the taxpayer to disprove the IRS's assertions is "heavy." Id. (quoting United States v. Abrahams , 905 F.2d 1276, 1280 (9th Cir. 1990) ).

B. The Powell Requirements

Petitioner argues that the Government did not meet any of the Powell requirements. (See Dkt. No. 23 at 12–19.) For the reasons explained below, the Court concludes that the Government has met all but the second Powell requirement. With respect to the second requirement, the Court concludes that, as...