Court Upholds Third-Party Summons on Cannabis Dispensary's Software Vendor

(Parker Tax Publishing May 2021)

The Sixth Circuit affirmed the dismissal by a district court of a cannabis dispensary's action to quash a third-party summons issued to the dispensary's point-of-sale systems provider for lack of subject matter jurisdiction. On an issue of first impression, the Sixth Circuit held that Code Sec. 7609 provides a statutory waiver of the government's sovereign immunity and that, if one of the exceptions in Code Sec. 7609(c)(2) applies, the bar of sovereign immunity remains, and subject-matter-jurisdiction does not exist. Gaetano v. U.S., 2021 PTC 105 (6th Cir. 2021).

Background

Kimberly and Richard Gaetano own several cannabis dispensary businesses located in Michigan. The IRS began a criminal investigation of the Gaetanos to determine whether they owed federal taxes. In 2019, Special Agent Tyler Goodnight of the IRS's Criminal Investigation Division interviewed the owners of Portal 42, LLC. Portal 42 is a software company that provides the cannabis industry with point-of-sale systems, featuring the capacity for businesses to track customer sales data or delete the data remotely with a "kill switch." The owners of Portal 42 confirmed that the Gaetanos are clients.

At the conclusion of the interview, Agent Goodnight served Portal 42 with a summons. The summons ordered Portal 42 (and its agent) to appear before Agent Goodnight to give testimony and produce various records and other data relating to the Gaetanos' tax liability or for the purpose of inquiring into any offense connected with the administration or enforcement of the internal revenue laws concerning the Gaetanos "for the periods shown." Above that statement, in the space labeled "Periods," the summons stated "01/01/2015 to 09/01/2019." The attachment to the summons directed Portal 42 to produce any and all records related to the Gaetanos or one of their businesses (including records of sales, deliveries, and the hours employees worked) for the same period noted on the face of the summons - January 1, 2015 to September 1, 2019. The IRS did not notify the Gaetanos about the summons.

A few weeks later, Portal 42 sent Agent Goodnight an email with a hyperlink to the requested records. An IRS computer investigative specialist copied the documents to a disc, and the disc was placed in a sealed envelope. Agent Goodnight has not viewed the records Portal 42 produced, nor have any other personnel in the IRS's Criminal Investigation Division.

The Gaetanos filed a petition against the United States in a district court seeking to quash the summons issued to Portal 42. The Gaetanos alleged that the IRS should have notified them about the summons and that it was issued in bad faith. The district court referred the case to a magistrate judge. After a hearing on the motion, the magistrate judge dismissed the Gaetanos' petition to quash for lack of subject-matter jurisdiction because the Gaetanos did not have standing under Code Sec. 7609. Nonetheless, the magistrate judge ordered that the summons be enforced because the Gaetanos had failed to establish that the summons was issued in bad faith. The Gaetanos filed objections, but the district court overruled most of them after concluding that the petition to quash had to be dismissed for lack of subject-matter jurisdiction under Code Sec. 7609(c)(2)(E). However, the court set aside the portion of the magistrate judge's order that enforced the summons because, without subject-matter jurisdiction over the Gaetanos' case, the court concluded such relief could not be granted. The Gaetanos appealed to the Sixth Circuit.

Under Code Sec. 7602, the IRS is authorized to issue a summons to a person who is under investigation as well as to any third party with information relevant to the investigation. Code Sec. 7609 provides the procedures under which the IRS may issue a summons to a third party. Under Code Sec. 7609(a), the IRS generally is required to provide notice to the taxpayer whose records are identified in a third-party summons. Code Sec. 7609(b)(2) provides that any person who is entitled to notice of a summons under Code Sec. 7609(a) has the right to bring a proceeding in court to quash the third party summons. However, Code Sec. 7609(c)(2) excludes five categories of summons from coverage under the statute. One exception, provided in Code Sec. 7609(c)(2)(E), applies to a summons that is (1) issued by a criminal investigator of the IRS in connection with the investigation of an offense connected with the administration or enforcement of the internal revenue laws, and (2) served on any person who is not a third-party recordkeeper (as defined in Code Sec. 7603(b)).

