10 Feb 20 Audra Walter
Cannabis' current federal status as a Schedule I controlled substance means that the IRS treats businesses in this industry a little differently. The biggest difference is that these businesses are technically not allowed to make any deductions to their tax bill. However, the rapid growth of this industry is forcing law-makers and taxing authorities to reconsider their stance on this issue.
The cannabis industry continues to evolve and change rapidly throughout the United States. Many states, including Washington State and Colorado, have legalized marijuana for both recreational and medicinal purposes. Other states have legalized marijuana strictly for medicinal purposes but may permit recreational use in the future. Because the recreational cannabis industry is still quite new, the industry still has a number of legal issues which haven’t been fully ironed out. One of the big issues pertains to the application of IRC Section 280E to the cannabis industry. At the federal level, cannabis is still considered a controlled substance, which means that it is subject to Section 280E. Section 280E states that no deductions or credits may be taken in connection with income generated through the sale of controlled substances. The IRS has flagged certain cannabis businesses which have attempted to take deductions in connection with their cannabis-derived sales income. Many in the cannabis industry have spoken out against the application of Section 280E.
Two recent cases have called into question whether Section 280E will continue to apply to the cannabis industry. Some analysts contend that a viable case can be built which argues against the constitutionality of Section 280E applied to the cannabis industry. Let’s explore these two cases and then discuss the potential ramifications of these cases for Section 280E and the cannabis industry.
Overview of Colorado State Case
The Colorado labor department issued a fine against a motel owner for $425,000 when the owner failed to maintain worker’s compensation insurance coverage. The motel owner contested the fine on the grounds that the fine violated the Eighth Amendment to the U.S. Constitution because it was an “excessive” penalty. Ultimately, the Supreme Court of Colorado ruled in favor the motel owner. The State of Colorado petitioned to have the case reviewed by the Supreme Court of the United States. Colorado had grounds for appeal given the issue of constitutionality raised by the case. But, the Supreme Court of the U.S. ultimately declined to review the case. Essentially, this leaves the door open for businesses in the cannabis industry to contend that deficiencies assessed under Section 280E are excessive fines in violation of the U.S. Constitution.
Overview of California / U.S. Tax Court Case
This decision to leave the Colorado case alone by the U.S. Supreme Court occurred a bit after another related case was heard by the U.S. Tax Court back in October of 2019. In that case, the IRS determined that $1.5 million in deductions taken by a cannabis company in California violated Section 280E. The U.S. Tax Court agreed with the IRS that the deductions were illegal and upheld the deficiency assessed by the IRS. Even though the California company lost the case, there were a couple of dissenting opinions which argued that Section 280E creates an excessive fine or penalty in violation of the Eighth Amendment to the Constitution. Essentially, the dissenting judges argued that Section 280E can result in taxes which exceed income, and that situation violates the Sixteenth Amendment of the Constitution. And if Section 280E violates the Sixteenth Amendment in this way, it is necessarily in violation of the Eighth Amendment.
Potential Ramifications for Cannabis Industry and IRC Sec. 280E
The fact that U.S. Supreme Court chose not to review a determination that a business fine was an excessive penalty is quite significant. What’s more, the dissenting opinions in the California / U.S. Tax Court case provide reason to believe that a viable case can be made against the constitutionality of Section 280E when applied to the cannabis industry. If Section 280E is determined to be a penalty, this determination could have a huge impact on the cannabis industry. For one thing, this determination could cause the IRS to base its tax assessments on the actual ability of a given business to pay. This could dramatically alter existing and future tax liabilities in the cannabis industry. Cannabis businesses which have outstanding tax liabilities are strongly encouraged to contact an experienced tax attorney. An experienced tax attorney can help you plot the best course to resolve or settle this tax debt.
Contact Boxelder Consulting for Additional Information
This is quite a bit of information to take in. Many businesses in the cannabis industry are understandably confused when it comes to Section 280E, tax deductions, and so forth. These are complex topics. If you’re in this industry and need counsel on these issues, don’t hesitate to contact Boxelder Consulting for assistance today. The attorneys and tax professionals at Boxelder Consulting can help you navigate this difficult territory and give you the clarification you need to set your business straight. Call us today at 303-317-6111 today for more information.