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Alpenglow Botanicals, LLC v. United States

United States Court of Appeals, Tenth Circuit

July 3, 2018

ALPENGLOW BOTANICALS, LLC, a Colorado Limited Liability Company; CHARLES WILLIAMS; JUSTIN WILLIAMS, Plaintiffs - Appellants,

          Appeal from the United States District Court for the District of Colorado (D.C. No. 1:16-CV-00258-RM-CBS)

          James D. Thorburn (Richard Walker with him on the briefs), Thorburn Walker LLC, Greenwood Village, Colorado, for Plaintiffs - Appellants.

          Patrick J. Urda, Attorney, Tax Division (Gilbert S. Rothenberg and Michael J. Haungs, Attorneys, Tax Division, and Counsel Robert C. Troyer, United States Attorney, with him on the brief), Department of Justice, Washington, D.C., for Defendant - Appellee.

          Before HARTZ, MURPHY, and McHUGH, Circuit Judges.

          McHUGH, Circuit Judge.

          Alpenglow Botanicals, LLC ("Alpenglow") sued the Internal Revenue Service ("IRS") for a tax refund, alleging the IRS exceeded its statutory and constitutional authority by denying Alpenglow's business tax deductions under 26 U.S.C. § 280E. The district court dismissed Alpenglow's suit under Federal Rule of Civil Procedure 12(b)(6) for failure to state a claim upon which relief could be granted, and denied Alpenglow's subsequent motion under Federal Rule of Civil Procedure 59(e) to reconsider the judgment. Exercising jurisdiction under 28 U.S.C. § 1291, we affirm.

         I. BACKGROUND

         Although twenty-eight states and Washington, D.C. have legalized medical or recreational marijuana use, the federal government classifies marijuana as a "controlled substance" under schedule I of the Controlled Substances Act ("CSA"). Green Sol. Retail, Inc. v. United States, 855 F.3d 1111, 1113 (10th Cir. 2017); see 21 U.S.C. § 812(c), Schedule I(c)(10); 21 C.F.R. § 1308.11(d)(23). The CSA makes it unlawful to knowingly or intentionally "manufacture, distribute, or dispense . . . a controlled substance." 21 U.S.C. § 841(a)(1). Under former President Obama, the Justice Department had declined to enforce § 841(a)(1) against marijuana businesses acting in accordance with state law, [1] but the IRS has shown no similar inclination to "overlook federal marijuana distribution crimes." Feinberg v. Comm'r, 808 F.3d 813, 814 (10th Cir. 2015). Instead, the IRS consistently denies business deductions to state-sanctioned marijuana dispensaries under 26 U.S.C. § 280E, [2] which prohibits any "deduction or credit" for any business that "consists of trafficking in controlled substances (within the meaning of . . . the Controlled Substances Act)." E.g., id.; Olive v. Comm'r, 792 F.3d 1146, 1147 (9th Cir. 2015).

         This appeal is the product of the clash between these state and federal policies. Alpenglow is a medical marijuana business owned and operated by Charles Williams and Justin Williams, doing business legally in Colorado. See Alpenglow Botanicals, LLC v. United States (Alpenglow I), No. 16-cv-00258-RM-CBS, 2016 WL 7856477, at *2 (D. Colo. 2016) (unpublished). After an audit of Alpenglow's 2010, 2011, and 2012 tax returns, however, the IRS issued a Notice of Deficiency concluding that Alpenglow had "committed the crime of trafficking in a controlled substance in violation of the CSA" and denying a variety of Alpenglow's claimed business deductions under § 280E. Id. Alpenglow's income and resultant tax liability were increased based on the denial of these deductions. Because Alpenglow is a "pass through" entity, the increased tax liability was passed on to Charles Williams and Justin Williams. As a result, Charles Williams owed the IRS an additional $24, 133 in taxes and Justin Williams owed an additional $28, 961. The two men paid the increased tax liability under protest and filed for a refund, which the IRS denied. Id.

