10th Circuit: IRS Can Audit Marijuana Information

The 10th Circuit Court of Appeals building in Denver, also known as the Byron White building.

In one of several cases over the past years surrounding the Internal Revenue Service’s ability to investigate and impose tax consequences on marijuana-related business in Colorado, the 10th Circuit Court of Appeals affirmed the district court’s ruling in favor of the IRS. 

The arguments in the case were familiar to the court, as over the past three years and in at least five cases cited by the court, many dispensaries have challenged the IRS’s ability to investigate and impose tax consequences. The opinion notes those dispensaries are represented by the same attorneys fighting the summons again in this case. 

“The dispensaries have lost every time,” the opinion states. “The same result is warranted here. We affirm the district court’s rulings in favor of the IRS.”

Despite the court’s decision to affirm the IRS in the case, Jim Thorburn, attorney for the appellants, said he may seek review at the U.S. Supreme Court.

The case was before judges Nancy Moritz, Joel Carson and Mary Briscoe, who penned the opinion. The case examined the power of the IRS to enforce part of the tax code prohibiting deductions for business activities involving controlled substances illegal under federal law.

The relevant IRS provision states no credit or deduction will be allowed for carrying on a trade or business, or comparable activities, that “consists of trafficking in controlled substances” prohibited by federal law — or the law of any state where that business is conducted —  in schedule I and II of the Controlled Substances Act.

The appellants, whom are all involved with Green Solution and Medical Wellness marijuana dispensaries in Colorado, objected to the IRS’s attempt to collect and audit information about marijuana-related business practices, and argued the investigation was “quasi-criminal,” exceeded IRS authority and conducted for an illegitimate purpose.

They further argued that the information sought was irrelevant for the IRS investigation, that the investigation is in “bad faith” and an abuse of power because the information could be shared with federal law enforcement agents. IRS summonses are overly broad, the dispensaries asserted, and they dispensaries have a reasonable expectation of privacy in the data tendered to state regulatory authorities and that the information from those authorities can’t be provided without violating state law.

“These arguments are familiar to us,” the opinion states. In addition to the multiple challenges to IRS authority, the court pointed to an earlier 10th Circuit case, Standing Akimbo v. U.S., where the IRS audited taxpayers to verify their tax liabilities for their dispensary and investigated whether the taxpayers had taken improper deductions for business expenses. 

The taxpayers there also claimed fear of criminal prosecution and declined to provide the audit information to the IRS. The IRS then sought the information from other governmental agencies, and the taxpayers filed a motion to quash and the government moved to dismiss, which the district court and the 10th Circuit affirmed the dismissal and enforcement of the summonses. 

The 10th Circuit summarized the relevant case law, saying it “is directly on point for almost every argument raised” and quoted the decision from earlier this year.

The case began with IRS audits of Green Solutions’ tax returns for 2013 and 2014, and Medical Wellness’s tax returns from 2014-16. Because some of the businesses are pass-through entities for tax purposes, the IRS investigation included Green Solutions owner Eric Speidel, and Medical Wellness owners Michael Aragon and Steven Hickox’s individual tax returns. The IRS requested information and sent summonses to these parties but only received partial responses, and in cases didn’t produce information given to the Colorado Marijuana Enforcement Division, or it’s tracking, reporting and compliance system, METRC.

The Green Solution parties petitioned to quash the IRS summonses, and the IRS moved to dismiss, and enforce the summonses. The federal district court denied the motion and granted the IRS motions to enforce, according to the opinion. The district court denied Speidel’s individual motion to quash on different grounds.

The Medical Wellness parties say the requested immunity from the prosecution prior to providing the information, and they did not provide information reported to MED, including the METRC system. These parties also petitioned to quash the summonses, and the IRS moved to dismiss and enforce. The federal district court denied the motions to quash and allowed the IRS to move forward. 

After appeals had been filed in various Green Solutions and Medical Wellness cases, the court consolidated the cases and requested briefs addressing whether the questions in the Standing Akimbo case would answer the questions posed here. 

In its analysis of the case, the 10th Circuit pointed to U.S. v. Powell, a 1964 case, which provided the framework for the analysis. In general, the IRS has “broad latitude” to issue summonses for several purposes. However, the IRS must first show it hasn’t made “a referral of a taxpayer’s case” to the Department of Justice for criminal prosecution.

The appellants argued that prior 10th Circuit opinion created rules that impose a slight burden on the IRS and a heavy burden on the taxpayer to prove what are called Powell factors, requiring that the IRS establish the investigation is legitimate in purpose, the inquiry is relevant, the information isn’t already in the IRS’s possession and the steps required by the Internal Revenue Code have been followed. The opinion notes that the connections with these factors were “slight.”

Past the descriptions of slight and heavy, and apply traditional summary standards, the opinion states that the appellants “simply have not submitted proof” to create a genuine dispute of material fact. In addition, the opinion states that the appellants haven’t pointed to evidence contradicting the IRS’s denial that the case was referred to the DOJ for prosecution, nor have they pointed contradictions to the IRS explanation of the audits of the appellants.

Further, the opinion states that rather than challenging factual assertions, the appellants maintain that the IRS lacks the authority to decide whether their conduct is prohibited by the CSA and the IRS powers don’t supersede or preempt state law.

“Neither argument has legs,” the opinion states. The court goes on later to state, “We have rejected the appellants’ ‘lack of authority’ argument several times, most recently in Standing Akimbo.”

The opinion notes that the appellants claimed that the IRS’s refusal to grant immunity constituted bad faith and made the proceedings quasi-criminal.

“It doesn’t,” the opinion states. “In the words of Standing Akimbo, the Appellants “proffer nothing to support their conclusory assertion that the IRS’s refusal to grant immunity turned its civil tax investigation ‘quasi-criminal.’”

Regarding the appellants’ assertions that they have reasonable expectations of privacy in METRC information under the Fourth Amendment, which they say would require the IRS to obtain search warrants supported by probable cause, the court held again that, as in Standing Akimbo, the taxpayers had no reasonable expectation of privacy in the METRC data collected on their business. 

And, in terms of enforcement, “Referencing the current versions of the statutes, we held that state law permits disclosure of confidential data for an authorized purpose, such as ‘allowing a law-enforcement agency’s investigation into a medical marijuana dispensary’s unlawful activity.’”

For all these reasons, the court affirmed the district court’s decisions denying or dismissing the petitions to quash and granting the IRS’s motions to enforce the summonses.

-Avery Martinez

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