Alpenglow Botanicals, LLC v. United States

FILED
United States Court of Appeals
PUBLISH Tenth Circuit
UNITED STATES COURT OF APPEALS July 3, 2018
Elisabeth A. Shumaker
FOR THE TENTH CIRCUIT Clerk of Court
_________________________________
ALPENGLOW BOTANICALS, LLC, a
Colorado Limited Liability Company;
CHARLES WILLIAMS; JUSTIN
WILLIAMS,
No. 17-1223
Plaintiffs - Appellants,
v.
UNITED STATES OF AMERICA,
Defendant - Appellee.
_________________________________
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
1
This policy encouraging federal prosecutors not to prosecute these cases was
implemented through memoranda of the prior Attorneys General. See, e.g.,
Memorandum from David W. Ogden, Deputy Att’y Gen., U.S. Dep’t of Justice for
Selected U.S. Att’ys (Oct. 19, 2009), revised by Memorandum from James M. Cole,
Deputy Att’y Gen., U.S. Dep't of Justice for all U.S. Att’ys (Aug. 29, 2013). The
current Attorney General has since rescinded this policy. Memorandum from
Jefferson B. Sessions, Att’y Gen., U.S. Dep’t of Justice for all U.S. Att’ys (Jan. 4,
2018).
2
“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
2
26 U.S.C. § 280E states in full:
No deduction or credit shall be allowed for any amount paid or incurred
during the taxable year in carrying on any trade or business if such trade
or business (or the activities which comprise such trade or business)
consists of trafficking in controlled substances (within the meaning of
schedule I and II of the Controlled Substances Act) which is prohibited
by Federal law or the law of any State in which such trade or business is
conducted.
3
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;
3
The Motion to Dismiss also asserted that the district court did not have
subject matter jurisdiction to issue the injunctive relief requested by Alpenglow in
the complaint. Alpenglow Botanicals, LLC v. United States (Alpenglow I), No. 16-cv-
00258-RM-CBS, 2016 WL 7856477, at *1 (D. Colo. 2016) (unpublished). The
district court denied Alpenglow’s request for injunctive relief without addressing the
subject matter jurisdiction argument, id. at *6 n.3, and Alpenglow does not challenge
this ruling on appeal. Thus, the jurisdictional issue, which was limited to the
injunction claim, is not before us.
4
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
4
In the Amended Complaint and Motion for Partial Summary Judgment
briefing, Alpenglow also raised a Fifth Amendment claim, “alleg[ing] that the IRS
should have informed plaintiffs that they were under investigation for violating the
CSA.” Alpenglow I, 2016 WL 7856477, at *6. The district court denied this claim,
id., and Alpenglow does not raise it on appeal.
5
Alpenglow also filed a Motion for Order to Certify Question of
Constitutionality of Colorado’s Medical Marijuana Laws to Colorado State Attorney
General Pursuant to 28 U.S.C. § 2403(b). Alpenglow I, 2016 WL 7856477, at *1. The
district court denied this motion, id. at *8, and Alpenglow does not challenge that
ruling on appeal.
5
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.
II. DISCUSSION
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,
6
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
7
§ 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
6
Although the district court based its dismissal of these claims on the United
States’ Motion to Dismiss, it also denied Alpenglow’s Motion for Partial Summary
Judgment under Federal Rule of Civil Procedure 56 “with respect to whether the IRS
improperly denied the cost of goods sold, whether the IRS has authority to apply
§ 280E, and whether the application of § 280E violates the Sixteenth Amendment.”
Alpenglow I, 2016 WL 7856477, at *7.
8
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.
9
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 F. App’x 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);
10
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
11
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 denying Alpenglow’s business deductions under
§ 280E.
12
b. Evidence of trafficking7
Alpenglow also contends the IRS’s denial of its deductions was arbitrary
because the IRS had no proof Alpenglow trafficked in a controlled substance. But in
an action to recover taxes paid to the IRS, the “taxpayer has the burden to show not
merely that the IRS’s assessment was erroneous, but also the amount of the refund to
which the taxpayer is entitled.” Dye v. United States, 121 F.3d 1399, 1408 (10th Cir.
1997). Under this rule, the burden falls on Alpenglow to show error, not on the IRS
to prove trafficking. See Green Sol., 855 F.3d at 1121; Feinberg, 808 F.3d at 815.
