Tax Court Denies Marijuana Dispensary’s Deductions and Rules that Section 280E is Not a Penalty Provision; Dissenting Opinion Finds that Section 280E is a Penalty

On October 23, 2019, the United States Tax Court issued its latest opinion regarding the federal taxation of state sanctioned marijuana dispensaries. Northern California Small Business Assistants Inc. v. Commissioner, 153 T.C. No. 4.

Northern California Small Business Assistants (NCSBA) is a California medical marijuana dispensary. Following an audit, the IRS determined a deficiency in NCSBA’s income tax of $1.26 million. The deficiency was the result of IRS disallowing all business deductions under section 280E.

NCSBA argued that it wasn’t in the business of “trafficking” marijuana and that it was entitled to its business deductions regardless of section 280E. Based on its section 280E line of cases, the Tax Court gave short shrift to this argument and found that NCSBA trafficked in a controlled substance by selling marijuana.

NCSBA also argued that section 280E is unconstitutional under the Eighth Amendment’s Excessive Fines Clause because section 280E operates as a penalty. Judge Goeke’s majority opinion states that deductions from gross income are pure acts of legislative grace and do not operate to deter actions, setting them apart from fines or penalties. Further, courts have routinely held that the denial of a deduction does not violate the Eighth Amendment. Finally, there is no way to reconcile the argument that section 280E operates as a penalty when Congress has the authority to tax gross income.

Judge Gustafson dissented from the majority and decided that Section 280E does indeed impose a penalty for purposes of the Eighth Amendment. Overly summarized, his reasoning goes like this. The Sixteenth Amendment gives Congress the power to tax “income.” When a business is taxed on its gross receipts without accounting for its ordinary and necessary expenses, the business is not being taxed on income. In essence, section 280E results in a tax on something other than “income.” Furthermore, section 280E imposes a “fine” because it is plainly directed toward the unlawful act of trafficking in controlled substances and creates an increased income tax liability for state sanctioned marijuana businesses.

Agreeing with Judge Gustafson, Judge Copeland states in his separate opinion that even if section 280E was not written as a penalty provision, it operates as such by attacking an entire industry and it sweeps so broadly as to deny every deduction the Code would otherwise allow.

In sum, for the first time, the Tax Court – albeit through a lengthy dissenting opinion – has offered some hope for marijuana businesses hoping to attack section 280E as unconstitutional. It is possible that this dissent may spark a future taxpayer to further tee up this issue.

Going forward, in order to avoid income tax deficiencies and penalties, it is necessary for marijuana businesses to pay close attention to the case law and any potentially forthcoming IRS regulations.

If you own a business selling, growing, or producing marijuana, you need to work with an experienced tax lawyer in Nevada to understand your tax rights and responsibilities. The landscape is changing so quickly that you need a legal advocate on your side to help you navigate it all. If your business is audited and you don’t have detailed information about every single transaction, you risk forfeiting your COGS claim and you could be subject to penalties for filing an inaccurate tax return.

Silver Law PLC operates in Nevada and Arizona and all of its lawyers are former trial attorneys for the IRS. A tax lawyer from our team can help you understand how the complex Tax Code applies to your marijuana business operations. We’ll help you ensure that you are meeting your obligations. If you have been audited or are facing collections, we are also in a position to help you navigate that process. We can either find ways to bring down your tax debt or can negotiate a settlement for you. Call us today to talk with a Nevada tax lawyer and learn more.

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