General Tax Controversy News & Updates

In Palmolive Building Investors, LLC v. Commissioner, 149 T.C. No. 18, the Tax Court denied a charitable contribution deduction of a donated façade easement because the easement deed failed to satisfy the perpetuity requirement of section 170.

Background – Perpetuity Requirement

A contribution of a qualified real property interest is deductible as a qualified conservation contribution if, among other requirements, the contribution is exclusively for conservation purposes. The “exclusivity” requirement is only satisfied if the conservation purposes are protected in perpetuity. To be protected in perpetuity, the interest in the property retained by the donor must be subject to legally enforceable restrictions that will prevent uses of the retained interest inconsistent with the conservation purposes of the donation. The Regulations provide rules for many of these legally enforceable restrictions.

When donated property is subject to a mortgage, the mortgagee must subordinate its rights in the property to the right of the easement holder to enforce the conservation purposes of the gift in perpetuity. If the mortgagee fails to actually subordinate its rights in the property, the perpetuity requirement is not satisfied. Further, if an unexpected change in conditions makes the property’s continued use for conservation purposes impossible or impractical, then the restrictions required to protect the conservation purpose may be extinguished by judicial proceedings. In the event an easement is extinguished and the donor subsequently conveys the property and receives proceeds for it, the donee organization must be guaranteed to receive a certain portion of the proceeds.

Why Deed Failed to Satisfy Perpetuity Requirement in Palmolive Building Investors

In Palmolive Building Investors, Partnership PB (“Partnership”) transferred a façade easement by executing an easement deed (“Deed”) in favor of the Landmarks Preservation Council of Illinois (“LPCI”), a qualified organization. The purpose of the deed was to preserve the exterior perimeter walls of a building’s façade. At the time of the execution of the Deed, two mortgages encumbered the building. Before executing the Deed, Partnership secured an ostensible agreement from both mortgagees to subordinate their mortgages in the property to LCPI’s rights to enforce the purposes of the easement. However, the mortgagees’ subordination was limited by a provision in the Deed that gave the mortgagees a prior claim to any insurance and condemnation proceeds until the mortgage was paid off. This limitation proved to be fatal, as certain interests of the mortgagees were not actually subordinated to the interests of LPCI.

The IRS filed a motion for partial summary judgment, arguing that the easement deed did not satisfy the perpetuity requirement because it gave the mortgagees prior claims to extinguishment proceeds in preference to LPCI. The Tax Court agreed, holding that the easement deed failed to satisfy the perpetuity requirement for two reasons: (1) the mortgages on the building were not fully subordinated to the easement, and (2) LPCI was not guaranteed to receive its requisite share of proceeds in the event that the easement was extinguished and the donor subsequently conveyed the property and received proceeds for it.

It is worth noting that the Tax Court continued to strictly construe the requirement that the donee must be guaranteed to receive a certain portion of proceeds upon extinguishment, as it did in Kaufman v. Commissioner, 134 T.C. 182 (2010) – if a donee is not absolutely entitled to its requisite share of extinguishment proceeds, then the contribution’s conservation purpose is not protected in perpetuity. The First Circuit Court of Appeals has previously expressed its disagreement with this restrictive interpretation. In Kaufman v. Shulman, 687 F.3d 21 (1st Cir. 2012), the First Circuit explained that if any owner donates a facade easement and thereafter fails to pay taxes, a lien on the property arises in favor of the Government, and such lien would not be subordinated to the easement donee’s interest. Because this is always a possibility, a donee will never have an absolute entitlement to proceeds, so the perpetuity requirement will never be satisfied. The Tax Court refused to follow the First Circuit’s interpretation, explaining that it analyzes “conservation restrictions on the basis of property rights and interests that exist when the easement is granted, rather than conducting an analysis based on speculations of property interests that might arise in the future…”

This case illustrates the importance of ensuring that all requirements of section 170 are satisfied when a conservation easement is granted, as the Tax Court also held that the defects in the easement deed were not cured by a provision that sought to retroactively amend the deed to comply with section 170, because the requirements set forth in section 170 must be satisfied at the time of the gift.

You can read the full opinion here, and you can find more discussion on charitable contribution deductions for conservation easements here and here.

