US Tax Court denies deduction request under §280E, but leaves door open for future challenges

Last week, the Tax Court continued the line of cases denying tax deductions under Internal Revenue
Code §280E. That section says that any business which is “trafficking in controlled substances” cannot
receive many of the traditional deductions that a business may take. Otherwise put, this means that a
company must pay taxes on all of its incoming revenue, before it subtracts most of its expenses.
This law can be a severe punishment for a cannabis company that may be operating entirely legally
under state law. Unfortunately, the federal government still considers them to be “drug dealers” and
holds this punitive tax measure over their heads.

The case before the tax court involved a dispensary which filed taxes and took deductions for its
business expenses. The IRS sent them a bill of $1.26 million, plus another 250K in fines. The company
filed suit, asking the court to declare that it did not have to pay those bills.

A divided court rejected the company’s three arguments. In addition to the majority opinion, there were
two concurring opinions and two dissenting opinions. Of particular interest is the Gustafson dissent,
which opens up a new avenue for declaring §280E to be a Constitutional violation. Essentially, Gustafson
argues, that the 16 th Amendment allows Congress to tax income. Income is defined as “gain”, or net
profits minus costs to get those profits. So for Congress to then disallow normal business expenses,
means that they are taxing more than actual income, which violates the 16 th Amendment.

This argument was only agreed to by one other Judge on the tax court, which ultimately ruled against
the dispensary. However, in the future, as the public opinion shifts, the policies behind these prohibitive
rules may fall away, and we may not be far away from a court coming to the opposite conclusion. Legal
cannabis companies are working tirelessly to follow the law, and they should be rewarded for doing so.
Continuing the regime of these prohibitive financial policies constitutes a “subsidy for the black market.”
The way to solve this problem is to shift the financial incentives in favor of operating under a legal
framework, and avoiding this severe tax problem is the best way forward.

Disclaimer: This article has been prepared and published for informational and educational purposes only and is not offered or intended, nor should it be construed, to be legal advice.

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