Court Finds IRS Allowed to Enforce Summons to Obtain Information from State of Colorado to Show Business Sold Controlled Substances

A taxpayer seeking to quash a summons from the IRS to the Colorado Department of Revenue’s Marijuana Enforcement Division failed to obtain the requested relief in the case of Rifle Remedies, LLC v. United States, USDC Colorado, Case No. No. 1:17-mc-00062.

The taxpayer had claimed that this subpoena was “really” a front for conducting a criminal investigation into the taxpayer’s marijuana business and, if the court didn’t accept that objection, the taxpayer had a series of other objections. 

But the Court found none of them met the requirements to quash a summons, specifically noting that, under the standard applied by the Tenth Circuit Court of Appeals (who would hear any appeal in this case).  The burden is first on the IRS but, as the Tenth Circuit noted in the case of Villareal v. United States, 524 F. App'x 419, 422-423 (10th Cir. 2013), that burden is slight.  The IRS must simply show:

  • The investigation is being conducted pursuant to a legitimate purpose;
  • The information being sought may be (as opposed to will be) relevant to that purpose;
  • The information is not already in the possession of the IRS; and
  • The IRS has followed the administrative steps required in the IRC.

Once that is shown the burden shifts to the taxpayer, a burden the Tenth Circuit labels a “heavy one” to show enforcement would constitute an abuse on the court’s process or that the IRS lacked institutional good faith in issuing the summons.

The opinion notes:

The declaration from IRS Revenue Agent Jean Walker (“Walker”) satisfies respondent's slight burden of establishing a legitimate purpose for its investigation. Notably, in her declaration, Walker stated that she is investigating petitioner's federal tax liabilities, and the purpose of the summons is to verify petitioner's financial records and to determine whether information reported in petitioner's tax returns can be substantiated. (ECF No. 5-1 at ¶¶ 4, 15.) The Court, thus, finds the IRS' investigation to have a legitimate purpose.

The taxpayer objected that the IRS’ “real” motivation was to obtain information for a criminal investigation. The Court rejected this position, noting:

Suffice to say, the Court does not find that the IRS is engaging in a criminal investigation when it investigates, for purposes of 26 U.S.C. § 280E (“§ 280E”), whether a business involves trafficking in a controlled substance. The purpose of such an investigation, as the statutory provision provides, is to determine whether a business is entitled to a deduction or credit; not to determine whether a business (or its proprietors) may be subject to criminal prosecution. See 26 U.S.C. § 280E. Moreover, none of the arguments that petitioner makes in this case have changed the Court's opinion. As such, the Court rejects petitioner's argument in this regard.

IRC §280E is an interesting provision in the law, providing that:

No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.

This provision denies deductions for expenses (other than cost of sales) for carrying on a trade or business where the business traffics in items that are controlled substances under federal law.  As the Court notes here, the question of whether this entity traffics in controlled substances is important in deciding if the entity is entitled to deductions for things like office supplies, rent, utilities, etc.  Obtaining information from the state of Colorado regarding the entity’s reporting of sales of what is controlled substance (marijuana) would seem clearly relevant in determining if IRC §280E applies to this business.

The taxpayer then advances a series of additional arguments about why this summons should be quashed, all of which the Court also rejected.