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In re Tax Liabilities of Does

United States District Court, N.D. California

November 15, 2016

IN THE MATTER OF THE TAX LIABILITIES OF JOHN DOES, United States persons who, at any time during the period January 1, 2013, through December 31, 2015, conducted transactions in a convertible virtual currency as defined in IRS Notice 2014-21.

          CAROLINE D. CIRAOLO Principal Deputy Assistant Attorney General JEREMY N. HENDON (ORBN 982490) AMY MATCHISON (CABN 217022) Trial Attorneys

          BRIAN J. STRETCH (CABN 163973) United States Attorney THOMAS MOORE (ALBN 4305-O78T) Chief, Tax Division COLIN C. SAMPSON (CABN 249784) Assistant United States Attorney Attorneys for United States of America

          DECLARATION OF SENIOR REVENUE AGENT DAVID UTZKE IN SUPPORT OF EX PARTE PETITION FOR LEAVE TO SERVE “JOHN DOE” SUMMONS

         I, David Utzke, pursuant to 28 U.S.C. § 1746, declare and state:

         1. I am employed as a duly commissioned Senior Revenue Agent by the Internal Revenue Service and am assigned to the IRS's Offshore Compliance Initiatives (OCI) program. I am assigned to work on virtual currency issues. The OCI program develops projects, methodologies, and techniques for identifying United States taxpayers who are involved in abusive offshore transactions and financial arrangements for tax-avoidance purposes. Although this program typically involves abusive offshore transactions and financial arrangements, the virtual currency issues I have been working on are not limited to offshore activities.

         2. I have been an Internal Revenue Agent since January 2008. From approximately October 2009 until April 2012, I worked as an International Individual Compliance field agent specializing in offshore investigations. After that, for approximately one and a half years, I was assigned as a Technical Specialist on the Jurisdiction-to-Tax and U.S. Investment Activities IRS International Practice Network where I worked on the emerging issue of virtual currencies. In October 2013, I was assigned to work in the IRS OCI program. I am currently assigned to investigate tax non-compliance connected with the use of virtual currencies.

         3. I graduated from the Federal Law Enforcement Training Center's advanced course of Economic Crimes Investigation and Analysis. I also hold a certificate of training in Open Source Intelligence research, which includes both surface web and deep web investigations. My academic credentials include a doctorate with relevant study in International Finance and Economics and a master's in Forensic Accounting and International Finance. I am a Certified Fraud Examiner and Certified Forensic Interviewer. My continuing professional education training each year focuses on tracking hidden offshore assets. I am an occasional lecturer at the Thomas Jefferson School of Law in San Diego, California, on the topic of virtual currencies. In addition, I develop and deliver training within the IRS on the topic of virtual currencies.

         I.BACKGROUND REGARDING VIRTUAL CURRENCIES

         4. In 2013, at the request of the Senate Finance Committee, the Government Accountability Office (GAO) completed a study of the use of virtual currency within virtual economies (such as on-line role playing games) and outside of virtual economies. Through interviews with industry representatives, tax professionals, IRS officials and academics, GAO identified several tax compliance risks associated with virtual currencies, ranging from lack of knowledge of tax requirements and uncertainty over how to report virtual currency transactions, to deliberate underreporting of income and tax evasion. See U.S. Gov't Accountability Office, GAO-13-516, Virtual Economies and Currencies: Additional IRS Guidance Could Reduce Tax Compliance Risks (2013).

         5. As the organization responsible for enforcing and administering the tax laws of the United States, the IRS has determined that transactions in a virtual currency that is convertible into real currency have tax consequences that may result in a tax liability.

         6. In March 2014, the IRS issued Notice 2014-21, which describes how the IRS applies U.S. tax principles to transactions involving virtual currency. A copy of Notice 2014-21 is attached as Exhibit A. In Notice 2014-21, the IRS stated its position: virtual currencies that can be converted into traditional currency are property for tax purposes, and a taxpayer can have a gain or loss on the sale or exchange of a virtual currency, depending on the taxpayer's cost to purchase the virtual currency (that is, the taxpayer's tax basis).

         A. How virtual currency works

         7. Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and a store of value. In some situations, virtual currency operates like “traditional currency, ” i.e., the coin and paper money of a country that is designated as legal tender. However, it does not have legal tender status in any jurisdiction. A virtual currency is “convertible” if it has an equivalent value in traditional currency or acts as a substitute for traditional currency. Convertible virtual currency can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other traditional or virtual currencies.

