High Desert Relief, Inc. v. United States

• Citation: 917 F.3d 1170
• Decision Date: 05 March 2019
• Docket Number: Nos. 17-2083 & 17-2095,s. 17-2083 & 17-2095
• Parties: HIGH DESERT RELIEF, INC., a New Mexico Non-Profit Corporation, Plaintiff-Appellant, v. UNITED STATES of America, Through Its Agency the Internal Revenue Service, Defendant-Appellee.
• Court: United States Courts of Appeals. United States Court of Appeals (10th Circuit)

917 F.3d 1170

HIGH DESERT RELIEF, INC., a New Mexico Non-Profit Corporation, Plaintiff-Appellant,

v.UNITED STATES of America, Through Its Agency the Internal Revenue Service, Defendant-Appellee.

Nos. 17-2083 & 17-2095

United States Court of Appeals, Tenth Circuit.

FILED March 5, 2019

James D. Thorburn (Richard Walker with him on the briefs), Thorburn Walker, LLC, Greenwood Village, CO, for Plaintiff-Appellant.

Michael J. Haungs, Attorney, Tax Division (David A. Hubbert, Deputy Assistant Attorney General, Tax Division; Gilbert S. Rothenberg and Patrick J. Urda, Attorneys, Tax Division; and Robert C. Troyer, former Acting United States Attorney, of counsel; with him on the briefs) Department of Justice, Washington, D.C., for Defendant-Appellee.

Before LUCERO, HOLMES, and EID, Circuit Judges.

HOLMES, Circuit Judge.

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 .

I

A

HDR is a New Mexico medical marijuana dispensary. Although such dispensaries are lawful under state law, see N.M. STAT. ANN. §§ 26-2B-3, 26-2B-4 (2017), "marijuana is still classified as a federal ‘controlled substance’ under schedule I of the CSA." Green Solution Retail, Inc. v. United States , 855 F.3d 1111, 1113 (10th Cir. 2017), cert. denied , ––– U.S. ––––, 138 S.Ct. 1281, 200 L.Ed.2d 468 (2018). And this federal classification has potential tax consequences, even for businesses that are lawful under state law. In particular, while 26 U.S.C. § 162(a) allows taxpayers to claim deductions for "all the ordinary and necessary expenses paid or incurred ... in carrying on any trade or business," § 280E prohibits deductions for business expenses when the underlying business "consists of trafficking in controlled substances (within the meaning of schedule I and II of the [CSA] ) which is prohibited by Federal law." 26 U.S.C. § 280E (emphasis added).

In February 2016, the IRS began to investigate whether HDR had taken improper deductions and thus had outstanding tax liabilities. IRS Revenue Agent Lisa Turk provided written notice to HDR that its return for the fiscal year ending June 30, 2014 ("2014 return") had been selected for examination. In this initial communication, Agent Turk identified several preliminary issues for inquiry (e.g., the costs of goods sold, gross receipts, and total deductions) and provided HDR with a copy of IRS Publication 1. Publication 1 outlines the IRS's audit procedures, and also explains, under a section titled "Potential Third Party Contacts," that the IRS might "sometimes talk with other persons if we need information that you have been unable to provide, or to verify information we have received." IRS Publication 1, Your Rights as a Taxpayer (Rev. 9-2017), https://www.irs.gov/pub/irs-pdf/p1.pdf.¹

After failing to receive a response from HDR by the date specified on the notice, Agent Turk made a phone call to one of HDR's two shareholders. During the call, the shareholder confirmed that HDR grows and sells medical marijuana to qualified patients. At that time, Agent Turk communicated, once more, that the IRS's audit would focus on gross receipts, costs of goods sold, and all other business expenses, and then "proceeded to explain the taxpayer's rights as outlined in Publication 1." Aplt.'s App. at 340 (Mem. for the file, dated Mar. 9, 2017).

