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On March 5, 2019, on appeal from the U.S. District Court for the District of New Mexico, the U.S. Court of Appeals for the Tenth Circuit upheld actions taken by the IRS while investigating the tax liability of a medical marijuana dispensary in New Mexico.

The IRS began an investigation into High Desert Relief (HDR) and whether they 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. In the process of conducting this investigation, the IRS requested HDR furnish certain documents and information. HDR refused and the IRS proceeded to issue four summonses to third parties in an attempt to obtain the materials by other means. HDR filed petitions to quash the third-party summonses and the government counterclaimed seeking enforcement.

The district judges ruled in favor of the United States and HDR appealed. Two arguments were made on appeal before the Tenth Circuit. HDR contends that (1) the district judges misapplied the Powell factors, which set out the requirements for the enforcement of an IRS summons, and thereby the IRS did not act in good faith, and (2) that enforcement of 26 U.S.C. §280E was improper because an “official federal policy of non-enforcement” of the Controlled Substances Act (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.

The Tenth Circuit concluded that (1) the IRS met its initial burden to demonstrate it acted in good faith by meeting all four Powell factors and HDR failed thereafter to rebut, and (2) HDR’s proposed “dead letter rule” is not applicable here.

As a threshold matter, the IRS is required to show that it has not made a referral of the taxpayer’s case to the Department of Justice (DOJ) for criminal prosecution. The court held that the IRS agent’s affidavits stating there was no DOJ referral were enough to meet this burden. Additionally, the court notes that the presence of DOJ attorneys in litigation involving the summonses does not establish a criminal referral.

Next, the court considered the Powell factors and determined that the IRS demonstrated good faith in issuing the summonses. [1]

Lastly, the court considered the argument made by HDR claiming that both the DOJ and Congress have de-prioritized enforcement of the CSA with regard to marijuana trafficking. Therefore, no public policy would be frustrated if the IRS simply overlooked marijuana dispensaries in its administration of §280E. The court held this argument failed because the presumption against public policy exceptions cannot be applied to §280E. The Supreme Court has held that the presumption against public policy exceptions applies only to those instances where “Congress has been wholly silent” as to whether deductions should be disallowed. §280E is a specific legislation denying deductions for payments that violate public policy.

In conclusion, the judgments of the district court judges were affirmed and the actions taken by the IRS were permissible.

1. There are four Powell factors a court will consider. The first factor is whether “the investigation will be conducted pursuant to a legitimate purpose.” The court held that the IRS agent’s declaration that the investigation’s purpose “was to examine the federal tax liabilities of HDR,” was enough to meet this factor. The second factor is whether “the inquiry is relevant to the legitimate purpose.” The IRS agent had adequately explained how each of the four summonses were relevant to the investigation by specifically breaking down the information sought and what it would help the IRS determine.  The third factor is whether “the information sought is already within the Commissioner’s possession.” The court held the IRS met this factor as evidenced by their repeated document requests sent to HDR as well as evidence they did not have the sought-after information in their possession. Finally, the fourth factor requires the IRS to prove that it followed the administrative steps required by the IRC. To meet this requirement, the IRS must comply with the procedures outlined in §7602(c), which require it to give “reasonable notice in advance to the taxpayer that contacts with persons other than the taxpayer may be made.” This has been met by the IRS agent’s declarations establishing that proper notice was provided to HDR. The agent’s declarations explain how she twice sent HDR copies of IRS Publication 1, which informs the taxpayer, under a section entitled “Potential Third Party Contacts,” that the IRS will “sometimes talk with other persons if we need information that you have been unable to provide, or to verify information we have received.”