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High Desert Relief, Inc. v. United States

United States Court of Appeals, Tenth Circuit

March 5, 2019

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.

          Appeals from the United States District Court for the District of New Mexico (D.C. Nos. 1:16-CV-00469-MCA-SCY, 1:16-CV-00816-MCA-SCY, and 1:16-CV-01255-WJ-KBM)

          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, 138 S.Ct. 1281 (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 (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 gave notice that it was converting the government's motions to dismiss into motions for summary judgment pursuant to Fed.R.Civ.P. 12(d). The judge both explained her rationale-the conversion allowed her to consider the parties' supporting declarations and sundry exhibits-and afforded the parties an opportunity to present additional material. The government did not submit further filings; HDR filed a supplemental pleading arguing that "the federal drug laws which the IRS seeks to enforce through § 280E are a 'dead letter, '" and could not therefore serve as basis for the summonses at issue. Aplt.'s App. at 414, 419 (Pet'r's Supp. to Mot. for Summ. J., dated Mar. 9, 2017). In particular, HDR relied on two Department of Justice directives-the "Ogden Memo" issued in 2009, and the "Cole Memo," issued in 2013-as purported evidence of a "strong, official federal policy of non-enforcement of the CSA against medical marijuana dispensaries." Id. at 418, 420.

         While these proceedings were ongoing, HDR filed in the District of New Mexico a third and final petition to quash, this time directed at the IRS summons issued to Southwest Capital Bank. This case was assigned to another district court judge. This judge issued an order requesting that the parties show cause why the case should not be consolidated with earlier litigation filed by HDR (i.e., involving the two consolidated cases).

         However, before the parties filed their responses in the Southwest Capital Bank case, the district court judge presiding over the earlier litigation granted summary judgment to the United States. The judge determined that the government carried its prima facie burden of proving the four factors set out in Powell, and that HDR failed to demonstrate that the IRS had issued the summonses in bad faith. In addition, the judge rejected HDR's argument that enforcement of § 280E was improper because the CSA's proscription on marijuana trafficking had become a "dead letter." The judge accordingly granted the United States' motions, entered a separate order enforcing the summons to My Bank, [2] and entered judgment.

         In light of the above ruling, the judge presiding over the Southwest Capital Bank case entered an order ruling in favor of the IRS for "the same reasons" found by the judge in HDR's earlier action, concluding that the reasoning of the judge in the earlier action was "very persuasive authority." Aplt.'s App. at 714 (Order, dated Apr. 11, 2017).[3] Thereafter, the judge in the Southwest Capital Bank case entered an order enforcing the summons to that bank.

         HDR has appealed from the rulings of both district court judges, and those appeals have been consolidated for our resolution.

         II

         On appeal, HDR makes two overarching arguments for why we should reverse the district court judges' enforcement of the summonses and their adverse rulings on HDR's petitions to quash. First, HDR contends that the district judges misapplied the Powell factors. To that end, HDR attempts to refute the government's prima facie Powell showing and to demonstrate that the IRS's investigation did not proceed in good faith. Second, HDR argues that the district court judges erred in not applying a "dead letter rule" to the government's motions to enforce the summonses.

         The resolution of both arguments turns on issues of law. We address these issues in succession and conclude (A) that the IRS met its initial burden to demonstrate that it acted in good faith and HDR failed to thereafter rebut that showing, and (B) that HDR's proposed "dead letter rule" has no application here. We therefore uphold the dispositive rulings of both district court judges.

         A

         1

         We review de novo the district court judges' dispositive orders granting the IRS's motions. See Jewell v. United States, 749 F.3d 1295, 1297 (10th Cir. 2014) (applying de novo review to the district court's grant of summary judgment to the government on its motion opposing the taxpayer's petition to quash). Further, we will not reverse a district court's denial of a petition to quash an IRS summons unless the denial amounts to an abuse of discretion. See id. at 1297; accord Hopkins v. I.R.S., 318 Fed.Appx. 703, 705 (10th Cir. 2009) (unpublished); Lain v. United States, 173 Fed.Appx. 651, 652 (10th Cir. 2006) (unpublished); see also Sugarloaf Funding, LLC v. U.S. Dep't of the Treasury, 584 F.3d 340, 346 (1st Cir. 2009).

         Notably, a district court necessarily abuses its discretion "when it commits an error of law." Wyandotte Nation v. Sebelius, 443 F.3d 1247, 1252 (10th Cir. 2006); accord Westar Energy, Inc. v. Lake, 552 F.3d 1215, 1224 (10th Cir. 2009); see also Fox v. Vice, 563 U.S. 826, 839 (2011) ("A trial court has wide discretion when, but only when, it calls the game by the right rules."); United States v. Clarke, 573 U.S. 248, 256 (2014) ("[T]he District Court's decision is entitled to deference only if based on the correct legal standard."). Because the disposition of this appeal turns on issues of law, our standard of review in considering the propriety of all of the district court judges' decisions-that is, both the decisions related to the IRS's motions and those pertaining to HDR's petitions-is, as a practical matter, de novo.[4]

         2

         Notwithstanding the government's effort to demonstrate its satisfaction of the Powell factors through the vehicle of motions for summary judgment, see supra note 3, the government contends that "in the summons context" our authority instructs that traditional summary-judgment standards should not apply insofar as they instruct courts to view the evidence in the light most favorable to the nonmovant. Aplee.'s Resp. Br. at 31. In other words, the government appears to reason that, in this context, where summary judgment in its favor would be based on a determination that it had satisfied its burden under Powell and would serve as the predicate for enforcing its summonses, this traditional summary-judgment principle does not apply.

