Don't Do This - Cautionary Tales in Cannabis: Don’t Bet the (Pot) Farm on Escaping 280E

Yet another cannabis company lost its bid to be taxed in a reasonable and rational manner - that is, like any other state-legal, highly-regulated, licensed business instead of like an illegal drug dealer.

 Tax Court Case

 In Northern California Small Business Assistants, Inc., v. Commissioner of Internal Revenue (October 23, 2019), the company argued, among other things, that the taxes under 280E are so excessive as to constitute a violation of the 8th Amendment’s prohibition on excessive fines.  The Tax Court disagreed.  The company has to pay $1.2 million in taxes and $252,842 in penalties for not paying the taxes in the first place.

As readers of this blog hopefully know, IRC section 280E essentially disallows business deductions or credits if your business is trafficking in controlled substances (which, under Federal law, includes cannabis).

 The Tax Court held that Congress has unquestionable power to tax gross income under the Sixteenth Amendment, and disallowing a deduction to this tax is not a penalty or a punishment.  As a result, the Eighth Amendment does not apply to the denial of a deduction.

 The company’s other arguments also fell flat.  An attempt to limit the breadth of 280E lost out to the plain language of the statute: “No deduction or credit shall be allowed”, which the Tax Court characterized by saying that “Congress could not have been clearer in drafting this section of the Code.”  The Company took a shot at claiming its medical marijuana business was not “trafficking”, but the Tax Court declined to overrule prior caselaw which clearly says that selling medical marijuana pursuant to California law is trafficking under 280E.

 A Glimmer of Hope?

 One justice, in dissent, argued that the concept of income only has meaning if it is a gain or increase.  For the same reason a reduction for Cost of Goods Sold (COGS) must be allowed (like the idea of a basis), there must be an “accounting for the ordinary and necessary expenses that are incurred in the course of business and must be paid before one can be said to have gain.”

The dissent argues that 280E “would fabricate gain where there was none and would impose a tax based on artificial income.”

 The dissent also discusses the 8th Amendment, going back to the 1689 English Bill of Rights, through a concurrence by Supreme Court Justice Thomas (“The right against excessive fines traces its lineage back in English law nearly a millennium, and from the founding of our country, it has been consistently recognized as a core right worthy of constitutional protection.”), and concludes that 280E should be considered a punishment for an unlawful act and can be limited by the 8th Amendment.  It remains, perhaps, on open question whether a corporation is entitled to 8th Amendment protections.  

 Interestingly, a couple of other justices joined the dissent in part.

 What Does This All Mean?

 It means that cannabis businesses should continue to plan on paying the 280E penalty tax.  It also means that there is a need for other brave companies to take up the fight and challenge the government on this policy which is manifestly punitive and irrational.  Either that, or there is a need for Congress to simply carve out an exception for businesses that operate lawfully under State law.

Don’t take my word for it, read the opinion for yourself here.