TIGTA recently released a report discusses their audit of the IRS’s estate and gift tax examination procedures.  TIGTA made eight recommendations of changes to the estate and gift tax examination process.  The bulk of TIGTA’s recommendations address the informal processes, lack of consistency, and unknown effectiveness of the estate and gift tax examination procedures.

One of the more significant findings of the report is that while the examination division proposed over $577 million of estate and gift tax deficiencies for FY 2016, only $98 million of those deficiencies were sustained after cases were considered by IRS Appeals.  The Examination division attributed this statistic to the fact that the Examination division proposes alternative deficiencies in order to prevent being whipsawed.  However, the Examination division could not separately identify the amount of deficiencies that were attributable to these alternative positions.  TIGTA highlighted that the Government could be subject to suits for attorneys’ fees pursuant to Section 7430 if the positions set forth in the notices of deficiency were not substantially justified.  TIGTA recommended that Examination division develop written guidance “on the circumstances in which it is advisable to propose and issue notices of deficiency in estate and gift tax examinations that contain alternative positions.”

Other highlights from the report include:

  • there is one gatekeeper who decides whether or not to route a case for examination and how to prioritize cases;
  • there is no quality review process;
  • unlike the process for selecting income tax returns for examination, the process of selecting estate and gift tax examinations for examination is based minimal written guidance and involves almost no objective procedures, but instead relies on human involvement and judgment; and
  • procedures for documenting case selection, examination documentation and managerial review either did not exist or if they did exist were not followed as closely as they should be.

TIGTA’s report can be accessed here.

On September 11, 2017, the Treasury Inspector General for Tax Administration (TIGTA) issued its final report discussing IRS compliance activities through fiscal year 2016 (the federal government’s fiscal year begins on October 1 and ends on September 30). TIGTA compiles statistical information reported by the IRS and issues the report annually in response to continuing stakeholder interest in the analysis and trends in IRS Collection and Examination function activities. Here are the highlights:

  • IRS Budget Increased, but Staffing Declined. Although the IRS budget increased in 2016, IRS staffing continued to decline. The budget increase was intended to improve customer service, prevent fraud and identity theft, and enhance cybersecurity to safeguard taxpayer data.
  • The Number of Tax Returns Examined Declined. The number of tax returns examined in 2016 decreased approximately nine percent compared to 2015. The number of examinations conducted in 2016 is approximately 32 percent lower than the number conducted during 2012. The report attributes the significant reduction in the number of examinations over that time period to a continued decline in examination staffing, which reached a 20-year low in 2016.

Percentage Change in the Number of Field Examiners and Examinations Since FY 2012

Source: IRS Data Book and Table 37 Examination Program Monitoring


  • IRS Issued Fewer Liens and Levies. The number of liens and levies issued continued to decline in 2016. The IRS issued its fewest amount of liens and levies since 2002.
  • Payment Alternatives – Increase in Direct Debit Installment Agreements. The number of direct debit installment agreements (a payment option available to certain taxpayers who cannot fully pay their tax obligations on time) has increased by 128 percent since 2012. The increased use of this payment option is likely attributable to reductions in enforcement personnel and the need to efficiently and effectively collect outstanding tax liabilities.
  • Legislative Initiatives. In December 2015, Congress enacted the Fixing America’s Surface Transportation Act. The law contains two measures designed to assist the IRS in collecting delinquent taxes: (1) authorizing the use of private debt collectors for the collection of outstanding inactive tax receivables, and (2) authorizing the State Department to revoke, or deny, passports to taxpayers with seriously delinquent tax debt. The IRS began assigning cases to private debt collection agencies in April 2017. The IRS also worked to coordinate with the State Department to implement the passport revocation program. You can read more about the passport revocation program here and here.

You can read the full report here.

