Standing Akimbo, LLC v. United States

• Court: U.S. Court of Appeals — Tenth Circuit
• Writing for the Court: PHILLIPS, Circuit Judge.
• Citation: Standing Akimbo, LLC v. United States, 955 F.3d 1146 (10th Cir. 2020)
• Decision Date: 07 April 2020
• Docket Number: No. 19-1049,19-1049
• Parties: STANDING AKIMBO, LLC, a Colorado limited liability company; Peter Hermes, an individual; Kevin Desilet, an individual; Samantha Murphy, an individual; John Murphy, an individual, Petitioners - Appellants, v. UNITED STATES of America, THROUGH its agency the INTERNAL REVENUE SERVICE, Respondent - Appellee.

955 F.3d 1146

STANDING AKIMBO, LLC, a Colorado limited liability company; Peter Hermes, an individual; Kevin Desilet, an individual; Samantha Murphy, an individual; John Murphy, an individual, Petitioners - Appellants,

v.UNITED STATES of America, THROUGH its agency the INTERNAL REVENUE SERVICE, Respondent - Appellee.

No. 19-1049

United States Court of Appeals, Tenth Circuit.

FILED April 7, 2020

James D. Thorburn (Richard A. Walker with him on the briefs), of Thorburn Walker, LLC, Greenwood Village, Colorado, for Petitioners-Appellants.

Nathaniel S. Pollock, Attorney, Tax Division (Richard E. Zuckerman, Principal Deputy Assistant Attorney General; Travis A. Greaves, Deputy Assistant Attorney General; Gilbert S. Rothenberg and Michael J. Haungs, Attorneys, Tax Division; Jason R. Dunn, United States Attorney, Denver, Colorado, of Counsel, with him on the brief), Department of Justice, Washington, D.C., for Respondent-Appellee.

Before LUCERO, PHILLIPS, and MORITZ, Circuit Judges.

PHILLIPS, Circuit Judge.

The Internal Revenue Service (IRS) is responsible to enforce the federal tax code against marijuana businesses operating legally under state law. This led to a civil audit of Peter Hermes, Kevin Desilet, Samantha Murphy, and John Murphy (collectively, the "Taxpayers") to verify their tax liabilities for their medical-marijuana dispensary, Standing Akimbo, LLC. The IRS was investigating whether the Taxpayers had taken improper deductions for business expenses arising from a "trade or business" that "consists of trafficking in controlled substances." 26 U.S.C. § 280E. But claiming to fear criminal prosecution, the Taxpayers declined to provide the audit information to the IRS. This left the IRS to seek the information elsewhere—it issued four summonses for plant reports, gross-sales reports and license information to the Colorado Department of Revenue’s Marijuana Enforcement Division (the "Enforcement Division"), which is the state entity responsible for regulating licensed marijuana sales.

In Colorado federal district court, the Taxpayers filed a petition to quash the summonses. The government moved to dismiss the petition and to enforce the summonses. The district court granted the motion to dismiss and ordered the summonses enforced. Exercising jurisdiction under 28 U.S.C. § 1291, we affirm.

BACKGROUND

I. The Audit

The Taxpayers own Standing Akimbo, and Samantha Murphy is its business manager.¹ Standing Akimbo is a Colorado Limited Liability Company operating a medical-marijuana dispensary in Denver, Colorado. Though such dispensaries are legal under Colorado law, see Colo. Rev. Stat. Ann. § 44-10-102 (West 2020), "marijuana is still classified as a federal ‘controlled substance’ under schedule I of the [Controlled Substances Act (CSA) ]," Green Sol. Retail, Inc. v. United States , 855 F.3d 1111, 1113 (10th Cir. 2017) (citations omitted), cert. denied , ––– U.S. ––––, 138 S. Ct. 1281, 200 L.Ed.2d 468 (2018) ; see also 21 U.S.C. §§ 812 (listing marijuana as a Schedule I controlled substance), 841 (prohibiting distribution of a controlled substance). This federal classification has federal tax consequences for marijuana dispensaries, such as § 280E ’s prohibition on their deducting business expenses. See 26 U.S.C. § 280E.

In May 2017, the IRS began investigating whether Standing Akimbo had claimed business deductions prohibited by § 280E. That month, IRS Revenue Agent Tyler Pringle provided Standing Akimbo written notice (in a letter) that the IRS was auditing its return for the 2014 tax year. In the letter, Agent Pringle asked that Standing Akimbo call him to discuss the items and documents he intended to request. Agent Pringle enclosed a copy of Publication 1, which outlines the IRS’s audit procedures. Under a section titled "Potential Third Party Contacts," this publication notes that the IRS may "sometimes talk with other persons if we need information that you have been unable to provide, or to verify information we have received." Internal Revenue Serv., Dep’t of the Treasury, Catalog No. 64731W, Publication 1: Your Rights as a Taxpayer (Rev. 9-2017), https://www.irs.gov/pub/irs-pdf/p1.pdf.² In a second letter, this one in June 2017, Agent Pringle notified Standing Akimbo that the IRS had expanded the audit to include its return for the 2015 tax year, because it raised the same issues as the 2014 return.