Because she was not able to obtain further information directly from HDR or its shareholders at this juncture, Agent Turk sent HDR an initial Information Document Request ("Document Request") relating to the dispensary's 2014 fiscal year. An updated Document Request was re-issued to HDR after the audit expanded to include HDR's tax return for the fiscal year ending in June 30, 2015 ("2015 return"). Agent Turk included an additional copy of IRS Publication 1 when providing notice of the expanded audit.

Around this period, Agent Turk also attempted to schedule an interview with HDR to discuss the tax years at issue and to tour the company's facilities. HDR ultimately objected to any such contacts because of its concern that the IRS's investigation into § 280E would be equivalent to a criminal investigation under the CSA.

HDR's wariness of triggering penalties under the CSA also informed its responses to the IRS's Document Requests. In correspondence, HDR insisted that it would only "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." Id. at 79 (Letter from Bridge West LLC to Agent Turk, dated May 23, 2016). The IRS informed HDR that it could not receive documentation under such a condition, as (1) the IRS was entitled to investigate whether § 280E applied, and (2) § 6103 of the Internal Revenue Code ("IRC")—which sets forth certain circumstances under which the IRS must disclose taxpayer material to other agencies—limited the IRS's ability to agree to HDR's conditional offer. See 26 U.S.C. § 6103(i). In response, HDR told Agent Turk that it "would not answer any questions, provide any records, or provide ... a tour of the business." Aplt.'s App. at 239 (Decl. of Lisa Turk, dated Oct. 21, 2016). There is no indication from the record that HDR ever sent the IRS any documents in response to either its initial, or its subsequent, Document Requests.

Employing alternative means to ascertain the correctness of HDR's 2014 and 2015 returns, the IRS issued four summonses to third parties for information allegedly pertinent to those returns. Summonses to My Bank and Southwest Capital Bank sought information concerning HDR's bank accounts. A summons to the New Mexico Department of Health's Medical Cannabis Program was aimed at HDR's financial records and statements, applications to the medical cannabis program, cannabis product descriptions, and a description of HDR's facilities. And a summons issued to the Public Service Company of New Mexico, a local electric company, requested information regarding HDR's application for service, credit data, and also billing statements regarding HDR's electricity consumption. Each time a summons was issued, HDR was provided a notice of the summons, a copy of the summons, and an explanation of HDR's right to bring a proceeding to quash the summons.

B

HDR first filed, in federal court, a petition to quash the summonses that had been issued to the New Mexico Department of Health and My Bank. HDR asserted that neither summons satisfied United States v. Powell , 379 U.S. 48, 85 S.Ct. 248, 13 L.Ed.2d 112 (1964), which, as discussed infra , sets out the requirements for the enforcement of an IRS summons. Specifically, HDR claimed that the summonses were devoid of a legitimate purpose because they were issued in furtherance of a "pseudo-criminal investigation[ ] ... to ... convict taxpayers of violating federal criminal drug laws"—i.e., the CSA—and sought an evidentiary hearing to test the IRS's alleged good faith. Aplt.'s App. at 10 (Pet. to Quash Summonses, dated May 23, 2016).

The United States moved to dismiss HDR's petition, arguing that the IRS satisfied each of the Powell criteria and that the summonses were issued for the valid purpose of determining the correctness of HDR's tax returns under § 280E. On the same day that the United States filed this motion to dismiss HDR's first petition to quash, HDR filed another petition to quash, this one directed at the summons issued to the Public Service Company of New Mexico. Because the arguments contained in HDR's second petition largely mirrored those in the first, the two cases were consolidated before one district court judge.

The United States moved to dismiss the new petition regarding the Public Service Company of New Mexico, appending a declaration made by Agent Turk, as well as more documentary evidence. The United States also moved to enforce the outstanding summonses against My Bank and the Public Service Company of New Mexico, but withdrew its request to enforce the summons issued to the New Mexico Department of Health, as the IRS had successfully obtained the summonsed information by means of a public records request.

At this juncture, the district court judge handling the consolidated cases...