Statutory Background

When a foreign corporation receives dividends from U.S. sources, the income is generally subject to tax at 30%. To avoid double taxation and encourage cross-border investments, the U.S. has entered into bilateral tax treaties with numerous countries. The bilateral tax treaty between the U.S. and Switzerland entitles Swiss-resident entities to a reduction in the tax rate applied to dividends received from U.S. sources provided it meets the criteria enumerated in the treaty. If none of the requirements listed in treaty are satisfied, the U.S. Competent Authority (“CA”) may authorize a lower rate if it determines the Swiss entity was not established for the principal purpose of obtaining treaty benefits (the CA is the official within the Treasury Department who is authorized to interpret provisions of bilateral tax treaties). The principal purpose test is designed to prevent business from establishing tax residency in a country primarily to obtain treaty benefits (i.e. treaty shopping).

Starr’s Request for Treaty Benefits

Starr International Company Inc. (“Starr”), a Swiss resident company, was once the largest shareholder of the insurance giant AIG. In 2007, Starr, which did not meet any of the criteria for the reduced dividend tax rate in the U.S.-Swiss tax treaty, petitioned the IRS for a discretionary reduction in the tax rate applicable to approximately $191 million in dividends Starr received from AIG in 2007. The CA denied Starr’s request for treaty benefits because it concluded that obtaining Swiss treaty benefits was a principal purpose of Starr’s recent relocation to Switzerland. The CA pointed to Starr’s history in low-tax jurisdictions as suggesting that it sought to avoid U.S. tax: it initially incorporated in Panama, it was first managed and controlled from Bermuda, it briefly relocated to Ireland and finally settled in Switzerland.

Starr challenged the decision, but the U.S. District Court for the District of Columbia upheld the CA’s denial of treaty benefits (see Starr International Company Inc. v. U.S. (120 AFTR 2d 2017-5488 (DC Dist Col, 8/14/2017)). Starr argued that it was not treaty shopping because Starr was a resident of Switzerland and treaty shopping always involves a resident of a country not party to the relevant tax treaty. However, the District Court rejected Starr’s definition of treaty shopping as narrow because Starr did not differentiate between “on paper” residency and bona fide residency required by the treaty. “On paper” residency is based on objective factors like domicile, nationality and place of management whereas bona fide residency is based on a substance-over-form determination that a taxpayer has a genuine connection to its “on paper” residence. Starr conceded that it was not a bona fide resident of Switzerland before it made its decision to establish residency in Switzerland and, according to the Court, in applying the principal purpose test, the CA properly looked beyond the objective factors of residency and properly concluded that Starr’s motivation for establishing bona fide residency was primarily motivated by obtaining the benefits of the U.S.-Swiss tax treaty.

Starr also argued that even if the CA applied the correct residency standard, it did not benefit from choosing Switzerland over Ireland or over its other finalists. However, the Court explained that the analysis is not limited to whether a company’s current jurisdiction is more favorable than its previous one, but rather why a company chose to establish itself in Switzerland over any other jurisdiction (a totality of the circumstances inquiry). In addition, the Court concluded that tax considerations were obviously important because Starr acknowledged that U.S. tax was one of four key criteria that the company analyzed in its decision to establish tax residency in Switzerland.

The Tax Court has issued its long-awaited decision addressing captive insurance arrangements. In Avrahami v. Commissioner, 149 T.C. No. 7 (2017), the Tax Court held that payments made from a number of businesses owned by the Avrahamis to a microcaptive insurance company that was wholly-owned by Mrs. Avrahami were not for “insurance,” and thus were not deductible as insurance premiums paid. Here is what you need to know.

Captive Insurance Generally

Amounts paid for insurance are deductible as ordinary and necessary business expenses. Insurance companies are generally taxed on the insurance premiums they receive. However, small insurance companies that satisfy certain requirements are eligible to make a section 831(b) election, in which case they are only taxed on their taxable investment income (which does not include premiums received). For 2009 and 2010, an insurance company other than a life insurance company that had written premiums that did not exceed $1.2 million could elect to be taxed under section 831(b) as long as they met all other requirements.

A pure captive insurance company is one that only insures the risks of companies related to it by ownership. A captive insurance company that is eligible to make a section 831(b) election (referred to as a “microcaptive”) does not pay tax on the premiums it receives. Thus, if a business owner creates a microcaptive that insures only the risks of the business owner’s business, the business is able to deduct up to $1.2 million for insurance premiums paid to the related microcaptive while the microcaptive does not pay tax on the premiums received. However, the premiums are only deductible if the payments are for “insurance,” which begs the question: what is “insurance”? This is the question Avrahami addressed in the context of payments made to microcaptives.

