A majority of the Tax Court concluded in the case of Northern California Small Business Assistants Inc. v. Commissioner, 153 TC No. 4,[1] that the denial of deductions for those operating businesses trafficking in cannabis is not a fine.  Therefore, the provision could not be found to be an excessive fine.

The Eighth Amendment to the U.S. Constitution provides:

Excessive bail shall not be required, nor excessive fines imposed, nor cruel and unusual punishments inflicted.

The taxpayer, a medical marijuana dispensary operating under California law that allows such operations, argued that IRC §280E served as an excessive fine under the Eighth Amendment and thus should be disregarded by the Court.

The Tenth Circuit denied a taxpayer’s attempt to force the IRS to bear the burden of proof that an LLC operating as an S corporation was trafficking in a controlled substance that would lead to a denial of most business deductions per IRC §280E in the case of Feinberg, et at v. Commissioner, Case No. 18-9005, CA10.  The taxpayer argued that, despite the fact that the burden of proof generally falls on the taxpayer to prove the right to a deduction, to do so in this case would involve a violation of the taxpayers’ Fifth Amendment privilege.

This was the second trip up to the Tenth Circuit for the taxpayers in this exam.  While their first trip was ultimately successful in the eventual result, if not 100% in the decision, this second trip was not fruitful for the clients.

A business does not have to have title to marijuana to be engaged in trafficking in controlled substances, triggering the denial of deductions under IRC §280E, the Tax Court ruled in Alternative Health Care Advocates et al. v. Commissioner, 151 TC No. 13.

IRC §280E bars deductions, other than those for the cost of sales, to businesses that traffic in items considered controlled substances by federal law.  The fact that certain states have legalized the sale of marijuana in some situations does not change that federal tax result.

As marijuana has become, at the state level in certain states, legal to sell in some form (medical or recreational) those looking to enter that market find that federal law does not condone this business.  In addition to still being treated as an illegal substance under federal law, the Internal Code has a nasty treatment for any such business found at IRC §280E.  The taxpayer in the case of Alterman v. Commissioner, TC Memo 2018-83, discovered just how harsh the federal tax law is in this area.

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In the case of Feinberg v. Commissioner, T.C. Memo 2017-211, a taxpayer attempted to use the expert opinion of a CPA whom was claimed to be an expert in cost accounting, with an emphasis in the marijuana industry.

The taxpayers were shareholders in an LLC that ran a marijuana dispensary in Colorado.  On the original tax return filed for their S corporation claimed several deductions as ordinary trade or business deductions that the IRS determined were costs of sales—and important issue, since under IRC §280E only costs of goods sold may be deducted by a business that traffics in controlled substances under federal law.  Despite being legalized in Colorado, marijuana remains a controlled substance under federal law.

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A taxpayer seeking to quash a summons from the IRS to the Colorado Department of Revenue’s Marijuana Enforcement Division failed to obtain the requested relief in the case of Rifle Remedies, LLC v. United States, USDC Colorado, Case No. No. 1:17-mc-00062.

The taxpayer had claimed that this subpoena was “really” a front for conducting a criminal investigation into the taxpayer’s marijuana business and, if the court didn’t accept that objection, the taxpayer had a series of other objections. 

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The marijuana cases continue in the Tax Court as a consequence of various state laws allowing for state (though not federal) legal sales of marijuana.  In the case of Beck v. Comissioner, TC Memo 2015-149 another unique issue for such operations was addressed.

IRC §280E generally does allow deductions, aside from cost of sales, for a taxpayer selling a federally controlled substance such as marijuana, even if the that sale is deemed to be legal under state law.  In this case, one key issue was what was considered a cost of sale.

The taxation of medical marijuana clinics came back into the Tax Court in the case of Olive v. Commissioner, 139 TC No. 2, later appealed to the Ninth Circuit who affirmed the lower court.  In this case, in addition to reminding us of the Tax Court’s previous holding that IRC §280E holds to prevent the deduction of expenses other than costs of sales related to the operation of such a clinic (a position the Court put forward in the 2007 case of Californians Helping to Alleviate Med. Problems, Inc., 128 TC 173), the Court dealt with some additional items.