Alpenglow has not satisfied this burden. As the district court noted, the “Amended
Complaint contains no allegations related to the IRS’[s] lack of evidence for
disallowing plaintiffs’ business expenses” and is instead “entirely premised upon the
IRS’[s] alleged lack of authority to disallow” them. Alpenglow I, 2016 WL 7856477,
at *7.
Rather than challenge the district court’s conclusion, Alpenglow relies on
26 U.S.C. § 7491 and argues that once it raised the allegation that the IRS lacked
7
Unlike Alpenglow’s other arguments, the district court dismissed this claim
solely within the context of Alpenglow’s Motion for Partial Summary Judgment. See
Alpenglow I, 2016 WL 7856477, at *7 (“The only argument . . . remaining in the
motion for summary judgment is whether the IRS has failed to produce sufficient
evidence that plaintiffs trafficked in a controlled substance.”). “We review a district
court’s grant of summary judgment de novo.” Amparan v. Lake Powell Car Rental
Cos., 882 F.3d 943, 947 (10th Cir. 2018). “Summary judgment is appropriate ‘if the
movant shows that there is no genuine dispute as to any material fact and the movant
is entitled to judgment as a matter of law.’” Id. (quoting Fed. R. Civ. P. 56(a)). “On
appeal, we examine the record and all reasonable inferences that might be drawn
from it in the light most favorable to the non-moving party.” Id. (internal quotation
marks omitted).
13
evidence of Alpenglow’s purported trafficking, “the burden shifted to the
Government as a matter of law to show it actually had the evidence.” Aplt. Br. at 29
(citing 26 U.S.C. § 7491). But § 7491 states:
If, in any court proceeding, a taxpayer introduces credible evidence
with respect to any factual issue relevant to ascertaining the liability of
the taxpayer . . . , the Secretary shall have the burden of proof with
respect to such issue.
26 U.S.C. § 7491(a)(1) (emphasis added).
Alpenglow did not make an arbitrariness argument in the Amended Complaint
or allege any “credible evidence” that it is not engaged in marijuana trafficking.
Thus, even if we assume the burden shifts to the IRS to prove its action was not
arbitrary, Alpenglow is not relieved of its initial obligation to provide “credible
evidence” that it does not traffic in a controlled substance. By choosing not to
advance this theory, or allegations supporting it, in the Amended Complaint,
Alpenglow has waived the claim. See J.V. v. Albuquerque Pub. Sch., 813 F.3d 1289,
1299 (10th Cir. 2016) (holding that “Appellants waived [a disparate impact] basis for
ADA liability by omitting it from their complaint”).
2. Taxable Income Under the Sixteenth Amendment
Alpenglow next raises a Sixteenth Amendment claim consisting of two
arguments: (1) under the constitutional definition of income, ordinary and necessary
business expenses must be excluded from gross income calculations; and (2) the IRS
improperly disallowed Alpenglow “costs of goods sold” exclusions under § 263A.
14
a. Ordinary and necessary business expenses
The Sixteenth Amendment grants Congress the power “to lay and collect taxes
on incomes, from whatever source derived, without apportionment among the several
States, and without regard to any census or enumeration.” For purposes of calculating
tax liability, the Internal Revenue Code includes two types of income: “gross
income” and “taxable income.”
The Tax Code codified the Sixteenth Amendment’s definition of income by
defining gross income as “all income from whatever source derived, including . . .
[g]ross income derived from business.” 26 U.S.C. § 61(a); see Comm’r v. Glenshaw
Glass Co., 348 U.S. 426, 432 n.11 (1955) (Section 61(a) “is based upon the 16th
Amendment and the word ‘income’ is used in its constitutional sense.” (internal
quotation marks omitted)); Samples v. Comm’r, 98 T.C.M. (CCH) 27, *3 (2009)
(“26 U.S.C. section 61(a) is in full accordance with Congressional authority under the
Sixteenth Amendment to the Constitution to impose taxes on income without
apportionment among the states.” (quoting Perkins v. Comm’r, 746 F.2d 1187, 1188 (6th
Cir. 1984))). “The starting point in the determination of the scope of ‘gross income’ is the
cardinal principle that Congress in creating the income tax intended to use the full
measure of its taxing power.” Comm’r v. Kowalski, 434 U.S. 77, 82 (1977) (internal
quotation marks omitted). To that end, Congress has the unquestioned constitutional and
statutory authority to tax gross income. New Colonial Ice Co. v. Helvering, 292 U.S. 435,
440 (1934). To ensure taxation of income rather than sales, the “cost of goods sold” is a
mandatory exclusion from the calculation of a taxpayer’s gross income. See Max
15
Sobel Wholesale Liquors v. Comm’r, 630 F.2d 670, 671 (9th Cir. 1980); Sullenger v.