Case Background

The Avrahamis owned jewelry stores and commercial real estate companies (the “Avrahami Entities”). In November 2007, they created an insurance company (the “Captive”) to insure the risks of the Avrahami entities. The Captive was wholly-owned by Mrs. Avrahami. In 2009 and 2010 – the years at issue in this case – the Avrahami entities paid the Captive premiums for direct insurance policies of approximately $730,000 and $810,000, respectively, for policies covering seven types of risk including: administrative actions, business risk indemnity, business income protection, employee fidelity, litigation expense, loss of key employee, and tax indemnity. In addition to its direct policies, the Captive participated in a risk distribution program with other small captive insurance companies through Pan American. Through Pan American’s risk distribution program, the Avrahami Entities paid approximately $360,000 to Pan American for terrorism coverage only. Pan American then reinsured all of the risk it had assumed and would make sure that the Captive received reinsurance premiums equal to the amount paid by the Avrahami Entities to Pan American ($360,000), and in exchange the Captive would reinsure a small percentage of Pan American’s total losses. In total, the Avrahamis deducted approximately $1.1 million and $1.3 million in 2009 and 2010, respectively, for insurance premiums paid from the Avrahami Entities to the Captive or Pan American for both direct policies and for the terrorism coverage obtained through the risk distribution program. Only the Avrahami Entities were covered by the direct policies while over 100 insureds were included in the risk distribution program.

The IRS argued that neither the Captive nor Pan American sold “insurance”, meaning the premiums paid by the Avrahami Entities were not deductible as ordinary and necessary business expenses. The Tax Court agreed.

The Court’s Analysis

To be considered insurance, the arrangement must: (1) involve risk-shifting; (2) involve risk-distribution; (3) involve insurance risk; and (4) meet commonly accepted notions of insurance. The Tax Court analyzed only two of these elements: risk distribution and commonly accepted notions of insurance.

Risk distribution occurs when the insurer pools a large enough collection of unrelated risks. The Tax Court looked to the number of companies the Captive insured and the “number of independent risk exposures” (i.e., how many policies does the Captive issue and what do those policies cover). Ultimately, the Court determined that insuring 3 companies in 2009 and 4 in 2010, issuing 7 direct policies that covered 3 jewelry stores, 3 commercial real estate companies, 2 key employees, and 35 other employees did not cover a sufficient number of risk exposures to achieve risk distribution through the affiliated entities. The Court distinguished the facts present in this case from other cases where they have determined that insurers adequately distributed risk.

The Avrahamis argued that they adequately distributed risk because, in addition to the Captive insuring the Avrahami Entities, the Captive participated in the Pan American risk distribution program and reinsured third-party risk. The Court determined that Pan American was not a bona fide insurance company in the first place, meaning the policies it issued were not “insurance” and the Captive could not have distributed risk by reinsuring policies that were not insurance to begin with. The Court looked to a number of factors to determine whether Pan American was a bona fide insurance company, ultimately concluding that it was not for the following reasons:

  • There was a circular flow of funds. Avrahami Entities paid Pan American, Pan American turned around and reinsured all of the risk it had assumed, making sure that the Captive received reinsurance premiums equal to those paid by the Avrahami Entities. Thus, money was effectively transferred from an entity owned by the Avrahamis (one of the Avrahami Entities) to an entity wholly-owned by Mrs. Avrahami (the Captive).
  • The premiums charged for terrorism coverage were “grossly excessive”. The only policy Pan American issued was for terrorism coverage, and the policy was worded in a way that it was highly unlikely that the triggering event would ever occur.
  • Pan American charged high premiums for an event that was unlikely to ever occur (and had never occurred in the past), and if the event did occur Pan American may have not been able to pay the claims.
  • Because the risk distribution program was not recognized by the Court, when the Court reviewed the direct policies it determined that on a stand-alone basis they also did not adequately distribute risk because the direct policies only covered the Avrahami Entities and the combination of risks and entities covered by the direct policies did not distribute risk among an adequate number of independent insurance risks.

