In Cannabis Case, Tax Court Dissent Concludes Section 280e Is Unconstitutional

Author:Mr Thomas Ostrander and Justin M. L. Stern
Profession:Duane Morris LLP

Section 280E of the Internal Revenue Code has long been a thorn in the side of the cannabis industry. However, in a United States Tax Court opinion issued October 23, 2019, one judge's partial dissent suggests that the firm ground undergirding Section 280E may be starting to weaken. At the very least, the opinion provides a potential roadmap for arguing against Section 280E's application to marijuana-related businesses.

I.R.C. § 280E

The section of the law in question states:

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.

There may be no single provision in the tax code with more implications for cannabis companies—and their accountants—than the 77-word sentence making up Section 280E. Section 280E prohibits companies from deducting what would normally be deductible business expenses where the business "consists of" dealing in items found in Schedules I or II of the Controlled Substance Act. For example, a cannabis operator in California or Colorado with a legal marijuana business may be fully compliant with state law. But because the sale of marijuana is prohibited by federal law, no deductions relating to that business may be had because of the proscription of Section 280E... for now.

Potential Game Changer: Northern California Small Business Assistants, Inc. v. Commissioner of Internal Revenue

The court's opinion in NCSBA v. Commissioner has been a long time in the making, beginning with the IRS informing NCSBA—an operator of a medical marijuana dispensary in California—that for 2012 there was an income tax deficiency of over $1.2 million and an associated penalty of over $250,000. The deficiency, the IRS informed NCSBA, resulted from the fact that NCSBA was not entitled to claim otherwise normal business deductions because of Section 280E.

Although the court as a whole rejected all of the dispensary owner's arguments, Judge Gustafson wrote a substantive, and potentially groundbreaking, partial dissent in which he stated that Section 280E is unconstitutional because it is not permitted under the Sixteenth Amendment, which gives Congress the power...

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