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:

Eleventh Circuit Discusses the Plausible Inference of Impropriety In Order to Avoid Summary Enforcement of an IRS Summons (3/20/16)

The IRS summons power is the IRS's principal compulsory investigative tool.  In United States v. Clarke, 573 U.S. ___, ___, 134 S. Ct. 2361 (2014), here, the Supreme Court confirmed that the summons enforcement proceeding brought by the U.S. in a district court case against the noncomplying witness (usually the taxpayer or a party related to the taxpayer) is a summary proceeding where the IRS's prima facie showing is minimal.  In the original Clarke case, the compelled parties alleged improper purposes under Powell in order to obtain an evidentiary hearing in which it could examine IRS witnesses to establish the improper purpose.  At that time, most district courts summarily enforced the summonses with minimal, if any, evidentiary proceedings to explore the compelled parties' bare allegations of impropriety.  The Eleventh Circuit earlier bucked that trend and held that an evidentiary proceeding was required.  The Government obtained certiorari, and the Supreme Court remanded the case for further consideration under the standards it set forth in the opinion (set forth below).  Upon remand, the district court summarily enforced the summonses involved.  The case then went back to the Eleventh Circuit which, on March 15, sustained the district court's summary enforcement of the summons.  United States v. Clarke, ___ F.3d ___, 2016 U.S. App. LEXIS 4728 (11th Cir. 2016), here.  I will cut and paste and comment, as appropriate, on key parts of the Eleventh Circuit's opinion

First, the Court makes the introduction with a succinct summary of the applicable law.

The IRS's authority to investigate is extensive. See United States v. Arthur Young & Co., 465 U.S. 805, 816, 104 S. Ct. 1495, 1502 (1984). Under 26 U.S.C. § 7602(a), the IRS may issue a summons for the purpose of "ascertaining the correctness of any return, making a return where none has been made, determining the liability of any person for any internal revenue tax . . ., or collecting any such liability." See also United States v. Morse, 532 F.3d 1130, 1132 (11th Cir. 2008). 

The summons authority is subject to limitations. Under Powell, the IRS must make a four-part prima facie showing to obtain enforcement of a summons from the district court: that (1) "the investigation will be conducted pursuant to a legitimate purpose," (2) "the inquiry may be relevant to the purpose," (3) "the information sought is not already within the Commissioner's possession," and (4) "the administrative steps required by the Code have been followed." United States v. Powell, 379 U.S. 48, 57-58, 85 S. Ct. 248, 255 (1964). Afterward, "the burden shifts to the party contesting the summons to disprove one of the four elements of the government's prima facie showing or convince the court that enforcement of the summons would constitute an abuse of the court's process." United States v. La Mura, 765 F.2d 974, 979-80 (11th Cir. 1985). However, a court reviewing an enforcement petition "may ask only whether the IRS issued a summons in good faith, and must eschew any broader role of 'oversee[ing] the [IRS's] determinations to investigate.'" Clarke, 573 U.S. at ___, 134 S. Ct. at 2367 (alterations in original) (quoting Powell, 379 U.S. at 56, 85 S. Ct. at 254). 

Under Clarke, a taxpayer is entitled to examine an IRS agent concerning the issuance of a summons only when he can "make a showing of facts that give rise to a plausible inference of improper motive." Id. at ___, 134 S. Ct. at 2368. Examples of an improper purpose to issue a summons include harassment of the taxpayer or "any other purpose reflecting on the good faith of the particular investigation." Powell, 379 U.S. at 58, 85 S. Ct. at 255.

Yet Another Appeals Court Enforcement of Summons for FBAR Required Foreign Bank Account Records (3/4/16)

In United States v. Chen, 2016 U.S. App. LEXIS ____ (1st Cir. 2016), here, the First Circuit enforced an FBAR required records summons, following the unbroken line of cases in the other circuits.  The opinion is well researched and well-written.  Because this holding is now routine in the circuits, I offer only certain items from the opinion that caught my interest.

1. One of the judges on the panel was former Supreme Court Justice David Souter.  He did not write the opinion.

2. In the statement of facts, the Court notes that, in its petition to enforce, the agent's supporting affidavit advised that:

"[t]here is no 'Justice Department referral[ ]' . . . in effect with respect to Chu H. Ng and Zhong H. Chen for the year under examination." n1
   n1 This statement meant that the taxpayers were not then referred for criminal prosecution by the Department of Justice. "A Justice Department referral is in effect with respect to any person if -- (i) the Secretary has recommended to the Attorney General a grand jury investigation of, or the criminal prosecution of, such person for any offense connected with the administration or enforcement of the internal revenue laws, or (ii) any request is made under section 6103(h)(3)(B) for the disclosure of any return or return information (within the meaning of section 6103(b)) relating to such person." 26 U.S.C. § 7602(d)(2)(A).

