Attorneys for the IRS are defending the agency's authority to block marijuana companies' tax deductions, calling a Colorado dispensary's “fevered assertions” to the contrary “scaremongering.”

The U.S. Department of Justice's Tax Division on Friday urged the U.S. Court of Appeals for the Tenth Circuit not to disturb a panel ruling that said the IRS has broad investigatory powers to determine whether owners of a state-legal marijuana dispensary improperly deducted business expenses from their federal tax returns.

The plaintiffs in Alpenglow v. United States of America “contend that the IRS was required to halt its investigation into the taxpayer's tax liability when it came upon potentially criminal conduct and transfer the case for criminal investigation,” Justice Department attorneys wrote.

That argument “would make little sense, as it would prohibit the IRS from fulfilling its responsibility to determine the income of all taxpayers—essentially exempting those involved in criminal activities,” the government's lawyers said.

At issue is Section 280E of the U.S. Internal Revenue Code, which bars businesses involved in what the federal government deems to be drug-trafficking from deducting certain business expenses from their tax bills. Without those tax deductions, state-legal marijuana operations can face effective tax rates of 70 percent or higher.

The father-and-son owners of Alpenglow Botanicals sued the federal government after the IRS determined they owed a combined $53,000 for allegedly improper tax deductions. A three-judge Tenth Circuit panel upheld the determination, saying Charles Williams and Justin Williams failed to show “why we should conclude the IRS has the authority to assess taxes under Section 280E, but cannot impose excess tax liability under Section 280E.”

“There is also no evidence that Congress intended to limit the IRS' investigatory power,” the appeals panel wrote.

In asking the full Tenth Circuit for reconsideration, Greenwood Village, Colorado, attorneys James Thorburn and Richard Walker of Thorburn Walker argued that the panel's decision is “a Pandora's box, which this court is opening by giving the IRS authority to administratively determine violations of federal criminal drug law crimes.”

“Given the IRS' new power … who will the IRS determine to be unlawfully 'trafficking' in controlled substances?” Thorburn and Walker wrote. “How about the welder who assists in putting together the grow facility? How about the doctor who recommends cannabis to the patient for medical purposes under Colorado law?”

Attorneys for the IRS said such arguments amount to “scaremongering about third parties.”

“Section 280E applies to strip deductions and credits from those taxpayers whose businesses consist of trafficking in controlled substances,” the Justice Department said. “Contrary to taxpayers' fevered assertions … this provision does not open the door to criminal prosecutions of welders or utility companies.”

The Justice Department's new brief is posted below:

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