         The men then filed a complaint in the United States District Court for the District of Colorado seeking to overturn the IRS's decision. Id. at *1. The United States filed a Motion to Dismiss the Complaint under Federal Rule of Civil Procedure 12(b)(6) for failure to state a claim upon which relief can be granted ("Motion to Dismiss"). In its Motion to Dismiss, the United States identified four claims raised by Alpenglow, three of which are relevant to this appeal: (1) the IRS does not have the authority to disallow deductions under 26 U.S.C. § 280E without a criminal conviction; (2) § 280E violates the Sixteenth Amendment's definition of gross income; and (3) § 280E is an excessive fine that violates the Eighth Amendment.[3]

         Following oral argument on the Motion to Dismiss, Alpenglow filed a Motion to Amend the Complaint "to allege further detail as to the specific deductions that the IRS denied." Id. The Amended Complaint alleged "the deductions denied were: rent for where the business was conducted; costs of labor; compensation of officers; advertising; taxes and licenses for doing business; depreciation; and other wages and salaries." Id. at *2. Alpenglow also filed a Motion for Partial Summary Judgment Refund Claim ("Motion for Partial Summary Judgment"). In addition to the claims identified in the Motion to Dismiss, Alpenglow's Motion for Partial Summary Judgment asserted two new claims: (1) the IRS's decision to apply § 280E was arbitrary because it had no evidence Alpenglow trafficked in a controlled substance; and (2) the IRS incorrectly disallowed exclusions for Alpenglow's costs of goods sold under 26 U.S.C. § 263A.[4] In its December 1, 2016 Opinion and Order, the district court granted Alpenglow's Motion to Amend the Complaint, granted the United States' Motion to Dismiss, and denied Alpenglow's Motion for Partial Summary Judgment ("Rule 12(b)(6) Dismissal").[5] Id. at *8.

         Twenty-eight days after the entry of final judgment, Alpenglow filed a Motion to Alter or Amend the Judgment pursuant to Federal Rule of Civil Procedure 59(e) ("Rule 59(e) Motion"). Alpenglow Botanicals, LLC v. United States (Alpenglow II), No. 16-cv-00258-RM-CBS, 2017 WL 1545659, at *1 (D. Colo. 2017) (unpublished). The motion contained a proposed Second Amended Complaint and asserted that the district court "misapprehended controlling law" by failing to consider the three new claims Alpenglow raised as a request to amend the complaint-specifically, that (1) the IRS improperly disallowed costs of goods sold; (2) the IRS produced no evidence of trafficking; and (3) § 280E violates the Eighth Amendment. Id. Alpenglow argued the district court should grant leave to amend because the United States would not be prejudiced by allowing Alpenglow to file the Second Amended Complaint. Id. The district court denied the motion, concluding it was not required to consider arguments not alleged in the Amended Complaint and Alpenglow was not entitled to amend because the request was untimely. Id. at *1-3.

         Alpenglow appeals both the Rule 12(b)(6) Dismissal and the court's denial of its Rule 59(e) Motion. We address each order in turn, beginning with the Rule 12(b)(6) Dismissal.


         A. Federal Rule of Civil Procedure 12(b)(6) Dismissal

         "We review a district court's dismissal under Federal Rule of Civil Procedure 12(b)(6) de novo." Khalik v. United Air Lines, 671 F.3d 1188, 1190 (10th Cir. 2012). "Under Federal Rule of Civil Procedure 8(a)(2), a pleading must contain 'a short and plain statement of the claim showing that the pleader is entitled to relief.'" Id. While "the pleading standard Rule 8 announces does not require 'detailed factual allegations, '" Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007)), the "complaint must contain enough allegations of fact, taken as true, 'to state a claim to relief that is plausible on its face, '" Khalik, 671 F.3d at 1190 (quoting Twombly, 550 U.S. at 570). "A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." Iqbal, 556 U.S. at 678.