Comm’r, 11 T.C. 1076, 1077 (1948); 26 C.F.R. § 1.61-3(a) (“‘[G]ross income’ means
the total sales, less the cost of goods sold . . . .”). Treasury Regulations include
“inventory price,” “transportation or other necessary charges incurred in acquiring
possession of the goods,” “cost of raw materials and supplies,” “direct labor” costs,
and “indirect production costs” as some of the mandatory exclusions to gross income.
26 C.F.R. § 1.471-3.88
Cost means:
(a) In the case of merchandise on hand at the beginning of the taxable year,
the inventory price of such goods.
(b) In the case of merchandise purchased since the beginning of the taxable
year, the invoice price less trade or other discounts, except strictly cash
discounts approximating a fair interest rate, which may be deducted or not
at the option of the taxpayer, provided a consistent course is followed. To
this net invoice price should be added transportation or other necessary
charges incurred in acquiring possession of the goods. For taxpayers
acquiring merchandise for resale that are subject to the provisions of
section 263A, see §§ 1.263A–1 and 1.263A–3 for additional amounts that
must be included in inventory costs.
(c) In the case of merchandise produced by the taxpayer since the beginning
of the taxable year, (1) the cost of raw materials and supplies entering into
or consumed in connection with the product, (2) expenditures for direct
labor, and (3) indirect production costs incident to and necessary for the
production of the particular article, including in such indirect production
costs an appropriate portion of management expenses, but not including
any cost of selling or return on capital, whether by way of interest or profit.
See §§ 1.263A–1 and 1.263A–2 for more specific rules regarding the
treatment of production costs.
26 C.F.R. § 1.471-3. “Treasury regulations must be sustained unless unreasonable and
plainly inconsistent with the revenue statutes . . . .” Comm’r v. S. Tex. Lumber Co., 333
U.S. 496, 501 (1948).
16
In contrast, taxable income is the taxpayer’s “gross income minus the
deductions allowed” by statute. 26 U.S.C. § 63(a). Deductions under § 162(a) are
matters of “legislative grace” specifically authorized by statute, see Commodore
Mining Co. v. Comm’r, 111 F.2d 131, 134 (10th Cir. 1940), and “Congress has
unquestioned power to condition, limit, or deny deductions from gross income in
arriving at the net which is to be taxed,” id. at 133 (citing Helvering v. Indep. Life
Ins. Co., 292 U.S. 371, 381 (1934)). One such statutorily-authorized deduction
“allows a business to deduct from its gross income ‘all the ordinary and necessary
expenses paid or incurred during the taxable year in carrying on the trade or
business.’” Olive, 792 F.3d at 1148 (quoting 26 U.S.C. § 162(a)). The Supreme Court
has defined “ordinary and necessary expenses” as those expenses that are
“‘appropriate and helpful’ to ‘the development of the (taxpayer’s) business,’” Colo.
Springs Nat’l Bank v. United States, 505 F.2d 1185, 1191 (10th Cir. 1974) (quoting
Comm’r v. Tellier, 383 U.S. 687, 689 (1966)), and “normal[] in the particular business,”
id. at 1193 (quoting Deputy v. du Pont, 308 U.S. 488, 496 (1940)). However, § 162(a)
prohibits certain deductions, such as “when the ‘amount paid or incurred during the
taxable year’ is for the purpose of ‘carrying on any trade or business consisting of
trafficking in controlled substances.’” Olive, 792 F.3d at 1148 (quoting 26 U.S.C.
§ 280E).
Alpenglow does not challenge Congress’s authority to limit or deny
deductions. Nor does Alpenglow contest that the IRS specifically enumerates nearly
all of the challenged expenses listed in the Amended Complaint as “Deductions.”
