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05 June 2020
The United States Court of Appeals for the Tenth Circuit's recent opinion in Standing Akimbo, LLC v. United States, No. 19-1049 (10th Cir. April 7, 2020), reminds us of the Internal Revenue Service's (IRS) ability to obtain the information it needs to examine taxpayers' returns using its powerful summons tool.
In May 2017, the IRS began auditing Standing Akimbo, LLC (Standing Akimbo), a Colorado limited liability company operating as a medical-marijuana dispensary. The audit focused on whether Standing Akimbo improperly claimed business deductions that were prohibited under Internal Revenue Code (IRC) section 280E. Generally, IRC section 280E provides that no deduction or credit is allowed for any amount paid or incurred in the carrying of a business if such business trafficks in controlled substances that are prohibited by Federal law. While legal under Colorado law, marijuana is still classified as a controlled substance under Federal law, and specifically the Controlled Substances Act. As a pass-through entity, any adjustments to Standing Akimbo's returns would affect its owners' (Taxpayers) individual tax returns.
In connection with the examinations, the IRS revenue agent sent Standing Akimbo Information Document Requests (IDRs) seeking information related to Standing Akimbo's business, including a list of licenses held by Standing Akimbo and the Taxpayers as well as specific reports from the Colorado Department of Revenue's Marijuana Enforcement Division's (Enforcement Division) Marijuana Enforcement Tracking Reporting Compliance (METRC) system. The information provided by Standing Akimbo in response to the IDRs "was so minimal and incomplete" that the revenue agent could not verify the accuracy of Standing Akimbo's returns. The Taxpayers cited fear of criminal prosecution for their failure to provide all of the requested information. In response, the revenue agent issued third-party summonses to the Enforcement Division, and provided the Taxpayers with copies of the summonses along with an explanation of their right to petition to quash the summonses. The revenue agent appended a declaration to the summonses to support its enforcement.
The Taxpayers filed a petition to quash the summonses in federal district court, asserting that the summonses did not satisfy the requirements for enforcement under United States v. Powell, 379 US 48 (1964). Under Powell, an agency seeking to enforce a summons must show that: (1) "the investigation will be conducted pursuant to a legitimate purpose;" (2) "the inquiry may be relevant to the purpose;" (3) " the information sought is not already within the Commissioner's possession;" and (4) "the administrative steps required by the Code have been followed." In response, the government moved to dismiss the petition and enforce the summonses, arguing that the revenue agent's declaration satisfied the Powell requirements. The district court judge ultimately denied the petition to quash, granted the motion to dismiss, and enforced the summonses.
On appeal, the Taxpayers argued that the district court misapplied Powell in enforcing the summonses. The Tenth Circuit addressed each of the Powell factors, and concluded that the government offered sufficient evidence to meet each requirement. The government's burden of proof under the Powell factors is low, and once the government meets its low burden, the burden of proof then shifts to the taxpayer to either factually refute the Powell showing or factually support an affirmative defense. See United States v. Balanced Fin. Mgmt., Inc., 769 F.2d 1440, 1444 (10th Cir. 1985). The taxpayer bears a heavy burden to refute Powell.
The Tenth Circuit largely relied on the revenue agent's declaration to conclude that the government satisfied its low burden to establish the Powell factors. Regarding the first factor, the court concluded that the investigation was conducted pursuant to a legitimate purpose because the revenue agent declared he was assigned to conduct an examination of Standing Akimbo's tax returns, and the examination would necessarily affect the Taxpayers' tax returns. Regarding the second factor, the revenue agent's declaration stated that the third-party summonses sought information to "verify the accuracy of Standing Akimbo's internal books and records and to determine whether what Standing Akimbo reported on its returns is consistent with that information." Accordingly, the information sought by the summonses was relevant to a legitimate, investigatory purpose of the IRS.
Regarding the third factor, whether the sought information was already in the IRS's possession, the revenue agent's declaration stated that the summonses specifically requested the licenses held by the Taxpayers as well as specific METRC reports for tax years 2014 and 2015. The Taxpayers' partial responses to the IDRs did not give this information and did not include any information reported to the Enforcement Division, including METRC data. Similarly, regarding the fourth and final factor, the Tenth Circuit concluded the revenue agent complied with the administrative steps required by the Internal Revenue Code required in issuing the summonses
With respect to each of the Powell factors, the Tenth Circuit found that the Taxpayers failed to demonstrate the existence of a genuine factual dispute. Accordingly, the Tenth Circuit held that the IRS met its low burden under Powell, and the Taxpayers failed meet their "heavy burden" to refute this showing.
The government's burden of proof to enforce an administrative summons under Powell is very low. To be successful in defending against a summons, make sure to have a strong case, for example non-disclosure based upon a privilege claim. It may have been strategically better for the taxpayer work with the IRS agent to get information that would satiate the agent's needs.
For further information on this topic please contact Andrew Roberson or Kevin Spencer at McDermott Will & Emery by telephone (+1 312 372 2000) or email (email@example.com or firstname.lastname@example.org).The McDermott Will & Emery website can be accessed at www.mwe.com.
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