Section 280E disallows deductions for business activities concerning controlled substances which are illegal under federal law. State law increasingly allows the selling of marijuana for medicinal and recreational purposes. Federal law classifies marijuana as an illegal controlled substance. This tension between state and federal law means that taxpayers engaged in the legal selling of marijuana are unable to deduct expenses that would otherwise be deductible for federal income tax purposes. This leads to the bogarting of the ability to pay principle, and effectively penalizes taxpayers who operate legal state law marijuana businesses.
Over the last few years as part of civil tax audits IRS has investigated a number of dispensary taxpayers. At times IRS used its vast summons powers to gather information from third parties like financial institutions and state marijuana regulatory bodies. In many of these cases, the dispensaries and their individual owners have challenged those efforts, in part by arguing that the IRS could use the information to assist in the possible prosecution for violations of federal law. The courts, applying the Supreme Court’s Powell factors, have rejected challenges and found that IRS had a legitimate purpose in seeking the information from the businesses themselves and from third parties. The courts have generally held that was no abuse of process or bad faith because there was no evidence that the IRS was seeking the information to place the dispensaries and their owners in jeopardy of federal criminal investigations.
The latest case that upheld the IRS’s summons’ power over state law marijuana dispensaries is Speidell v US out of the Tenth Circuit, which has taken the lead on these cases given Colorado’s budding and booming marijuana business. The case breaks no new ground, but is a useful reminder that the IRS has broad latitude to use its summons power, and, despite the inequity in Section 280E, challenges to IRS audits of these businesses face an uphill struggle.
read more...As a refresher, under Powell the IRS must establish (1) that the investigation will be conducted pursuant to a legitimate purpose, (2) that the inquiry may be relevant to the purpose,'(3) that the information sought is not already within the IRS’s possession, and (4) that the administrative steps required by the Internal Revenue Code have been followed.
As the Speidell opinion notes the district court held that (1) the IRS had a legitimate purpose in issuing the summonses because there was no pending criminal investigation (2) the information sought was not already in the IRS’s possession (3) the IRS followed the required administrative steps; and (4) there was no showing of an abuse of process or bad faith because the summonses had a valid purpose, did not violate the Fourth Amendment’s right to privacy or Colorado law.
In Speidell, the circuit court addressed some wrinkles that distinguish the case from prior marijuana business challenges to IRS investigations. In rejecting the challenge the district court had treated the government’s response to the petitions to quash the summonses as a motion to dismiss; it should have treated the government’s efforts as a motion for summary judgment. The Tenth Circuit held that the distinction made no substantive difference, nor did the lower court’s citation of the 1985 Tenth Circuit opinion Balanced Financial Management that referred to the burden in establishing the Powell factors as “slight.” On appeal, the plaintiffs argued that the lower court and recent similar Tenth Circuit opinions in Standing Akimbo v US and High Desert v US failed to apply the Supreme Court’s 2014 decision in US v Clarke, which recalibrated the standards that parties must satisfy to challenge the Powell factors. In failing to apply Clarke or treat the government’s actions as a summary judgment motion, the appellants argued that the lower court improperly sided with the government.
The Speidell court disagreed:
The Appellants argue that the rules announced in our 1985 Balanced Financial Management decision, which rules impose a “slight” burden on the IRS and a “heavy” burden on the taxpayer, are incompatible with normal summary judgment standards and the Supreme Court’s 2014 ruling in Clarke. Although Standing Akimbo does not directly address this issue, the panel in that case was clearly aware of Clarke and continued to apply Balanced Financial Management principles. See Standing Akimbo, 955 F.3d at 1154–55, 1157, 1160–61, 1163, 1166 (citing both Clarke and Balanced Financial Management). High Desert embraces a similar analysis. See 917 F.3d at 1181–84, 1187, 1191, 1194 (same). In any event, we need not decide whether this point in Standing Akimbo and High Desert is dictum or a holding. As discussed below, even if we eschew descriptions like “slight” and “heavy” and apply traditional summary judgment standards, the Appellants simply have not submitted proof sufficient to create a genuine dispute of material fact. The Appellants thus fall short even if we assume arguendo that Balanced Financial Management has been displaced by Federal Rule of Civil Procedure 56 and Clarke.