17
Instead, Alpenglow argues that, despite being listed in the Tax Code as deductions,
“certain necessary items like . . . ordinary and necessary [business] expenses” are
actually exclusions that, like the cost of goods sold, must be subtracted from the
calculation of a business’s gross income. See Davis v. United States, 87 F.2d 323,
324 (2d Cir. 1937). Consequently, Alpenglow claims § 280E violates the Sixteenth
Amendment because it “prevent[s] the deduction of expenses that a business could
not avoid incurring.” See Aplt. Br. at 25; Alpenglow I, 2016 WL 7856477, at *4.
Although there can be similarity between expenses that qualify as cost of
goods sold and ordinary and necessary business expenses (such as labor),9 the cost of
goods sold relates to acquisition or creation of the taxpayer’s product, while ordinary
and necessary business expenses are those incurred in the operation of day-to-day
business activities. The cost of goods sold is a well-recognized exclusion from the
calculation of gross income, while ordinary and necessary business expenses are
deductions. Indeed, while the Tax Code has statutorily excluded certain expenses
from the calculation of gross income, only the cost of goods sold is mandatorily
excluded by “[t]he very definition of ‘gross income’ . . . even in the absence of
specific statutory authority for such exclusion.” See Max Sobel, 630 F.2d at 671. In
contrast, ordinary and necessary business expenses have been repeatedly recognized
as statutorily-authorized deductions. See, e.g., Woolford Realty Co. v. Rose, 286 U.S.
9For example, while the cost of labor is typically considered “a subtractable
cost of goods sold,” Congress has the constitutional authority to “limit[] the amount
which may be subtracted for income tax purposes, on account of salaries and labor,
from the selling price of goods to a ‘reasonable allowance’ for salaries and wages.”
See Pedone v. United States, 138 Ct. Cl. 233, 239–40 (1957).
18
319, 328 (1932); Burnet v. Sanford & Brooks Co., 282 U.S. 359, 363 (1931); United
States v. Akin, 248 F.2d 742, 743–44 (10th Cir. 1957). Although the Supreme Court
has never been confronted with the exact argument Alpenglow makes—that
necessary business expenses are actually exclusions—the Court has indicated that
Congress has the authority to disallow the types of unavoidable expenses Alpenglow
identifies.
For example, prior to the enactment of 26 U.S.C. § 280E, the Supreme Court
refused the IRS’s attempt to deny the cost of rent and wages as ordinary and
necessary business expense deductions for a gambling business operating in violation
of state law. Comm’r v. Sullivan, 356 U.S. 27, 28 (1958). The Court held that, to
deny the business “the normal deductions of the rent and wages necessary to operate
it” would “come close to making this type of business taxable on the basis of its
gross receipts, while all other businesses would be taxable on the basis of net income.
If that choice is to be made, Congress should do it.” Id. at 29 (emphasis added); see
also Tellier, 383 U.S. at 692, 693 (“Deduction of expenses falling within the general
definition of § 162(a) may, to be sure, be disallowed by specific legislation, since
deductions are a matter of grace and Congress can, of course, disallow them as it
chooses.” (internal quotation marks omitted)). And, in passing 26 U.S.C. § 280E,
Congress did exactly that by denying ordinary and necessary business expenses
incurred by businesses engaged in drug trafficking. Where the Supreme Court
proposed that Congress make the choice whether to deny such deductions, we find it
difficult to conclude Congress acted unconstitutionally in doing so. It would be
19
strange indeed for the Supreme Court to invite Congress to pass legislation violating
the Constitution. It follows then that the business expenses here are deductions, not
costs of goods sold. Indeed, the United States Tax Court has expressly reached that
same conclusion.