The Court returns to this key fact later in the opinion:

Additionally, the IRS may not issue a summons "with respect to any person if a Justice Department referral is in effect with respect to such person." 26 U.S.C. § 7602(d)(1). The government here submitted an affidavit executed by the IRS revenue agent stating that the summons was issued for the purpose of determining the 2008 tax liability of Chen and Ng, and that the IRS had not referred Chen or Ng to the Department of Justice for criminal prosecution. The agent acknowledged that the government had some documents pointing to the existence of Chen's foreign bank accounts, but not enough documents to know whether there was underpayment of taxes. this key fact later in the opinion:

Is a Party Entitled to a Hearing in a Summons Enforcement Case Based Solely on Allegations of Improper Purpose? (12/14/13)

Yesterday, I posted on my Federal Tax Procedure Blog, an entry regarding the Government's petition for certiorari seeking to insure a streamlined procedure for summons enforcement proceedings.  See Is a Party Entitled to a Hearing in a Summons Enforcement Case Based Solely on Allegations of Improper Purpose? (Federal Tax Procedure Blog 12/13/13), here.  Because summonses and summons enforcement are key investigative tools in the criminal tax universe, I will post "cut and paste" the contents of that blog here:

The United States has petitioned the Supreme Court in United States v. Clarke, 517 Fed. Appx. 689, 2013 U.S. App. LEXIS 7773 (11th Cir. 2013), here, an unpublished decision.  The Eleventh Circuit's opinion in Clarke is short and pithy, so I quote it all (except I omit the caption and two of the three footnotes):

This case involves the Internal Revenue Service's (IRS) issuance of five administrative summonses, pursuant to 26 U.S.C. § 7602, during an investigation into the tax liabilities of Dynamo Holdings Limited Partnership (Dynamo). Specifically, [List of summonsed parties omitted] appeal the district court's orders granting the IRS's petitions to enforce the summonses. After careful review of the record, and having had the benefit of oral argument, we vacate the district court's order enforcing the summonses and remand for the district court to hold a hearing. 

To obtain enforcement of a summons, the IRS must make a four-part prima facie showing that (1) "the investigation will be conducted pursuant to a legitimate purpose," (2) "the inquiry may be relevant to the purpose," (3) "the information sought is not already within the Commissioner's possession," and (4) "the administrative steps required by the Code have been followed." United States v. Powell, 379 U.S. 48, 57-58, 85 S. Ct. 248, 13 L. Ed. 2d 112 (1964); see also Nero Trading, LLC v. U.S. Dep't of Treasury, IRS, 570 F.3d 1244, 1248 (11th Cir. 2009). Once the IRS makes its prima facie showing, the burden shifts to the party opposing the summons to either (1) disprove one of the four elements of the IRS's prima facie case, or (2) "convince the court that enforcement of the summons would constitute an abuse of the court's process." Nero, 570 F.3d at 1249 (internal quotation omitted). The Supreme Court has stated that because the district court's process is used to enforce a summons, the court should not permit its process to be abused by enforcing a summons that was issued for an improper purpose. See Powell, 379 U.S. at 58. According to the Powell Court, an improper purpose may include any purpose "reflecting on the good faith of the particular investigation." Id. 

In Powell, the Supreme Court also explained that a party opposing a summons is entitled to an adversary hearing before enforcement is ordered, and that, at the hearing, the opponent "may challenge the summons on any appropriate ground." Id. (internal quotation omitted). Subsequently, in United States v. Southeast First National Bank of Miami Springs, we held that "an allegation of improper purpose is sufficient to trigger a limited adversary hearing where the taxpayer may question IRS officials concerning the Service's reasons for issuing the summons." 655 F.2d 661, 667 (5th Cir. 1981) (footnote omitted). More recently, we have reaffirmed Southeast First National Bank, calling it "the legitimate offspring of the Supreme Court's seminal decision in Powell." Nero, 570 F.3d at 1249. 

Appellants contend they were entitled to discovery and an evidentiary hearing before the district court granted the IRS's petitions to enforce the summonses because they alleged the IRS may have issued and sought to enforce the summonses for at least four improper purposes.One of the reasons the IRS may have issued the summonses, according to Appellants, was solely in retribution for Dynamo's refusal to extend a statute of limitations deadline. Although Appellants raised the possibility of numerous improper purposes, federal pleading standards allow claims and defenses to be pled in the alternative, and do not require them to be consistent. See Fed. R. Civ. P. 8(d)(2) & (d)(3). If the IRS issued the summonses only to retaliate against Dynamo, that purpose "reflect[s] on the good faith of the particular investigation," and would be improper. See Powell, 379 U.S. at 58.