According to a recent ruling by a U.S. court of appeals, federal law does not bar a taxpayer from challenging a “John Doe” summons the IRS served on a virtual currency exchange as an unlawful attempt to collect private financial information. In its ruling, the U.S. Court of Appeals for the 1st Circuit rejected the IRS’s claim that the Internal Revenue Code’s Anti-Injunction Act bars the suit, with the appeals court finding the John Doe summons was an attempt to collect information, not taxes.

The 1st Circuit’s ruling on Harper v. Rettig, No 21-1316 (1st Cir. 2022), is notable because until the decision was issued in August 2022, the IRS had successfully blocked court challenges to the agency’s collection of data through John Doe summonses. The Tax Code allows the IRS to issue a John Doe summons to gather financial information when trying to identify unknown taxpayers believed to have violated U.S. tax laws. The 1st Circuit’s decision appears to clear the way for the subjects of John Doe summonses to ask a federal court to keep their financial information from being turned over to the IRS.

In its ruling, the 1st Circuit leaned heavily on the U.S. Supreme Court’s 2021 decision on CIC Services LLC v. IRS, No. 19-930 (U.S. 2021). In that case, the Supreme Court unanimously found that court challenges to information gathering by the IRS were not barred by the Anti-Injunction Act simply because the information could eventually lead to tax assessments or collection.

Taxpayer challenges Coinbase summons

James Harper is a non-resident senior fellow at the American Enterprise Institute (AEI), where he focuses on privacy issues and has served as global policy counsel for the Bitcoin Foundation. In 2013, Harper opened an account with Coinbase, where he deposited bitcoin during 2013 and 2014. Harper started selling his bitcoin in 2015, and by 2016, he no longer held any bitcoin through Coinbase. Beginning in 2016, Harper and his wife sold bitcoin through other digital exchanges.

Harper reported the income from his Coinbase transactions on his 2013 through 2016 federal income tax returns. Additionally, he declared and paid taxes on the capital gains he realized through his bitcoin transactions during the 2016 through 2019 tax years.

The IRS filed a John Doe administrative summons on Coinbase in 2016. The initial summons sought information on transactions conducted in convertible virtual currency. Eventually, the scope of the summons was narrowed and the IRS only sought information on accounts with transactions valued at $20,000 or more from 2013 through 2015.

Coinbase and an unnamed John Doe opposed the revised IRS summons. While he participated as an expert in the Coinbase filing, Harper did not choose to intervene personally in Coinbase’s challenge. After hearing oral arguments, a judge for the U.S. District Court for the Northern District of California permitted the government to enforce its summons in 2017.

Harper received a letter from the IRS in 2019, which said the agency had information on virtual currency accounts and transactions of his that may not have been properly reported. The letter said that he could face civil or criminal enforcement action if he failed to accurately report his virtual currency transactions.

Taxpayer lawsuit claims IRS summons unlawful

Harper filed a complaint against the IRS, the IRS commissioner and 10 unidentified IRS agents in July 2020. Harper claimed that the IRS violated his rights under the Fourth and Fifth amendments, as well as the Internal Revenue Code’s special procedures for third-party summonses, by acquiring his personal information from Coinbase and the Abra virtual currency platforms through a third-party summons.

Specifically, Harper maintained that he had an ownership interest, as well as a reasonable and subjective expectation of privacy in the financial information maintained by Coinbase and Abra. He asked the court for damages and declaratory and injunctive relief that included an order requiring the IRS to expunge his financial information from the agency’s records.

The U.S. District Court for the District of New Hampshire dismissed all of Harper’s claims, including his claim for declaratory and injunctive relief. The court found that it could not grant Harper declaratory and injunctive relief because it lacked jurisdiction under the Anti-Injunction Act. It explained that the Anti-Injunction Act was an exception to the Administrative Procedure Act’s (APA’s) waiver of sovereign immunity.

Anti-Injunction Act bars suits preventing tax collection  

The APA allows a person suffering a legal wrong as the result of an agency’s action to have a court review of those actions, the 1st Circuit said. The court explained that the APA represented a waiver of the doctrine of sovereign immunity, which generally prevents the U.S. government from being sued without its consent. It added that, according to the language of the APA, Harper’s suit should be allowed to proceed.

The 1st Circuit then noted that the Anti-Injunction Act provides the IRS with a statutory exception to the waiver of sovereign immunity outlined in the APA. It pointed out that the Anti-Injunction Act bars lawsuits for “restraining the assessment or collection of any tax,” regardless of whether the person filing the suit has been subject to tax.

However, the Supreme Court has recently found in CIC Services that the Anti-Injunction Act does not apply to all activities that may improve the government’s ability to assess and collect taxes, the 1st Circuit said. The Supreme Court ruled that “information gathering” is a phase of administrative tax procedure that occurs before the tax has been assessed or collected. Therefore, the Supreme Court reasoned that the Anti-Injunction Act would not bar a lawsuit that challenged ordinary reporting requirements, even if the reporting facilitates the collection of taxes by identifying those who have not paid their taxes because that constituted information gathering.

Summons was an attempt to collect information

The 1st Circuit said §7602 authorizes the IRS to issue summonses to determine whether a return is correct or where no return has been filed, to determine a taxpayer’s liability or to collect a tax liability. The court concluded that those activities fall within the category of information gathering, which the Supreme Court has distinguished from tax assessment or collection.

While the IRS maintained that the Anti-Injunction Act barred Harper’s suit because it was filed to prevent the assessment or collection of taxes, the 1st Circuit explained that the Supreme Court has found the act kicks in when the target of the injunction is a tax obligation. The 1st Circuit went on to say that the target of Harper’s injunction request is the IRS’s continued retention of his personal financial information.

The 1st Circuit then concluded that the Anti-Injunction Act does not bar Harper’s suit because it applies to his financial information and not his taxes. The court then remanded the case to the district court to determine whether Harper had stated a claim upon which relief could be granted.