A federal judge in Colorado recently upheld a summons issued by the IRS to the Marijuana Enforcement Division (MED) of the Colorado Department of Revenue. Rifle Remedies, LLC v. U.S., 120 AFTR 2d 2017-5447, (DC CO), 10/26/2017. The ruling contains very few facts but suggests that a taxpayer actively engaged in the cannabis industry objected to an IRS summons issued to MED for information related to such taxpayer.
The IRS may enforce a summons when the following conditions are met:
- The investigation will be conducted pursuant to a legitimate purpose,
- The information sought may be relevant to that purpose,
- The information sought is not already in the IRS’s possession, and
- The IRS follows the required administrative steps.
In this particular case, the IRS asserted that it sought records from MED pertaining to the taxpayer’s federal tax liabilities to 1) verify financial records and 2) determine if the IRS could substantiate information contained in the taxpayer’s returns.
The taxpayer’s arguments against the summons focused on whether or not the IRS had a legitimate purpose for obtaining MED records. The taxpayer argued the IRS summons was pretext for a criminal investigation. The fact that an IRS summons could have a criminal investigation impact is not relevant to determining its validity when the summons has an otherwise valid and non-criminal basis such as revenue recognition or section 280E compliance.
The taxpayer also asserts that the IRS summons includes MED “Transfer Reports” that could be used by the IRS as a fishing exercise for determining other taxpayers in the cannabis industry and subject to section 280E. According to the court, the taxpayer’s argument did not put “much meat on the bone” because the summons applied to a single taxpayer. So-called John Doe summons are subject to section 7609(f) when a summons does not identify the person with respect to the potential tax liability.
IRS examination of taxpayers in the cannabis industry may lead to John Doe summons in the future. See U.S. v. Coinbase, Inc. 120 AFTR 2d 2017-5239 (DC CA), 07/18/2017. In general, an IRS John Doe summons is valid when:
- The summons relates to the investigation of a particular person or ascertainable group or class of persons,
- There is a reasonable basis for believing that such persons or group or class of persons may fail or may have failed to comply with any provision of any internal revenue law, and
- The information sought to be obtained from the examination of the records (and the identity of the person or persons with respect to whose liability the summons is issued) is not readily available from other sources.
The first and third prong should not be much of an IRS obstacle. The validity of an IRS John Doe summons will likely depend on the second prong — whether or not the IRS can assert a reasonable basis for believing cannabis-industry taxpayers generally fail to report revenue includable under section 61 or comply with section 280E. A systemic failure of taxpayers to accurately report revenue or calculate taxable income may lead to widespread issuance of John Doe summons of MED (and other state’s) records.
The takeaway? Taxpayers subject to state seed-to-sale tracking requirements should expect and anticipate that the IRS (and state taxing authorities) have complete and full access to such records. Furthermore, taxpayers lucky enough to have access to bank accounts should expect their financial institution to perform due diligence including comparing seed-to-sale records to financial records and tax returns. See FinCEN memo — “BSA Expectations Regarding Marijuana-Related Businesses.” Any differences should be reconciled and explained.