         8. In a virtual currency system, a user creates a “wallet.” A wallet is a digital computer file that contains information used in sending and receiving units of a virtual currency. When the wallet is created, a random wallet address is generated; this is a unique alphanumeric identifier, which is conceptually similar to an e-mail address. Basic wallets can be created free of charge.

         9. A wallet holds any number of public keys with their associated private keys. The public key and private key are conceptually similar to a user ID and a digital signature, respectively. A virtual currency user will electronically send their public key to anyone with whom he or she wants to exchange units of a virtual currency. The public key contains information that verifies the wallet and the private key used to authenticate a transaction. If the transaction is signed by both parties, the transaction is complete.

         10. A completed transaction is then introduced to a network of computers monitored by competing groups of people called miners. Miners maintain the integrity of a sequential public list of all transactions called the blockchain; miners also validate transactions that go into the blockchain with the motive of earning virtual currency.

         11. After computers on the network confirm that a transaction is authentic, the transaction is posted to a “block” - a grouping of transactions. When a specified number of confirmed transactions have been grouped, a block is formed. Miners then compete against each other to find a solution to a mathematical puzzle that depends on the contents of the block; once a solution is found, that block will be added to the blockchain. When a new block is added to the blockchain, new virtual currency coins are generated and awarded to the miner who discovered the mathematical puzzle solution that allows the new block to be added to the blockchain. The cycle then repeats.

         12. All transactions in a virtual currency blockchain can be viewed by the public on any computer connected to the Internet. However, the blockchain transactional history only reveals the date, the time, the amount (denominated in virtual currency), and the wallet addresses associated with a transaction. The blockchain does not identify the actual identities of the wallet owners.

         13. There are nearly a thousand virtual currencies, but the most widely known virtual currency, and largest by capitalization, is bitcoin. Other virtual currencies mimicking bitcoin using the blockchain technology are known as alternative coins or altcoins for short. Just a few examples of altcoins are Ethereum, Litecoin, Ripple, Feathercoin, and Dogecoin.

         B. How virtual currency can be obtained and utilized

         14. In order to buy virtual currency with a medium of exchange denominated in a traditional currency, such as a conventional check, credit card, wire, Automated Clearing House (ACH) electronic payments, the virtual currency user will have to find some way to transfer traditional currency to someone who already has virtual currency and wishes to exchange it for traditional currency. This exchange can occur with anyone holding a virtual currency, but tends to be handled through businesses called virtual currency exchangers that trade between virtual currencies and traditional currencies.

         15. A virtual currency exchanger functions much like an exchanger for traditional currency except it can exchange virtual currency for traditional currency or vice versa. Because virtual currency exchangers may receive conventional checks, credit card, debit card, or wire transfer payments in exchange for virtual currency, they are a link between virtual currency systems and conventional banking and money-transmittal systems.

         16. A virtual currency exchanger may operate on one or more virtual currency platforms. The exchange rate between traditional currency and virtual currency, and between different virtual currency systems, is typically set by supply and demand, and different exchangers compete for business. Because mechanisms exist for exchanging virtual currencies and traditional currencies, virtual currencies have spread beyond online transfers between consumers; they are now used for purchases from brick-and-mortar businesses as well as online merchants.

         17. Virtual currency exchangers may also provide wallet services, which allow a user to quickly authorize virtual currency transactions with another user through the use of a traditional money account held at the exchanger similar to a margin account held with a stock broker. Wallet accounts are easily accessed through a computer or mobile device like a smartphone. A wallet can be held in a number of different ways, but millions of users have a wallet provided by an exchanger.

         18. Some virtual currency exchangers are registered with the U.S. Treasury Department Financial Crimes Enforcement Network (FinCEN) as Money Services Businesses. Registration carries with it the requirement of following Anti-Money Laundering (AML) rules, including Know Your Customer (KYC) rules. KYC principles require a registered exchanger to confirm and document the identities of its customers and to relate each account to a known beneficial owner.

         19. The graph below illustrates some of the ways in which individuals can obtain and spend bitcoins.

         9IMAGE OMITTED)

         U.S. Gov't Accountability Office, GAO-14-496, Virtual Currencies' Emerging Regulatory, Law Enforcement, and Consumer Protection Challenges (2014), p. 8.

         C. Tax compliance concerns associated with the use of ...


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