         Under the Twombly/Iqbal pleading standard, courts take a two-prong approach to evaluating the sufficiency of a complaint. Iqbal, 556 U.S. at 678-79. The first prong of the test requires the court to identify which pleadings "are not entitled to the assumption of truth." Id. at 679. This includes "legal conclusions" as well as "[t]hreadbare recitals of the elements of a cause of action, supported by mere conclusory statements." Id. at 678. The second prong of the test requires the court to "assume th[e] veracity" of the well-pleaded factual allegations "and then determine whether they plausibly give rise to an entitlement to relief." Id. at 679. "Accordingly, in examining a complaint under Rule 12(b)(6), we will disregard conclusory statements and look only to whether the remaining, factual allegations plausibly suggest the defendant is liable." Khalik, 671 F.3d at 1191.

         Alpenglow argues it raised three legal theories that plausibly stated a claim and therefore precluded the district court's dismissal of the Amended Complaint under Rule 12(b)(6). First, Alpenglow asserts the IRS lacks the general authority to investigate and deny tax deductions under § 280E without a criminal conviction, and that, even if it had such authority, the IRS has insufficient evidence of trafficking to apply § 280E in this case. Second, Alpenglow claims the IRS's calculation of Alpenglow's income violates the Sixteenth Amendment. Third, Alpenglow contends § 280E violates the Eighth Amendment.[6] We now explain why none of these arguments supports a conclusion that the district court erred in dismissing the complaint, beginning with the IRS's application of § 280E.

         1. Denial of Deductions Under 26 U.S.C. § 280E

         As indicated, Alpenglow raises two arguments relating to the IRS's denial of its business deductions under § 280E: the IRS (1) lacks the authority to investigate whether Alpenglow trafficked in controlled substances because such a determination requires the IRS to conclude that the business violated federal drug laws and (2) acted in an arbitrary manner because it did not have any evidence that Alpenglow trafficked in controlled substances.

         a. Authority to investigate

         Alpenglow claims the IRS could not use § 280E to deny the deductions in the absence of a conviction from a criminal court that its owners had violated federal drug trafficking laws. At the core of Alpenglow's argument is the assumption that a determination a person trafficked in controlled substances under tax law is essentially the same as a determination the person trafficked in controlled substances under criminal law. Because Alpenglow sees the two as inextricably linked, it contends the IRS lacks the authority to apply § 280E until after a federal prosecutor has investigated and charged the taxpayer with violating federal criminal law and a judge or jury in a criminal proceeding has issued a verdict of guilty.

         We recently rejected this argument in Green Solution, 855 F.3d at 1120-21. There, Green Solution sued to enjoin the IRS from investigating Green Solution's business records in connection with an audit focused on whether certain business expenses should be denied under § 280E. We concluded the Anti-Injunction Act ("AIA") prevented the court from exercising jurisdiction over Green Solution's "suit for the purpose of restraining the assessment or collection of any tax." Id. at 1119 (quoting 26 U.S.C. § 7421(a)). In an attempt to avoid that conclusion, Green Solution argued the AIA did not preclude the action because a determination of "whether [it] trafficked in a controlled substance . . . is a criminal investigation properly carried out by the United States Attorney," id. at 1120, and thus "a determination of whether a taxpayer violated the CSA is not within the authority of the IRS," id. at 1121 (internal quotation marks omitted). In rejecting this argument, we noted that "§ 280E has no requirement that the Department of Justice conduct a criminal investigation or obtain a conviction before § 280E applies." Id. at 1121. And we noted that under 26 U.S.C. § 6201(a), "the IRS's obligation to determine whether and when to deny deductions under § 280E[] falls squarely within its authority under the Tax Code." Id. But because our analysis was limited to determining that the AIA precluded Green Solution's suit, we lacked subject matter jurisdiction to address the merits of the claim that "the IRS exceeded its authority under the Internal Revenue Code." Id. at 1121 & n.8. Instead, we decided "only that the IRS's efforts to assess taxes based on the application of § 280E fall within the scope of the AIA." Id. at 1121 n.8.