         The authority that the government relies on in making this argument is an unpublished decision from our court, Villarreal v. United States, 524 Fed.Appx. 419 (10th Cir. 2013) (unpublished), which the district court judges here cited to support similar reasoning. Specifically, the Villarreal panel held that, in the summons-enforcement context, "the traditional summary judgment standards such as viewing the facts in [the taxpayer's] favor, do not apply. Instead, [the taxpayer's] burden 'is significantly more stringent than that of a party opposing a motion for summary judgment.'" Id. at 423 (quoting United States v. Kis, 658 F.2d 526, 543 (7th Cir. 1981)). HDR contests the government's Villarreal-based argument, arguing that there is no reason to deviate from the traditional summary-judgment framework.

         We conclude that our published disposition in Jewell undercuts the government's argument, and, based on Jewell, the district court judges were mistaken in relying on Villarreal. In Jewell, we held that the traditional summary-judgment standard applies in the summons context when the taxpayer presents a challenge to the government's prima facie case under Powell. See 749 F.3d at 1297 n.1 ("The government argues that the summary judgment standard does not apply when the government makes its prima facie case under [Powell]. But the issue here is whether the government presented a prima facie case under Powell." (emphasis added)). Jewell thus provides the proper summary-judgment standard in this instance because, like the taxpayer in Jewell, HDR disputes the government's prima facie case under Powell.

         Although the district court judges were mistaken in applying the modified summary-judgment standard that the Villarreal panel articulated, it is axiomatic that we may affirm on any basis that the record adequately supports. See, e.g., Safe Streets All. v. Hickenlooper, 859 F.3d 865, 879 (10th Cir. 2017); Champagne Metals v. Ken-Mac Metals, Inc., 458 F.3d 1073, 1088 (10th Cir. 2006). Accordingly, in our assessment of whether the district court judges properly entered judgment against HDR, see infra, we will apply traditional Rule 56 summary-judgment standards and carefully consider the record de novo.

         More specifically, we will view the record in the light most favorable to HDR and ask whether the IRS has shown that there are no genuine disputes of material fact and that it is entitled to judgment as a matter of law. See Jewell, 749 F.3d at 1297. Notably, "[t]he substantive law at issue determines which facts are material in a given case." Beaird v. Seagate Tech., Inc., 145 F.3d 1159, 1165 (10th Cir. 1998). Accordingly, as explicated infra, the substantive rubric that the Supreme Court defined in Powell, 379 U.S. at 57-58, is of central importance in our determination of whether there are genuine disputes of material fact here.

         Notably, the traditional summary-judgment standard will not permit HDR to rest on conclusory statements in the summary-judgment record; such statements "do not suffice to create a genuine issue of material fact." Adler v. Wal-Mart Stores, Inc., 144 F.3d 664, 674 (10th Cir. 1998); see Mitchell v. City of Moore, Okla., 218 F.3d 1190, 1199-1200 (10th Cir. 2000) (noting that the plaintiff's "conclusory statement" was "woefully inadequate to survive a summary judgment motion").

         3

         We now address the substantive legal framework governing the enforcement of administrative summonses. "Congress has 'authorized and required' the IRS 'to make the inquiries, determinations, and assessments of all taxes' the [IRC] imposes." Clarke, 573 U.S. at 249-50 (quoting 26 U.S.C. § 6201(a)), accord Codner v. United States, 17 F.3d 1331, 1332 (10th Cir. 1994). "[I]n support of that authority," Congress has given the IRS "broad latitude" to issue summonses "[f]or the purpose of ascertaining the correctness of any return, making a return where none has been made, [and] determining the liability of any person for any internal revenue tax." Clarke, 573 U.S. at 250 (quoting 26 U.S.C. § 7602(a)). These summonses may be issued not only to the taxpayer being investigated, but also to third-parties who may hold relevant information. See 26 U.S.C. § 7602(a)(2). If a summonsed person or entity fails to comply with a summons, the IRS can bring an enforcement proceeding in a district court. See id. at § 7604.

         However, the taxpayer is not entirely without defenses. For instance, Congress requires the IRS to give notice of a third-party summons, id. at § 7609(a), and has granted the taxpayer the right to petition a district court to quash such a summons. Id. at § 7609(b)(2). That said, in proceedings to quash a third-party summons, the government can counterclaim for enforcement. Id. at § 7609(b)(2)(A). The proceedings associated with these dueling motions "should be summary in nature and discovery should be limited." United States ...


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