In Californians Helping to Alleviate Medical Problems, the United States Tax
Court analyzed § 280E and concluded that the ordinary and necessary business
expenses associated with operating a medical marijuana business were deniable
deductions. C.H.A.M.P., 128 T.C. at 181–82. The tax court noted that the legislative
history of § 280E indicates the statute was enacted “as a direct reaction to the
outcome of a case in which [the tax] [c]ourt allowed a taxpayer to deduct expenses
incurred in an illegal drug trade.” Id. at 181. That case, Edmondson v. Comm’r,
permitted the taxpayer to deduct not only the cost of goods sold, but also his
“ordinary and necessary” business expenses. 42 T.C.M. (CCH) 1533 (1981),
superseded by statute, 26 U.S.C. § 280E. In its report discussing the enactment of
§ 280E, the Senate Finance Committee cited Edmonson as the impetus for the
provision and explained that § 280E was designed to disallow “[a]ll deductions and
credits for amounts paid or incurred in the illegal trafficking in drugs.” C.H.A.M.P.,
128 T.C. at 182 (citation omitted). Tellingly, the report’s next sentence stated: “[t]o
preclude possible challenges on constitutional grounds, the adjustment to gross
receipts with respect to effective costs of goods sold is not affected by this provision
of the bill.” Id. (citation omitted); see Peyton v. Comm’r, 85 T.C.M. (CCH) 1345, *5
20
(2003) (“[S]ection 280E disallows deductions and credits (but not costs of goods sold)
with respect to the sale of controlled substances.”).
Alpenglow also argues that, by refusing to allow deductions for unavoidable
business expenses, Congress is permitting the IRS to tax its gross receipts rather than
its income. But, “it is [not] a violation of due process to impose a tax on gross receipts
regardless of the fact that expenditures exceed the receipts. . . . The mere fact of intake
being less than outgo does not relieve the taxpayer of an otherwise lawfully imposed
tax.” Penn Mut. Indem. Co. v. Comm’r, 277 F.2d 16, 20 (3d Cir. 1960).
The Internal Revenue Code and United States Tax Court have characterized
ordinary and necessary business expenses as discretionary deductions—not
mandatory exclusions—to gross income calculations. Congress’s choice to limit or
deny deductions for these expenses under § 280E does not violate the Sixteenth
Amendment.
b. Costs of goods sold
Alpenglow also claims the IRS improperly denied it an exclusion from income
for costs of goods sold. Although Alpenglow did not make this argument until its
Motion for Partial Summary Judgment, the district court treated it as part of
Alpenglow’s Sixteenth Amendment claim and dismissed it under Rule 12(b)(6). The
court concluded Alpenglow did not “plausibly allege[] a claim that the IRS
improperly disallowed the cost of goods sold [because] the Amended Complaint
neither raises such a claim nor alleges any facts in that regard.” Alpenglow I, 2016
WL 7856477, at *5. We agree.
21
In its Amended Complaint, Alpenglow alleges the IRS issued a Notice of
Deficiency “denying all ordinary and necessary business deductions and increasing
the income of Alpenglow.” See Aplt. App. vol. 1, at 197 (emphasis added). The
Amended Complaint does not include “costs of goods sold” as one of the denied
deductions and nowhere in the Amended Complaint does Alpenglow claim, or allege
facts to support, that the IRS’s characterization of the denied expenses as
deductions—rather than costs of goods sold—was erroneous.
3. Eighth Amendment
Alpenglow’s third assertion is that § 280E is a penalty and enforcing it violates
the Eighth Amendment. Our recent decision in Green Solution, 855 F.3d 1111,
forecloses this argument. Green Solution held that “Section 280E is not a penalty,”
because “[t]he disallowance of a deduction is not an exaction imposed as a
punishment. Deductions are not a matter of right. Neither do they turn upon equitable
considerations. They are a matter of legislative grace.” Id. at 1121 (internal quotation
marks omitted). Alpenglow contends this conclusion in Green Solution is non-
binding dicta. We are not convinced.
In Green Solution, the taxpayer argued the district court could assert subject
matter jurisdiction over its injunction action against the IRS because § 280E is a
penalty, not a tax subject to the AIA. Id. We rejected that argument, concluding
instead that the attempt to enjoin the IRS’s investigation into the applicability of
§ 280E fell squarely within the jurisdiction-stripping provision of the AIA. Id.
Because the panel’s holding in Green Solution that § 280E is not a penalty was
22
necessary to its disposition of the case, that holding was not dicta. See Bishop v.
Smith, 760 F.3d 1070, 1083 (10th Cir. 2014) (“Statements which appear in an opinion
but which are unnecessary for its disposition are dicta.”). And although Green
Solution assessed whether § 280E was a penalty under the Anti-Injunction Act,
Alpenglow has offered no reason why the result should be different under the Eighth
Amendment. We remain convinced that § 280E is not a penalty.
