U.S. Tax Court Judge Upholds § 280E; Strikes Industry’s Hopes

On November 29, a U.S. Tax Court judge confirmed that § 280E of the Internal Revenue Code prevents state-legal cannabis businesses from deducting ordinary and necessary business expenses from their federal taxes. The ruling is a blow to businesses in the cannabis industry, who incur significantly higher federal tax burdens than they otherwise would if, like other businesses, they were allowed to deduct their business expenses.

Section 280E declares that “[n]o deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business . . . consists of trafficking in controlled substances . . . which is prohibited by Federal law or the law of any State in which such trade or business is conducted.” 26 U.S.C. § 280E. Congress enacted the provision to abrogate a 1981 Tax Court decision allowing a cocaine dealer to deduce the ordinary and necessary expenses of his illicit trade. The Tax Court had previously decided that the provision extended beyond its original context and reached cannabis businesses, but this most recent case nonetheless raised a number of arguments as to why the statute does not apply.

Most notably, Harborside Health Center argued that § 280E’s reference to a business that “consists of trafficking in controlled substances” means businesses that only traffic in controlled substances, and do not provide other services. This narrow construction did not convince the court, which concluded that Harborside’s interpretation would render § 280E ineffective. “If that section denies deductions only to businesses that exclusively traffic in controlled substances, then any street-level drug dealer could circumvent it by selling a single item that wasn’t a controlled substance – like a pack of gum, or even drug paraphernalia such as a hypodermic needle or a glass pipe.”

The ruling provides yet another indication that relief from § 280E won’t come from the courts – it will have to come from Congress. To that end, the industry will have its sights fixed on the bi-partisan STATES Act and other federal legislation.

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