         Although not directly on point, our analysis in Green Solution is persuasive. Alpenglow offers no reason why we should conclude the IRS has the authority to assess taxes under § 280E, but cannot impose excess tax liability under § 280E. There is also no evidence that Congress intended to limit the IRS's investigatory power. Indeed, the Tax Code contains other instances where the applicability of deductions or tax liability turns on whether illegal conduct has occurred. See 26 U.S.C. § 162(c)(2) (denying deductions for illegal bribes, kickbacks, etc.); id. § 6663 (imposing civil tax penalty for fraud); id. § 165(e) (allowing deduction for theft loss). And other courts have upheld tax deficiencies against state-sanctioned marijuana dispensaries based on application of § 280E, without questioning the IRS's authority on this issue. See Olive, 792 F.3d at 1151; Beck v. Comm'r, 110 T.C.M. (CCH) 141, *5-6 (2015); Canna Care, Inc. v. Comm'r, 110 T.C.M. (CCH) 408, *3-4 (2015), aff'd, 694 Fed.Appx. 570 (9th Cir. 2017); Californians Helping to Alleviate Med. Problems, Inc. v. Comm'r (C.H.A.M.P.), 128 T.C. 173, 181-82 (2007).

         Nonetheless, Alpenglow argues that because Congress has not expressly delegated the IRS authority to investigate violations of federal drug laws, the IRS cannot make the predicate finding necessary for a denial of deductions under § 280E. In support of this proposition, Alpenglow points to a series of cases from the Supreme Court striking regulations involving the taxation of illegal conduct: Leary v. United States, 395 U.S. 6 (1969); Grosso v. United States, 390 U.S. 62 (1968); Haynes v. United States, 390 U.S. 85 (1968); and Marchetti v. United States, 390 U.S. 39 (1968). But these cases concern the invocation of the privilege against self-incrimination where the IRS investigation involved gambling, marijuana, or, in Haynes, possession of an unregistered firearm. See Leary, 395 U.S. at 13. Critically, these cases struck down IRS regulations that required the taxpayers to disclose information such as the names and addresses of the sellers and buyers, their registration numbers, and the quantity of the products sold. See id. at 15; see also Marchetti, 390 U.S. at 42-49. The Supreme Court concluded these tax provisions violated the Fifth Amendment due to the "substantial and 'real' . . . hazards of incrimination." Marchetti, 390 U.S. at 53 (quoting Rogers v. United States, 340 U.S. 367, 374 (1951)); Leary, 395 U.S. at 15. For example, in Marchetti, the Court noted that the regulation in question required the taxpayer to obtain a tax stamp, which necessarily "declar[ed] . . . a present intent" to violate gambling laws, and that federal and state courts had consistently relied on payment of the tax in subsequent criminal cases against the taxpayer. Marchetti, 390 U.S. at 47-48, 53. Indeed, some states and municipalities criminalized the mere possession of a tax stamp, making it impossible to comply with both laws. Id. at 48 n.10.

         Alpenglow's case is easily distinguishable from these cases. First, Alpenglow has not raised a Fifth Amendment challenge on appeal and is instead citing these cases for the IRS's authority to tax based on its conclusion that the taxpayer is engaged in illegal conduct. But the Supreme Court has repeatedly asserted, including in the cited opinions, that "the unlawfulness of an activity does not prevent its taxation." Id. at 44. The cases cited by Alpenglow were challenges to "the methods employed by Congress" in enforcing these statutes, id. (emphasis added), not the authority of the IRS to investigate and tax illegal activity. Second, these statutes involved the imposition of a tax for specific illegal conduct, not the denial of a tax deduction. Third, the tax information at issue in the cited cases was routinely shared with the Department of Justice and frequently used to support criminal charges, creating a tax provision that served as a proxy for a criminal investigation. Here, Alpenglow has failed to cite a single case in which the government relied on a denial of deductions under § 280E as evidence of guilt in a criminal trial. Accordingly, these decisions do not prohibit the IRS from applying § 280E to deny Alpenglow's deductions.

         In summary, it is within the IRS's statutory authority to determine, as a matter of civil tax law, whether taxpayers have trafficked in controlled substances. Thus, the IRS did not exceed its authority in ...

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