***
Alpenglow has failed to state a claim entitling it to relief because § 280E does
not violate the Eighth or Sixteenth Amendments and the IRS did not exceed its
statutory authority in applying it to deny Alpenglow’s business deductions. We
therefore affirm the district court’s Rule 12(b)(6) Dismissal.
B. Federal Rule of Civil Procedure 59(e) Motion
We turn now to the denial of Alpenglow’s Motion to Alter or Amend the
Judgment pursuant to Federal Rule of Civil Procedure 59(e). “We review Rule 59(e)
decisions for abuse of discretion.” Etherton v. Owners Ins. Co., 829 F.3d 1209, 1228
(10th Cir. 2016). “An abuse of discretion is defined in this circuit as judicial action
which is arbitrary, capricious, or whimsical.” United States v. Pacheco, 884 F.3d
1031, 1047 (10th Cir. 2018) (quotation marks omitted). Grounds warranting a motion
to alter or amend the judgment pursuant to Rule 59(e) “include (1) an intervening
change in the controlling law, (2) new evidence previously unavailable, and (3) the
need to correct clear error or prevent manifest injustice.” Servants of the Paraclete v.
Does, 204 F.3d 1005, 1012 (10th Cir. 2000). “Thus, a motion for reconsideration is
23
appropriate where the court has misapprehended the facts, a party’s position, or the
controlling law.” Id. “It is not appropriate to revisit issues already addressed or
advance arguments that could have been raised in prior briefing.” Id. To reverse the
district court’s denial of a Rule 59(e) motion, “we must have a definite and firm
conviction that the lower court made a clear error of judgment or exceeded the
bounds of permissible choice in the circumstances.” Etherton, 829 F.3d at 1228
(internal quotation marks omitted).
1. Motion to Amend the Complaint
“An issue raised for the first time in a motion for summary judgment may
properly be considered [as] a request to amend the complaint, pursuant to Federal
Rule of Civil Procedure 15.” Pater v. City of Casper, 646 F.3d 1290, 1299 (10th Cir.
2011). “We therefore construe the district court’s refusal to address the new issue as
a denial of plaintiffs’ request.” Id. “Although leave to amend shall be freely given
when justice so requires,” Las Vegas Ice & Cold Storage Co. v. Far W. Bank, 893
F.2d 1182, 1185 (10th Cir. 1990) (internal quotation marks omitted), “[t]he decision
to grant leave to amend the pleadings is within the discretion of the trial court, and
we will not reverse the court’s decision absent an abuse of discretion,” Pater, 646
F.3d at 1299 (internal quotation marks omitted).
In light of our liberalized pleading rules, plaintiffs generally “should not be
prevented from pursuing a claim merely because the claim did not appear in the
initial complaint.” Id. at 1299. But plaintiffs cannot “wait until the last minute to
ascertain and refine the theories on which they intend to build their case.” Id.
24
(quotation marks omitted). We have repeatedly held that, “untimeliness alone is a
sufficient reason to deny leave to amend when the party filing the motion has no
adequate explanation for the delay.” Id. (quotation marks omitted); see Las Vegas Ice
& Cold Storage Co., 893 F.2d at 1185. And, “[w]here the party seeking amendment
knows or should have known of the facts upon which the proposed amendment is
based but fails to include them in the original complaint, the motion to amend is
subject to denial.” Las Vegas Ice & Cold Storage Co., 893 F.2d at 1185 (quotation
marks omitted).
In its Rule 59(e) Motion, Alpenglow challenges the district court’s Rule
12(b)(6) Dismissal Order and asserts that three of its claims should have been
permitted to be advanced in a Second Amended Complaint: (1) the IRS incorrectly
disallowed deductions for costs of goods sold under § 263A; (2) the IRS failed to
provide any evidence of trafficking to support its denial of Alpenglow’s deductions
under § 280E; and (3) § 280E violates the Eighth Amendment. Alpenglow II, 2017
WL 1545659, at *1–3. Alpenglow claimed the court “misapprehended controlling
law” by dismissing these claims for failure to sufficiently raise and/or support them
in its Amended Complaint rather than treating them as a request to further amend the
complaint. Id. at *1. Alpenglow also asserted that the district court relied on an
erroneous public policy announcement to support its dismissal of Alpenglow’s claim.
The district court noted that, although it had the ability to consider the
arguments as a request to further amend the complaint, it was not required to do so.
