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Courts operate under a familiar framework during proceedings under 26 U.S.C.S. § 7609. As a threshold matter, the IRS must first show that it has not made a referral of the taxpayer's case to the Department of Justice for criminal prosecution. Then the IRS need only demonstrate good faith in issuing the summons, which means establishing what have become known as the Powell factors. Powell requires that the IRS establish: (1) that the investigation will be conducted pursuant to a legitimate purpose, (2) that the inquiry may be relevant to the purpose, (3) that the information sought is not already within the IRS's possession, and (4) that the administrative steps required by the Internal Revenue Code have been followed.
The Internal Revenue Service (IRS) was the one responsible to enforce the federal tax code against marijuana businesses operating legally under state law. This led to a civil audit of Peter Hermes, Kevin Desilet, Samantha Murphy, and John Murphy (collectively, the "Taxpayers") to verify their tax liabilities for their medical-marijuana dispensary, Standing Akimbo, LLC. The IRS was investigating whether the Taxpayers had taken improper deductions for business expenses arising from a "trade or business" which consisted of trafficking in controlled substances. However, claiming to fear criminal prosecution, the Taxpayers declined to provide the audit information to the IRS. This left the IRS to seek the information elsewhere—it issued four summonses for plant reports, gross-sales reports and license information to the Colorado Department of Revenue's Marijuana Enforcement Division (the "Enforcement Division"), which was the state entity responsible for regulating licensed marijuana sales. In Colorado federal district court, the Taxpayers filed a petition to quash the summonses. The government moved to dismiss the petition and to enforce the summonses. The district court granted the motion to dismiss and ordered the summonses enforced. The Taxpayers appealed.
Did the district court err in ordering that the summonses in question be enforced?
The court held that the district court properly ordered enforcement of a third-party summons to the Colorado Department of Revenue's Marijuana Enforcement Division under 26 U.S.C.S. § 7609, stemming from the IRS's investigation of whether the taxpayers, marijuana dispensary owners, had taken improper deductions for business expenses under 26 U.S.C.S. § 280E, because the Powell requirements were satisfied; Marijuana Enforcement Tracking Reporting Compliance information was relevant in determining whether the taxpayers trafficked in marijuana, a proper inquiry the IRS could make in determining § 280E's application. The court also held that the Taxpayer's affirmative defenses failed because the IRS's ability to share the collected information with law enforcement did not constitute bad faith, the summons did not require the creation of new documents, and the taxpayers had no legitimate expectation of privacy in the reports.