For these reasons, the Court concluded that the Captive did not adequately distribute risk.

The Tax Court then analyzed whether the Captive met commonly accepted notions of insurance, which required the Court to work through a number of factors. The Court determined that the Captive was not selling insurance in the commonly accepted sense. The Court explained:

  • The Captive did not operate like an insurance company. No claims were filed until the IRS began its audit. The Captive only invested in illiquid, long-term loans to related parties and failed to get regulatory approval before transferring funds to them.
  • The Captive returned substantial portions of its surpluses to the insureds and owners of the insured through various loans and distributions.
  • The Captive policies were questionable because they were unclear and contradictory.
  • The Captive charged unreasonable premiums even though an actuary priced the policies. The Court did not find the actuary’s pricing methodology at all persuasive, noting that the actuary consistently chose inputs that would generate higher premiums. The Court noted that before creating the Captive, the Avrahami Entities paid $150,000 for commercial insurance policies. After creating the Captive, the Avrahami Entities paid $1.1 million and $1.3 million in 2009 and 2010, and paid $90,000 for a commercial insurance policy.

As a result, the Court concluded that payments made from the Avrahami Entities to the Captive and Pan American were not for insurance, and thus were not deductible as ordinary and necessary business expenses.

It is worth noting that the Captive was incorporated under the laws of the Caribbean nation of Saint Christopher and Nevis (St. Kitts). The Captive made a section 953(d) election to be treated as a domestic corporation for federal income tax purposes, and also made an election to be taxed as a small insurance company under section 831(b). However, since the Captive’s policies were not for “insurance”, both elections were invalid, and it was thus treated as a foreign corporation for federal income tax purposes. The parties stipulated that the taxable premiums earned by the Captive were not subject to U.S. Federal income tax.

Impact on Continuing IRS Scrutiny of Captive Insurance Arrangements

For several years, the IRS has devoted significant resources to examinations of captive insurance arrangements and numerous cases are the subject of Tax Court petitions.  There are several cases pending in the Tax Court post-trial.  The IRS increased its scrutiny of microcaptives when it issued Notice 2016-66, requiring self-reporting by taxpayers engaging in captive insurance arrangements where there has been a low incidence of claims or where significant loans have been made to related parties. In light of the Avrahami decision, the IRS is likely to continue devoting resources to scrutinizing and challenging captive insurance arrangements it believes are abusive.

As many readers know, the Bipartisan Budget Act of 2015 (“BBA”) repeals the long standing TEFRA procedures governing IRS examinations of partnerships.  As a result, beginning January 1, 2018, partnerships are subject to a centralized partnership audit regime.  However, partnerships are permitted to make an election to have the BBA rules apply to partnership returns filed for tax periods beginning after November 2, 2015 and before January 1, 2018.  For most partnerships, this will apply to the 2016 and 2017 tax years.

Early Election Procedures under Section 1101(g)(4) of the BBA

Partnerships who receive written notification that a partnership return for an eligible year has been selected for examination have 30 days after the date of such notification to file an election to be subject to the BBA centralized partnership regime for that year.  The election can be made on Form 7036,  or by preparing a statement that complies with the regulations.  The election statement requires the partnership representative to represent that the partnership (1) is not insolvent and does not reasonably anticipate becoming insolvent before resolution of any adjustment for the partnership taxable year for which the election is being made; (2) is not currently and does not reasonably anticipate become subject to the bankruptcy petition under Title 11; and (3) has sufficient assets, and reasonably anticipates having sufficient assets, to pay a potential imputed underpayment.

IRS Guidance

On June 29, 2017, the Commissioners of the LB&I division and the SB/SE division issued a memo addressing procedures initial contacts with taxpayers eligible to make the early election.  The memo educates managers and examiners on which partnerships are eligible to make the election, how and when the election is made, the proper content of the election statement, and related correspondence procedures.  The memo requires the issuance of a new Initial Contact Letter, Letter 2205-D, at the beginning of a partnership examination.  If the partnership responds by making an early election, the process outlined below is followed.  If an early election is not made, examiners are instructed to follow existing TEFRA or NonTEFRA procedures.