Id. The court also indicated that, even if it elected to consider Alpenglow’s request to
25
amend the complaint, it would deny the motion as untimely because Alpenglow had
sufficient facts to raise all three arguments in its original or Amended Complaint. Id.
at *2. And the court noted that it did not make a public policy analysis and would not
consider Alpenglow’s newly raised “Dead Letter Rule” argument on untimeliness
grounds. On appeal, Alpenglow argues this decision was an abuse of the district
court’s discretion. We have reviewed the district court’s decision on each of these
claims above and concluded the court did not err in dismissing them for failure to
state a claim. We now conclude the district court did not abuse its discretion in
refusing to allow Alpenglow to amend its complaint to address the relevant
deficiencies.
a. Costs of goods sold
Alpenglow first argues the district court abused its discretion in refusing to
grant it leave to amend the complaint to include a claim that the IRS improperly
included Alpenglow’s cost of goods sold in calculating its tax liability. As discussed
above, the district court denied this claim because Alpenglow’s Amended Complaint
failed to plausibly allege it. To address this deficiency, Alpenglow attached a
proposed Second Amended Complaint to its Rule 59(e) Motion. The critical
difference between the two complaints is that Alpenglow’s proposed Second
Amended Complaint asserts the IRS “den[ied] all ordinary and necessary business
deductions, including the cost of goods sold,” whereas the Amended Complaint made
“[t]he same allegation (minus reference to cost of goods sold).” Id. (emphasis added).
26
The district court denied the motion to amend the complaint on untimeliness
grounds because, despite having all the necessary facts, Alpenglow failed to raise the
claim earlier. As discussed above, Alpenglow failed to include the IRS’s alleged
denial of its cost of goods sold expenses in its Amended Complaint or to challenge
the IRS’s characterization of its denied expenses as deductions, despite having
received the Notice of Deficiency and the United States’ Motion to Dismiss—both of
which claimed the denied deductions excluded costs of goods sold. Under these
circumstances, the district court’s determination that Alpenglow had the facts
necessary to raise this argument sooner is not “a clear error of judgment.” See
Etherton, 829 F.3d at 1228 (quotation marks omitted).
b. Evidence of trafficking
Alpenglow concedes it did not raise the IRS’s alleged lack of trafficking
evidence in the Amended Complaint, but claims it could not have done so because
“the fact that the IRS did not have any evidence of purported trafficking came about
due to the representations made by the IRS in its response to the Plaintiff’s Motion
for Summary Judgment.” Aplt. Br. at 33. But, in its Motion for Partial Summary
Judgment on this issue, Alpenglow cites the IRS’s failure to make factual findings
establishing the purported trafficking conduct in the Notice of Deficiency as evidence
of the arbitrariness of the IRS’s decision. Because Alpenglow received the Notice of
Deficiency before it filed its initial complaint, as well as its Amended Complaint, the
district court’s conclusion that Alpenglow had all the necessary facts to argue this
27
claim sooner is not “a clear error of judgment.” See Etherton, 829 F.3d at 1228
(quotation marks omitted).
c. Eighth Amendment
Unlike its other arguments on appeal, Alpenglow’s claim that § 280E violates
the Eighth Amendment was raised in the Amended Complaint and dismissed by the
district court under Federal Rule of Civil Procedure 12(b)(6). See Alpenglow II, 2017
WL 1545659, at *2. The district court held Alpenglow did not raise a plausible
Eighth Amendment claim because “[t]he Amended Complaint is entirely devoid of
any allegations pertaining to the effect that § 280E has had on plaintiffs’ ability to do
business.” Alpenglow I, 2016 WL 7856477, at *6. Although Alpenglow argues the
district court should have allowed it to amend the complaint to allege sufficient
factual allegations to support its Eighth Amendment argument, we have concluded
that § 280E is not a penalty and thus does not violate the Eighth Amendment. So any
amendment to the complaint would be legally futile and the district court did not
abuse its discretion by denying the motion. See United States v. Greer, 881 F.3d
1241, 1244 (10th Cir. 2018), petition for cert. filed, 17-8775 (May 4, 2018). (“We are
not bound by the district court’s reasoning and may affirm on any ground adequately
supported by the record.” (internal quotation marks omitted)).