The Gaetanos conceded that the second requirement of Code Sec. 7609(c)(2)(E) was met because Portal 42 was not a third-party recordkeeper. Their sole argument was that the summons was not issued "in connection with a criminal investigation" because the summons identified the "Periods" of January 1, 2015 to September 1, 2019, but no annual or quarterly tax period ends on September 1, 2019. According to the Gaetanos, the IRS could not possibly investigate an offense for the "non-existent tax period" of January 1, 2019, through September 1, 2019. Therefore, according to the Gaetanos, the summons could not be enforced because it did not satisfy one of the four elements established in U.S. v. Powell, 379 U.S. 48 (1964) - that the records sought are relevant to the IRS's investigation.

Sixth Circuit's Analysis

The Sixth Circuit affirmed the district court's dismissal for lack of subject-matter jurisdiction. The court explained that there are two ways courts have viewed the exceptions in Code Sec. 7609(c)(2): (1) limitations on statutory standing, or (2) exceptions to Code Sec. 7609's waiver of the government's sovereign immunity. The Sixth Circuit noted that the district court did not specify on which of these two grounds it relied upon in dismissing the case for lack of jurisdiction. The court said that this distinction matters because while statutory standing is not always jurisdictional, sovereign immunity is. Moreover, a government official or attorney cannot waive the sovereign immunity of the federal government, and the issue can be raised at any stage of the litigation, even in a collateral attack on the judgment.

The Sixth Circuit held, as a matter of first impression, that if one of the exceptions in Code Sec. 7609(c)(2) applies, then the bar of sovereign immunity remains and the court lacks subject-matter jurisdiction. The court found that the text of the statute clearly dictates that the government's sovereign immunity waiver in Code Sec. 7609 is subject to the exceptions in Code Sec. 7609(c)(2). The court noted that the statutory language preceding the exceptions - "this section shall not apply to" - is almost identical to language in the Federal Tort Claims Act (FTCA) setting forth exceptions to the United States' sovereign immunity waiver. The court reasoned that, just as the exceptions in the FTCA suspend that statute, including the immunity waiver, the exceptions in Code Sec. 7609(c)(2) suspend the whole statute. Therefore, the court concluded that the sovereign immunity wavier provision of Code Sec. 7609 does not apply to suits arising from the five categories of summonses listed as exceptions in Code Sec. 7609(c)(2).

The court went on to find that the exception in Code Sec. 7609(c)(2)(E) applied to the summons issued to Portal 42. The court found that the summons was issued by Agent Goodnight, a criminal investigator of the IRS. The court further found that the summons was issued in connection with the investigation of an offense connected with the administration or enforcement of the internal revenue laws because the IRS was conducting a criminal investigation into the Gaetanos for the alleged filing of false income and employment tax returns for tax years 2015 through 2018, and quarterly filings for 2019. The court rejected the Gaetanos' argument regarding the dates shown on the summons. The court said that their argument hinged on their contention that the entry field for "Periods" on the summons referred to the tax periods under investigation, not the time period of records sought. The court noted that the Gaetanos relied on the Internal Revenue Manual (IRM) and reasoned that, while Agent Goodnight may have contravened the instructions in the IRM, that hardly meant that the summons was not issued "in connection with" an IRS criminal investigation. The court also noted that nothing in Code Sec. 7602 or Code Sec. 7609 requires that a summons identify the tax period(s) the IRS is investigating. In sum, the court concluded that, because the exception in Code Sec. 7609(c)(2)(E) applies, the bar of sovereign immunity remains, and subject-matter jurisdiction does not exist.

For a discussion of the IRS's summons authority, see Parker Tax ¶263,120.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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