The memo instructs examiners who receive elections to verify that no amended returns or administrative adjustment requests have been filed as this would disqualify the partnership from making the early election.  The memo also instructs examiners to ensure that Form 7036 is properly completed or that an election not on Form 7036 meets the requirements of Treas. Reg. section 301.9100-22T, request any missing information from the taxpayer if the 30-day election window is still open, and determine whether the election is valid.  The memo further instructs the examiner to wait 30 days after the valid election is received before issuing a notice of administrative proceeding.  The reason for the 30-day waiting period is to allow the partnership to file any administrative adjustment requests as permitted under Section 6227 as amended by the BBA.  During this 30-day period, examiners are instructed to perform a “cursory check” to determine whether the partnership representative’s name, address, identification number and phone number are correct.  Examiners are not permitted to issue a notice of administrative proceeding until the 30-day period expires.

We expect to see continued guidance from the IRS on BBA centralized partnership examination procedures as the rules become effective.

The IRS recently released Revenue Procedure 2017-31 which adds Belgium, Columbia and Portugal to the list of participates in the automatic exchange of information on bank interest paid to nonresident alien individuals for interest paid on or after January 1, 2017. Back in December, we discussed the previous additions to the list of participates and the implications of the expanding program. With these additional countries, there are now 43 countries participating in the automatic exchange program.

The IRS may only share information with a foreign government that has entered into a mutual information exchange agreement. The U.S. only enters into information exchange agreements after the U.S. Treasury and IRS are satisfied that the foreign government has strict confidentiality protocols and protections. The IRS is statutorily barred from sharing information with another country without such an agreement in place. All U.S. information exchange agreements require that the information exchanged under the agreement be treated and protected as secret by the foreign government.

As has been the case for the last decade, U.S. is ramping up enforcement through the use of information reporting requirements, which is one of the most effective tools it has to combat tax evasion.

On November 1, 2016, the IRS issued Notice 2016-66 imposing new reporting requirements on micro-captives and their material advisors (see prior post describing the Notice). On March 27, 2017, CIC Services, LLC and Ryan, LLC filed a complaint against the IRS seeking a preliminary injunction prohibiting the IRS from enforcing the disclosure requirements in the Notice. They argued that as material advisors subject to the Notice’s disclosure requirements, complying with the Notice’s disclosure requirements will force them to incur significant costs. In addition, they argued that the Notice constitutes a legislative-type rule that fails to comply with the mandatory notice-and-comment requirements under the Administrative Procedures Act. CIC Services had previously filed a lawsuit on December 28, 2016 against the IRS seeking an injunction but voluntarily withdrew the suit hoping that lobbying efforts undertaken on behalf of the captive insurance industry would result in the IRS eliminating or modifying the reporting requirements.

In denying the injunction, the US District Court for the Eastern District of Tennessee found that the Tax Anti-Injunction Act (AIA) prohibits injunctive relief restraining the assessment or collection of any tax and that the penalties assessed for noncompliance with the Notice are taxes within the AIA’s injunctive relief prohibition. However, the Court notes that the AIA does not prevent the plaintiffs from obtaining judicial review of the Notice, but only after they fail to report, pay the penalties and sue for a refund.

The Court conceded that the plaintiffs demonstrated that they are likely to suffer at least some irreparable harm in the absence of an injunction. The plaintiffs estimate that they and similarly situated captive insurance companies will expend at least $60,000 per year to comply with the Notice’s requirements. However, in weighing the public’s interest for the disclosures, the Court found that the public interest would not be served by issuing the injunction because Congress gave the IRS authority to designate certain transactions as “reportable transactions” as a way to identify transactions that have the potential for tax avoidance or evasion. During hearings on the motion, the principal and founder of CIC testified that captive insurance agreements can “most definitely” be used for tax avoidance or evasion purposes. As a result, the Court concluded that the public interest in identifying transactions potentially aimed at tax avoidance or evasion outweigh any incidental effect on entities forced to comply with the IRS’s reporting requirements.