2. Public Policy/Dead Letter Rule
Alpenglow raises two distinct but related policy arguments to support its claim
that the IRS should not be permitted to apply § 280E to tax the gross income, rather
than the net income, of marijuana dispensaries operating in accordance with state
28
law. For the reasons discussed below, we reject both arguments and conclude the
district court acted well within its discretion in denying Alpenglow’s Rule 59(e)
Motion with respect to this claim.
First, Alpenglow asserts that, in its order granting the United States’ Motion to
Dismiss, the district court conducted an inaccurate analysis regarding the “public
policy exception” to the requirement that taxpayers be taxed on net income and that
“the court relied upon this analysis, at least in part, in its rulings.” Aplt. Br. at 34. In
support, Alpenglow quotes the district court’s statement: “[i]t is at least arguable
whether allowing a taxpayer to deduct from its gross income expenses incurred in
allegedly selling marijuana to the public frustrates the policy of the CSA.” Alpenglow
I, 2016 WL 7856477, at *5 n.2. According to Alpenglow, this comment shows the
district court conducted a public policy analysis and concluded the state-approved
sale of medical marijuana frustrates a sharply-defined public policy. Alpenglow takes
issue with this inferred conclusion, but we need not address it here. The district court
clarified in its order denying the Rule 59(e) Motion that the public policy discussion
was “entirely irrelevant to the [c]ourt’s ultimate finding,” Alpenglow II, 2017 WL
1545659, at *3, and “had nothing to do with resolving the issue before the [c]ourt:
plaintiffs’ argument that the Constitution forbids including in gross income the cost
of ordinary and necessary business expenses,” id. at *4.
Second, Alpenglow relies on Sterling Distributors, Inc. v. Patterson, to claim
there is a “generally accepted” Dead Letter Rule prohibiting the IRS from denying
deductions under a law “[w]hen there is a public policy of non-enforcement of the
29
law.” Aplt. Br. at 39, 40 (citing 236 F. Supp. 479, 483–84 (N.D. Ala. 1964)). First,
Alpenglow has failed to demonstrate any widespread acceptance or adoption of the
“Dead Letter Rule” announced in Sterling Distributors. To the contrary, the Supreme
Court has held that a public policy analysis on the disallowance of deductions under
the Tax Code is only appropriate “where Congress has been wholly silent,” Tellier,
383 U.S. at 693, because “[d]eduction of expenses falling within the general definition
of § 162(a) may, to be sure, be disallowed by specific legislation, since deductions ‘are a
matter of grace and Congress can, of course, disallow them as it chooses,’” id. (quoting
Sullivan, 356 U.S. at 28). See also Sullivan, 356 U.S. at 29 (“If th[e] choice [to tax illegal
business on the basis of gross income] is to be made, Congress should do it.”). Congress
has not been silent here; by enacting § 280E, Congress has spoken expressly on its intent
to prohibit the deduction of business expenses related to drug trafficking illegal under
federal law.
Second, even assuming the existence of a Dead Letter Rule, Alpenglow cannot
succeed on such a theory. The district court refused to consider this argument
because Alpenglow “failed to raise it when [it] could have done so at any time during
the parties’ pre-Judgment briefing.” Alpenglow II, 2017 WL 1545659, at *3 n.4. The
district court did not abuse its discretion in failing to consider this untimely
argument. See Las Vegas Ice & Cold Storage Co., 893 F.2d at 1185. Furthermore, the
Department of Justice has specifically rescinded its former policy of non-prosecution
for marijuana dispensaries complying with state law, evidencing governmental intent
to enforce this law. See Memorandum from Jefferson B. Sessions, Att’y Gen., U.S.
30
Dep’t of Justice for all U.S. Att’ys (Jan. 4, 2018). As such, § 280E would not
constitute a Dead Letter Rule, even if such a rule existed.
***
The district court was not “arbitrary, capricious, or whimsical” in holding that
Alpenglow’s request to amend the complaint was untimely. See Pacheco, 884 F.3d
at 1047. Therefore, the court did not abuse its discretion in denying Alpenglow’s
Rule 59(e) Motion.
III. CONCLUSION
We AFFIRM the dismissal of Alpenglow’s suit under Federal Rule of Civil
Procedure 12(b)(6) and the denial of Alpenglow’s Motion to Alter or Amend the
Judgment pursuant to Federal Rule of Civil Procedure 59(e).
31