IRS Upholds § 280E Enforcement Against State-Legal Marijuana Dispensaries

Introduction

In the pivotal case of Standing Akimbo, LLC, et al. v. United States of America (955 F.3d 1146, 10th Cir. 2020), the United States Court of Appeals for the Tenth Circuit affirmed the enforcement of Internal Revenue Service (IRS) summonses against owners of a state-licensed medical marijuana dispensary operating under Colorado law. The Taxpayers—Peter Hermes, Kevin Desilet, Samantha Murphy, and John Murphy—as owners of Standing Akimbo, LLC, challenged the IRS's authority to obtain financial and operational data from the Colorado Department of Revenue's Marijuana Enforcement Division (METRC) under 26 U.S.C. § 280E. The central issue revolved around whether the IRS could enforce tax deductions against businesses engaged in activities deemed illegal under federal law, despite their legality under state statutes.

Summary of the Judgment

The Taxpayers owned and managed Standing Akimbo, LLC, a medical-marijuana dispensary legally operating in Denver, Colorado. Despite state legalization, marijuana remains a federal Schedule I controlled substance under the Controlled Substances Act (CSA), triggering federal tax implications, particularly under § 280E, which prohibits deductions for businesses trafficking controlled substances. The IRS audited the Taxpayers for the 2014 and 2015 tax years to verify the legitimacy of their business expense deductions.

Upon insufficient cooperation from the Taxpayers, the IRS issued summonses to the Colorado Department of Revenue's Marijuana Enforcement Division (METRC) for detailed financial and operational reports. The Taxpayers petitioned to quash these summonses, arguing that they lacked a legitimate purpose, exceeded IRS authority, and violated constitutional rights, among other claims. However, both the district court and the Tenth Circuit upheld the IRS's actions, affirming that the summonses were legally enforceable under § 280E and the precedents established by Powell v. United States.

Analysis

Precedents Cited

The judgment extensively references several key precedents that delineate the scope of IRS authority in tax investigations, especially concerning controlled substances:

Powell v. United States (379 U.S. 48, 1964): Established the four-factor test to determine the reasonableness of IRS summonses, focusing on legitimate purpose, relevance, possession of information, and adherence to administrative protocols.
Green Sol. Retail, Inc. v. United States (855 F.3d 1111, 10th Cir. 2017): Affirmed the IRS's authority to audit state-licensed marijuana businesses under § 280E.
Alpenglow Botanicals, LLC v. United States (894 F.3d 1187, 10th Cir. 2018): Reiterated that the IRS can enforce § 280E even when state laws permit marijuana sales, emphasizing federal supremacy.
High Desert Relief, Inc. v. United States (917 F.3d 1170, 10th Cir. 2019): Confirmed that the IRS’s use of summonses must meet the Powell criteria and that the burden of proof lies on the IRS to demonstrate good faith.
Carpenter v. United States (138 S. Ct. 2206, 2018): While primarily concerning digital privacy and the third-party doctrine, the judgment distinguishes its applicability to METRC data.

These cases collectively reinforce the IRS's broad authority to investigate tax liabilities, even in industries operating under conflicting state and federal laws.

Legal Reasoning

The court's legal reasoning hinged on the interpretation of § 280E and the authority it grants the IRS to deny business expense deductions for entities trafficking in controlled substances. Despite marijuana dispensaries being legal in Colorado, federal law supersedes state law, mandating that such businesses adhere to strict tax regulations.

The IRS's issuance of summonses to METRC was evaluated under the four Powell factors:

Legitimate Purpose: The IRS demonstrated that its audit was to ascertain the correctness of tax returns regarding potential violations of § 280E.
Relevance: The information sought from METRC was pertinent to verifying sales figures and expenses, crucial for determining the legitimacy of claimed deductions.
Possession of Information: The IRS established that it did not already possess the requested METRC data, justifying the need for third-party information.
Administrative Compliance: The IRS adhered to procedural requirements in issuing and attempting to enforce the summonses.

The Taxpayers' arguments, including claims of overbreadth, bad faith, and constitutional violations, were systematically dismantled. The court found that the Taxpayers failed to provide substantive evidence to counter the IRS's compliance with Powell criteria and did not present credible arguments to necessitate an evidentiary hearing or limit on discovery.

Moreover, the court addressed the Taxpayers' reliance on the third-party doctrine and the potential application of Carpenter, concluding that METRC data does not fall under the privacy concerns addressed in Carpenter due to its nature and the context of its collection.

Impact

This judgment has significant implications for the intersection of state-legal businesses operating in federally prohibited sectors. It underscores the IRS's robust authority under § 280E to audit and enforce tax regulations, irrespective of state-level legality. Key impacts include:

Reaffirmation of Federal Supremacy: State-legal marijuana businesses remain subject to strict federal tax codes, reinforcing the precedence of federal law over state legislation.
Strengthened IRS Authority: The affirmation ensures that the IRS can effectively utilize third-party information sources in audits, crucial for industries with complex compliance challenges.
Deterrence of Tax Evasion: By upholding the summonses, the court discourages non-cooperation and highlights the consequences of inadequate compliance with tax obligations.
Guidance for Future Cases: The detailed analysis provides a framework for similar cases, particularly those involving businesses operating under conflicting state and federal laws.

Furthermore, this ruling may influence legislative discussions around tax implications for state-legal controlled substance businesses and potential reforms to § 280E.

Complex Concepts Simplified

To better understand the judgment, it's essential to clarify several legal concepts and terminologies used:

26 U.S.C. § 280E: A federal tax code provision that prohibits businesses trafficking in controlled substances (as defined by the CSA) from deducting ordinary business expenses, thereby increasing their effective tax rate.
Controlled Substances Act (CSA): Federal legislation that categorizes drugs into schedules based on their potential for abuse and medical value, with marijuana classified as a Schedule I substance, making its distribution illegal federally.
Summons: A legal document issued by the IRS compelling individuals or entities to provide specific information or documents relevant to an audit or investigation.
Powell Factors: A four-pronged test established by the Supreme Court in Powell v. United States to assess the reasonableness and enforceability of IRS summonses.
Third-Party Doctrine: A legal principle where individuals have no reasonable expectation of privacy for information voluntarily given to third parties, allowing the government to access such information without suspicion.
Rule 28(j): Federal appellate procedure rule that requires raising certain defenses and objections before appeal to ensure they are considered during initial proceedings.

Understanding these concepts is crucial for comprehending the court's reasoning and the broader legal context of the case.

Conclusion

The Tenth Circuit's affirmation in Standing Akimbo, LLC, et al. v. United States of America reinforces the IRS's authority to enforce federal tax laws against businesses engaged in activities deemed illegal under federal statutes, even if such activities are legalized at the state level. By meticulously applying the Powell framework and dismissing the Taxpayers' arguments as insufficiently substantiated, the court underscored the precedence of federal tax code compliance over state-legal business operations in the realm of controlled substances.

This ruling serves as a critical reminder to state-legal businesses of the persistent federal oversight and the implications of § 280E. It highlights the complexities arising from conflicting state and federal laws and the stringent enforcement mechanisms the IRS can employ to ensure tax compliance. As the landscape of state legalization evolves, businesses must navigate not only the operational and regulatory challenges but also the intricate tax obligations imposed by federal law.

Ultimately, the judgment emphasizes the enduring supremacy of federal statutes in matters of tax enforcement and the limited scope of state legality in shielding businesses from federal regulatory frameworks. It sets a clear precedent that federal tax authorities possess the requisite authority to investigate and enforce compliance, regardless of state-level legalizations.