In The Green Solution Retail v. U.S., Case No. 16-1281, 10th Cir, May 2, 2017, the Tenth Circuit agreed with the District Court that a marijuana dispensary was not entitled to injunctions intended to stop an IRS examination of the taxpayer’s books and records. After the IRS initiated an examination, the taxpayer filed injunction to prevent IRS from investigating its business records and also sought declaratory judgment that IRS was acting outside its authority because in applying Section 280E, it was attempting to determine whether the taxpayer violated the Controlled Substances Act. The IRS moved for dismissal based on lack of subject matter jurisdiction asserting the Anti-Injunction Act (“AIA”) prevents the court from hearing the case and Declaratory Judgment Act (“DJA”) prohibits declaratory judgments in certain federal tax matters. Both the District Court and the Tenth Circuit agreed with the IRS.

  • The AIA prevents suits for the purpose of restraining the assessment or collection of any tax. Section 7421(a). The AIA is a jurisdictional statute which prevents the courts from entertaining suits which prohibit the collection of federal taxes. The taxpayer argued that the AIA did not apply because the IRS actions did not, yet, involve assessment of tax. However, pursuant to Lowrie v. United States, 824 F.2d 827, 830 (10th Cir. 1987), the AIA also bars “activities leading up to, and culminating in, such assessment and collection.” The Tenth Circuit and the District Court applied the holding in Lowrie to hold that the AIA barred a suit here.
  • The DJA allows a federal district court to grant declaratory relief in a case of a controversy…except with respect to Federal taxes.  28 U.S.C. section 2201.  The Tenth Circuit held “if AIA bars this suit, the DJA claims are likewise barred because the two Acts are coterminous.”
  • The taxpayer argued that the Supreme Court’s decision in Direct Marketing Ass’n v. Brohl, 135 S. Ct. 1124 (2015), holding that the Tax Injunction Act deprived the Courts from jurisdiction to stop the implementation of Colorado’s sales tax reporting regime, overruled Lowrie. The Tenth Circuit concluded that while Direct Marketing called into question the holding in Lowrie, it did not clearly undermine Lowrie, and therefore Lowrie controls here.
  • After concluding that Direct Marketing did not overrule Lowrie, the Court addressed the taxpayer’s arguments that the AIA was not applicable because the IRS was acting outside its jurisdiction and because section 280E is a penalty, not a tax.  The Tenth Circuit disagreed with both of these arguments, reviewing the Colorado District Court’s recent decision in Alpenglow Botanicals v. U.S., discussed in our prior post available here, to determine that the IRS was not acting outside its jurisdiction.  The Tenth Circuit also clearly held that “Section 280E is not a penalty,” primarily based on case law holding that disallowance of a deduction is not a penalty or punishment.

Followers of developments in this area should note that the taxpayer has also filed a petition to quash a summons issued to the Colorado Marijuana Enforcement Division. This case is pending in the United States District Court for the District of Colorado, Case no 1:16-mc-00137 (filed June 27, 2016).

In recent IRS summons litigation, a Federal District Court in New Mexico has ruled that the IRS may seek information from a bank, the New Mexico Department of Health – Medical Cannabis Program, and the Public Service Company of New Mexico, which was requested in order to determine whether the taxpayer was subject to Section 280E.  The taxpayer filed a motion to quash the summons on the basis that the IRS was engaging in a criminal investigation and did not have the authority to determine whether the taxpayer was violating the Controlled Substances Act (“CSA”).

The Court ruled that the summonses satisfied the Powell test and therefore should be enforced.  In response to the taxpayer’s allegation that the IRS is abusing its civil audit authority and is conducting a criminal investigation, the Court relied on the Revenue Agent’s statements that there was no criminal investigation.  The Revenue Agent stated that the IRS was enforcing the tax code and, in order to do so, needed to determine whether there were violations of the CSA.

The Court quoted the Alpenglow Botanical case (discussed here) in ruling that a criminal investigation is not required for the IRS to make a determination that the CSA was violated.  The Court stated that Section 280E “does not first require a determination by a non-IRS government official conducting a criminal investigation that the party claiming a deduction is trafficking in controlled substances.”  In short, Section 280E applies even if the taxpayer has not been charged or prosecuted for violating Federal law.

The opinion is available here: HDR NM Summons case.