Tenth Circuit Affirms Summons Enforcement Against Medical Marijuana Business Regarding Section 280E (3/7/19)

Section 280E, here, denies a deduction for expenses of a trade or business which "consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted."  I wrote recently about the denial of such expenses in Feinberg v. Commissioner, 2019 U.S. App. LEXIS 5618 (10th Cir. 2019), here.  See Taxpayers Fail to Prove Expenses of Medical Marijuana Business Deductible; Burden of Proof Does Not Violate Fifth Amendment Privilege (Federal Tax Crimes Blog 3/2/19), here.

The Tenth Circuit has another significant opinion related to Section 280E.  In High Desert Relief v. United States, 2019 U.S. App. LEXIS 6609 (10th Cir. 2019), here, the Court addressed the issue in a contentious summons enforcement proceeding where HDR tried to thread the needle to duck the consequences of Section 280E.  The Court provides a good summary in the opening paragraphs:

This case arises out of the efforts of the Internal Revenue Service (“IRS”) to investigate the tax liability of High Desert Relief, Inc. (“HDR”), a medical marijuana dispensary in New Mexico. The IRS began an investigation into whether HDR had improperly paid its taxes, and specifically whether it had improperly taken deductions for business expenses that arose from a “trade or business” that “consists of trafficking in controlled substances.” 26 U.S.C. § 280E. Because HDR refused to furnish the IRS with requested audit information, the IRS issued four summonses to third parties in an attempt to obtain the relevant materials by other means. 

HDR filed separate petitions to quash these third-party summonses in federal district court in the District of New Mexico, and the government filed corresponding counterclaims seeking enforcement of the summonses. HDR argued that the summonses were issued for an improper purpose—specifically, that the IRS, in seeking to determine the applicability of 26 U.S.C. § 280E, was mounting a de facto criminal investigation pursuant to the Controlled Substances Act (“CSA”), 21 U.S.C. § 801, et seq.  

HDR also asserted that enforcement of § 280E was improper because an “official [federal] policy of non-enforcement” of the CSA against medical marijuana dispensaries had rendered that statute’s proscription on marijuana trafficking a “dead letter” incapable of engendering adverse tax consequences for HDR. Aplt.’s Opening Br. at 30. The petitions were resolved in proceedings before two different district court judges. Both judges ruled in favor of the United States on the petitions to quash, and separately granted the United States’ motions to enforce the summonses. HDR challenges these rulings on appeal. 

Exercising jurisdiction under 28 U.S.C. § 1291, we affirm.

As readers know, the IRS's summons power to investigate tax matters is very broad.  United States v. Powell, 379 U.S. 48 (1964).  So, most contests in summons cases are resolved in favor of the IRS.  (One recent victory for the taxpayers was in J.B. v. United States, --- F.3d ----, 2019 WL 923717 at *1 (9th Cir. 2019), here, dealing with the IRS's failure to satisfy the notice requirement for third party contacts.  See Leslie Book, Ninth Circuit Rejects IRS’s Approach to Notifying Taxpayers of Third Party Contacts (Procedurally Taxing Blog 3/4/19), here; in HDR, the Tenth Circuit rejects (Slip Op. pp. 46-47) HDR's similar argument that the IRS did not give the required notice.)

Key points in getting to the bottom line:


1.  The Court meticulously ticks through the Powell factors requiring only a minimum showing which was met.  Among the items shown were:  (i) the IRS had not referred the case for criminal investigation and was solely conducting a routine civil audit; and (ii) there was no for a predicate CSA criminal investigation before the IRS can investigate the denial of deductions for dealing in CSA.

2.  The Court rejected HDR's argument for "constructive compliance" with the summons by requesting some type of immunity to do so.  Here is the discussion (Slip Op. pp. 42-45):

Nor does HDR get credit for “constructively” complying with the IRS’s Document Requests. As the district court observed, HDR’s “offer” to release information to the IRS came with significant strings attached. Prior  to the issuance of the summonses, HDR agreed to “furnish documentation . . . provided that [HDR is] given assurance from the IRS, that the IRS will use the information furnished for this civil audit, and not to support the IRS’s determination that the Taxpayer’s business consists of illegal activities.” Aplt.’s App. at 79. An IRS attorney responded that the IRS did not have the authority to agree to HDR’s conditions, as the IRS  was bound by 26 U.S.C. § 6103(i), which requires the IRS to turn tax-return documents over to other agencies in certain circumstances.  

