Taxable Talk

Two marijuana dispensaries were audited by the IRS. Because of Internal Revenue Code § 280E (which prohibits all deductions for carrying on a business of trafficking in a controlled substance, which marijuana is), the first dispensary was looking at a tax bill of $1,129,276 with penalties of $225,855; the second was “only” faced with additional taxes of $531,707 and penalties of $106,341. The dispensaries received Notices of Deficiency, and they petitioned the Tax Court. The attorneys sent the petitions by Federal Express First Overnight. But they made mistakes:

• They sent the package to the Tax Court just before the deadline to file a petition;
• They used a service that wasn’t on the IRS list of approved private delivery services; and
• The package arrived after the deadline.

The petitions were received, but the IRS filed motions to have them dismissed for “Lack of Jurisdiction.” This happens when you file late–the Tax Court is a court of limited jurisdiction, and you must follow the rules in order to have a case heard there. The IRS prevailed at the Tax Court (the case was dismissed for lack of jurisdiction), and the dispensaries appealed to the Ninth Circuit Court of Appeals.

In today’s ruling of the Ninth Circuit in Organic Cannabis Foundation, LLC v. Commissioner, the Court begins:

This unhappy case presents a cautionary tale about the need for lawyers to ensure that they have done exactly what is statutorily required to invoke a court’s jurisdiction. The unusual Internal Revenue Code (“I.R.C.”) provision at issue here allows taxpayers to benefit from a “mailbox” rule—i.e., that a document will be deemed filed when dispatched—only if the taxpayer uses one of the particular delivery services that the Internal Revenue Service (“IRS”) has specifically designated for that purpose in a published notice.

Read the rules! It’s not hard; the IRS maintains a list of such services. The attorneys used a faster service than what was then on the list. The problem is the plain language of the statute, as the Court notes:

Unlike Federal Rule of Appellate Procedure 25(a)(2)(ii), which applies a mailbox rule to the timely delivery of a brief to “a third-party commercial carrier,” § 7502 does not allow taxpayers to use the services of any bona fide commercial courier. Instead, the statute specifies that a particular “delivery service provided by a trade or business” will count as a “designated delivery service” only “if such service is designated by the Secretary for purposes of this section.” I.R.C. § 7502(f)(2). The term “Secretary” means “the Secretary of the Treasury or his delegate,” id. § 7701(a)(11)(B), and here that delegate is the Commissioner (or his further delegate). In addition to requiring a formal designation, the statute states that the IRS may designate a delivery service “only if [it] determines that such service” meets four enumerated statutory criteria designed to ensure that the delivery service is at least as adequate as the U.S. mail…

Congress did not merely require that a private delivery service meet certain functional criteria concerning the operation of that delivery service; it also pointedly insisted that the service must be “designated by the Secretary for purposes of this section.” I.R.C. § 7502(f)(2) (emphasis added). Given the wide range of documents that are eligible for § 7502(f)’s mailbox rule and the need for clear-cut rules on questions of timeliness, Congress understandably elected to establish a quality-control regime in which the IRS would vet each such service in advance and then issue bright-line designations as to which services are subject to the mailbox rule and which are not. The statutory language also makes clear that there must be separate designations for each “service” offered by a private courier—and not merely a designation of the courier itself—because § 7502(f) expressly distinguishes between the “trade or business” that engages in delivery of packages (e.g., FedEx) and the various “delivery service[s]” by which it does so (e.g., FedEx Priority Overnight).

So what can Organic Cannabis Foundation do? They can appeal this decision, though their chance of success is near zero. (They can try for either an en banc ruling of the Ninth Circuit or petition the Supreme Court.) They can pay the tax, file a claim for refund, and then after six months file a lawsuit in District Court. And given that every court that has looked at § 280E has come to the same conclusion (that Congress must act to change the law and that the IRS is correctly interpreting current law), their chance of success isn’t good. But that’s what they’re left with.

Sometimes faster isn’t better. Had the petitions been mailed certified mail at the post office, they would have been considered timely filed even if it took a month to reach the Tax Court. Had the petitions been sent with a slightly slower service (FedEx Priority Overnight), they would have been considered timely filed. Had they been sent three days earlier, they would have been received by the deadline and been timely filed. This is a Tax Court case where $1,993,179 is in dispute and the rules weren’t followed. Needless to say, it pays to follow the rules.

Hat Tip: How Appealing