The US Court of Appeals for the 10th Circuit upholds § 280E, dispensary and producer must pay back taxes.

March 11, 2019

In a case that went beyond simply stating that IRS Code § 280E does apply to cannabis businesses, the Court of Appeals ruled that burden is on the taxpayer to show a claimed business expense is not subject to 280E.  The case is Feinberg et al v. Commissioner of Internal Revenue, No. 18-9005, US Court of Appeals for the 10th Circuit, dated February 26, 2019.

In a well written opinion, the Court spelled out the history from which the IRS receives its power to tax and how the tax statutes apply that authority.  The 16th Amendment to the US Constitution provides the power to Congress to tax.  While Congress has the power to tax gross income, however, to ensure it only taxes income and not sales, Congress has stated “costs of goods sold” is a mandatory exclusion from the calculation of one’s income.

After that basic outline, Congress can then add items which can be deducted, and can change what are “allowable deductions” at any time.  Some of the statutes deny deductions, such as 26 U.S.C. § 280E, which prohibits deductions

“for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of    trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.”

As we all know only too well, cannabis is still listed as a Schedule I controlled substance at the federal level.

The vertically integrated taxpayer in this case, (Producer and Dispensary) argued that they did not have to prove their claimed deductions were legal and were not blocked by 26 U.S.C. § 280E.  They argued that to say otherwise was to force them to violate their 5th Amendment Rights against self-incrimination, as they believe IRS was forcing them to incriminate themselves, i.e., to state that they were violating a federal law.  Taxpayer went on to further argue that if they were “compelled” to provide information to the IRS, then the burden in on the IRS to show that a claimed expense in not subject to § 280E.

The Court ruled that this was not a case where the Taxpayer had a choice of whether to be prosecuted criminally because they did not provide the information, or to be prosecuted criminally because they did. The Court went on to say this matter was easily distinguishable. Here the Taxpayer was not facing criminal penalties, only the choice of whether to submit proof of legitimate business deductions or not.

The Court said Taxpayer had an opportunity to prove to the IRS it wasn’t operating in a federally illegal area, but the “Taxpayers failed to meet their burden of proving the IRS erroneously concluded THC was unlawfully trafficking in a controlled substance.”  Therefore  26 U.S.C. § 280E does apply to this cannabis business.

While the Taxpayer’s attorneys won some arguments along the way, the end result is still what we tell all cannabis businesses, 280E is a significant cost that other businesses do not have.  Time to write and call your Senator and Representative.  Tell them that cannabis businesses should be treated like any other business when it comes to taxes.