On appeal, the government argues that HDR’s “condition was a plain attempt to preclude the IRS’s investigation as to Section 280E,” which the IRS was authorized to conduct. Aplee.’s Resp. Br. at 47. Be that as it may, what is patent is that HDR’s conditional offer to furnish the documents put the IRS in an objectionable and unsuitable position. And, contrary to HDR’s suggestion—see Aplt.’s Opening Br. at 13 (noting that “[t]he necessary documents requested were originally tendered [to the IRS] by [HDR’s] representative” and “are available and constructively in control of the IRS”)—its conditional offer was not tantamount to placing the documents in the IRS’s constructive possession in satisfaction of Powell’s third factor. The IRS was “under no obligation to circumscribe its examination—or to ignore statutory complications—in order to obtain relevant documents.” Aplee.’s Resp. Br. at 47. 

HDR further argues that the IRS could have given it “use immunity” n9 pursuant to 18 U.S.C. § 6004, n10 and so the IRS’s protestation that it did not  [*45] have the authority to accept HDR’s proposed conditions was legally erroneous. Aplt.’s Opening Br. at 25–26. HDR seems to reason that the IRS has constructive possession of the documents because, if it granted “use immunity” to HDR, HDR would have been willing to turn the documents over. However, even assuming that the IRS is “an agency of the United States” within the meaning of § 6004, and thus authorized under certain circumstances to grant “use immunity,” and even assuming that it could confer such immunity on a corporation like HDR, the IRS could not do so without “the approval of the Attorney General.” 18 U.S.C. § 6004(a). Therefore, the IRS would not have been entirely free of its own accord to comply with HDR’s conditions. Furthermore, even if the IRS could have granted HDR “use immunity,” HDR cites no legal authority that indicates that the IRS was required to do so to secure HDR’s compliance with its Document Requests. In sum, we are not persuaded that any ostensible power that the IRS possessed to grant HDR “use immunity” gave it constructive  possession over the documents it sought from HDR. We thus agree with the district court that the IRS satisfied the third Powell factor. HDR has not demonstrated the existence of a genuine factual dispute that the IRS did not have the sought-after information in its possession.
   n9 See, e.g., United States v. Fishman, 645 F.3d 1175, 1185 n.6 (10th Cir. 2011) (“Use immunity ‘confers immunity [with regard to possible criminal prosecution] only against the use of testimony compelled under the immunizing order; it does not confer transactional immunity under which the witness could not be prosecuted at all for the transactions about which he testifies.’” (quoting In re Madison Guar. Sav. & Loan, 352 F.3d 437, 443 (D.C. Cir. 2003) (per curiam))); Use Immunity, BLACK’S LAW DICTIONARY (10th ed. 2014) (“Immunity from the use of compelled testimony (or any information derived from that testimony) in a future prosecution against a witness.”); see also United States v. Schmidt, 816 F.2d 1477, 1480–81 (10th Cir. 1987) (discussing the act-of-production doctrine, whereby “the act of producing the subpoenaed documents would involve testimonial self-incrimination”).
   n10 In pertinent part, this statute provides:
(a) In the case of any individual who has been or who may be called to testify or provide other information at any proceeding before an agency of the United States, the agency may, with the approval of the Attorney General, issue, in accordance with subsection (b) of this section, an order requiring the individual
to give testimony or provide other information which he refuses to give or provide on the basis of his privilege against self-incrimination . . . .
(b) An agency of the United States may issue an order under subsection (a) of this section only if in its judgment--
(1) the testimony or other information from such individual may be necessary to the public interest; and
(2) such individual has refused or is likely to refuse to testify or provide other information on the basis of his privilege against self-incrimination.
18 U.S.C. § 6004.

3.  The Court also rejected HDR's "dead-letter rule" argument regarding the CSA (Slip Op. 49-58).  The Court summarized (p. 49):

HDR alternatively contends that the IRS cannot deny HDR deductions for its ordinary and necessary business expenses because the underlying public policy that § 280E purports to vindicate as to marijuana trafficking—that is, the policy regarding marijuana trafficking embodied in the CSA—is a “dead letter.” We disagree. First, we set the stage with some background information regarding the role of public policy in the taxdeduction context. Second, we reject HDR’s argument that the presumption against judicially-recognized public policy exceptions applies to § 280E. And, third and lastly, we express our disagreement with HDR’s suggestion that the DOJ’s ostensible policy of non-enforcement of CSA in the marijuana context could render that statute’s proscription of marijuana trafficking a “dead letter.”