The opinion discusses further the relationship between its precedent and Clarke, noting that Clarke at its core emphasizes the need for credible evidence. Bare allegations of improper purpose under pre or post Clarke law are insufficient for evidentiary hearings at the summons enforcement stage. Even if there was some gap between the precise language in pre-Clarke Tenth Circuit law and the standard for all courts to apply following Clarke, Speidell held that any tension between the two was “indirect” and Clarke did not overturn its precedent.
Conclusion
There is more to the opinion, including an interesting discussion of the lower court’s treatment of one of the individual owner’s untimely petition to quash the summons, principles of sovereign immunity, and the relationship of the constitution’s Supremacy Clause to the legitimacy of the IRS investigation. At one level, the opinion highlights the difficulties parties face when fighting IRS and its vast summons powers. At another level, however, the opinion flags the need for Congress to update the federal tax laws to reflect the growing importance of the legal marijuana business. Help for these businesses is unlikely to come in summons enforcement cases; it will come in legislation that carves out the 280E prohibitions from the sale of substances that are allowed under state law. A recent Politico article Why the Next Congress is Unlikely to Legalize Marijuana suggests that this may not be high on the agenda next year, with the Senate the main stumbling block.
About Leslie Book
I did not know that this was an editorial page. The phrases “legal marijuana business” and “legal selling of marijuana” are oxymorons; as long as marijuana remains a schedule 1 narcotic under federal law, it is not legal, it merely is not illegal under a state’s law. just as there are other things that are illegal under federal law but not covered under state law or vice versa. Similarly, “inequity in Section 280E” as used here is an editorial statement.
Proponents of legalizing marijuana under federal law, or of carving it out of section 208E where it is not illegal under state law, have a cogent political point to be addressed to Congress, where there is some solicitude for the proposition that the status and regulation of marijuana should be primarily a state issue, but unless and until Congress removes it from the substances that are illegal under federal law, there is nothing more inequitable in section 280E as a matter of law regarding marijuana than regarding any other substance that is covered.
A case can be made, and I have heard that litigation is in the works to this effect, that section 280E in its entirety is inequitable and perhaps not consistent with the 16th Amendment because an income tax law’s function is to collect tax on economic profit, not to collect more than that in order to bolster social policy, but that argument is inconsistent with recent legislation that makes criminal fines non-deductible.
From one to another, OK boomer. On the 16th Amendment issue, a recent article in Tax Notes by Erik Jensen makes the case that 280E and its “broad denial of deductions, credits, and maybe more leaves us with a tax that is not an income tax within the meaning of the 16th Amendment.” https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3706247
The Speidell case and the context in which it arises are interesting in another way. When the government seeks information on tax liability relative to economic activity that itself is not likely to be illegal, Powel factor 1 is there to make sure that the civil investigation power is not used to assist a criminal investigation that has already been opened, such as for criminal tax fraud, where there are greater protections for the person being investigated. But where the activity itself that gave rise to the income is inherently illegal, it may be a different kind of question to establish Powell factor 1.
Isn’t the camel’s nose already under the tent, with the allowance of deductions for production or procurement as “cost of goods sold”?
I didn’t know this was a place to attempt rational discussion of irrational policy. It makes my mind wander. Will Camel soon be using the brand name for cannabis concoctions?
Your article is quite interesting. As counsel of record for both Standing Akimbo and Speidell, I wanted to let you know that both have been petitioned for cert to SCOTUS. Standing Akimbo is 20-645 and Speidell is 20-1332. Standing Akimbo has been rescheduled for conference three times now by the Justices. Speidell is still in the briefing stage.