Because Standing Akimbo is a pass-through entity,³ its audit would necessarily affect its owners’ tax returns. So Agent Pringle also sent letters, with Publication 1 attached, to Hermes and the Murphys, notifying them that the IRS would be examining their personal-income-tax returns for the 2014 and 2015 tax years. Agent Pringle had already notified Desilet that the IRS was examining his personal-income-tax liabilities for 2014, 2015, and 2016 because it had no record of his filing returns for these years.

As part of the examinations, Agent Pringle sent the Taxpayers an Information Document Request relating to the 2014 tax year. The Document Request sought, among other things, a list of licenses held by Standing Akimbo and the Taxpayers, as well as some specific reports from the Enforcement Division’s Marijuana Enforcement Tracking Reporting Compliance ("METRC") system: the annual gross-sales report, transfer report, annual harvest report, and monthly-plant-inventory reports. A month later, after receiving no response, Agent Pringle issued a second Document Request requesting the same information. Then, when the IRS expanded the audit to include the 2015 tax year, Agent Pringle issued a third Document Request requesting this same information for 2015.

The Taxpayers only partially responded to these Document Requests and did not provide enough information to substantiate their returns. For example, the Taxpayers provided none of the requested METRC reports. They claimed that Agent Pringle was in fact investigating federal drug crimes and declined to provide potentially incriminating evidence without receiving immunity from prosecution.

The information the Taxpayers did provide was so minimal and incomplete that Agent Pringle could not verify the accuracy of their returns. Accordingly, Agent Pringle used other means to assist him in evaluating the returns: he issued four third-party summonses to the Enforcement Division. One summons regarded Standing Akimbo and requested a list of the licenses it had held from 2014 through 2015, as well as its METRC annual gross-sales reports, transfer reports, annual harvest reports, and monthly plant-inventory reports for 2014 and 2015 (the "Standing Akimbo summons"). The other three summonses regarded the Taxpayers—one each for Hermes, Desilet, and the Murphys—requesting a list of the licenses they had held in 2014 and 2015 (collectively, the "Taxpayers summonses"). Agent Pringle provided the Taxpayers copies of all the summonses, along with an explanation of their right to petition to quash the summonses.

II. The Resulting Litigation

In Colorado federal district court, the Taxpayers filed a petition to quash the summonses. They asserted that none of the summonses satisfied the Supreme Court’s requirements for enforcement as announced in United States v. Powell , 379 U.S. 48, 85 S.Ct. 248, 13 L.Ed.2d 112 (1964). Specifically, the Taxpayers argued that the summonses lack a legitimate purpose, are deficient because the IRS failed to follow necessary administrative steps, exceed the IRS’s authority by forcing the Enforcement Division to create reports, and impermissibly seek the identity of third-party taxpayers. The Taxpayers also requested an evidentiary hearing to determine whether the summonses satisfied the Powell requirements.

The government moved to dismiss the petition under Federal Rule of Civil Procedure 12(b)(6) and to enforce the summonses under 26 U.S.C. §§ 7604(a) and 7609(b)(2)(A), arguing that Agent Pringle’s appended declaration established that the summonses satisfied Powell ’s requirements. The Taxpayers responded by reasserting their initial grounds for quashing the summonses and listing six more: (1) Congress has not authorized the IRS to investigate drug crimes, (2) the IRS must grant absolute immunity before collecting nontax-crime information for tax purposes, (3) the summonses violate the Taxpayers’ Fourth Amendment privacy rights, (4) the summonses are overbroad, (5) the IRS’s investigation into nontax crimes violates Powell ’s good-faith requirement, and (6) enforcing the summonses would compel a violation of Colorado law. The Taxpayers also noted that they "are fully asserting Fifth Amendment privilege" in light of the IRS’s supposed admission that the audit is "an investigation of whether the [T]axpayers violated federal criminal drug laws[.]" App. vol. 1 at 118. Finally, they argued that because the motion to dismiss relies on information outside the pleadings, the district court must convert it into a motion for summary judgment.

The district judge referred the matter to a magistrate judge. The magistrate judge did not convert the motion to dismiss into a motion for summary judgment, but she still relied on Agent Pringle’s declaration in concluding that the IRS had met Powell ’s requirements. In addition, of course, the magistrate judge had available before her the Taxpayers’ attachments to their response to the motion to dismiss. The magistrate judge concluded that the Taxpayers had not sufficiently supported their arguments against enforcement. So the magistrate judge recommended denying the petition to quash, granting the motion to dismiss, and enforcing the summonses. The magistrate judge also informed the parties of their right to object to the recommendation and warned that failing to object would waive de novo review by the district judge and would waive appellate review.

The Taxpayers timely objected to eight of the magistrate judge’s rulings: (1) that the IRS had issued the summonses for a legitimate purpose, (2) that the information summoned is...