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Tax Code 280E: The Dagger Pointed at the Heart of Medical Cannabis

280E Reform taxes cannabis now

Economics

Tax Code 280E: The Dagger Pointed at the Heart of Medical Cannabis

Near the end of 2015, in the case of Canna Care Inc v. Commissioner, Internal Revenue Service (IRS) tax code section 280E was found to disallow all “operating deductions” for every cannabis collective in California. To paraphrase and simplify, 280E means businesses making money from a Schedule I or II controlled substance are unable to claim credits and deductions on taxes.

Interestingly in the recent decision, the court parted from previous cases and did not address cost of goods sold (COGS) and instead focused on other issues. This case did not change any of the core holdings of the CHAMP or Olive decisions, which created the concept that collectives could engage in two or more businesses (such as caregiving and dispensing medical cannabis). These cases also set up a framework where collectives could only deduct their COGS for caregiving, because that was considered a legal business, while dispensing medical cannabis was not considered legal under federal law; CHAMP was successful at adding the cost of the medical cannabis itself to the list of deductible costs.

After all this fuss, you may be wondering, what does IRS code §280E actually say? Well, here it is:

“No 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 (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.”

It is quite simple in its stated purpose, and rather limited in its scope, a good example of well-crafted federal policy. The tax code section was passed by Congress in 1982 after a Tax Court ruled a taxpayer could “deduct expenses relating to his sales of cocaine, amphetamine, and marijuana. Deductible expenses included the costs of packaging, travel, and even scales used to weigh the illegal substances.” This system worked fine until states began to create medical cannabis programs in 1996 and the federal government repeatedly refused to give in to states’ rights to experiment with legalizing cannabis (at least until very recently). Now, states’ rights and the powers of the federal government are at odds, and 280E is one flashpoint in that battlefield.

There are varying views on how high of an increased tax rate is imposed on cannabis businesses, ranging from the low end at 40 percent to 70 percent and up to 90 percent. Those rates are all higher than the 39.1 percent taxes paid by other U.S. corporations (though it may be much lower at 12.5 percent). In practice, this means that many normal business expenses such as employee wages, healthcare costs, rent and advertising cannot be claimed on taxes. Another oddity of 280E, at least in California, is that it appears to treat businesses owned by corporations better than those owned by individuals, granting them more exemptions on their taxes under 280E.

Harborside – A Case Study in 280E

With two locations in California and one in PortlandHarborside Health Center (HHC) is the largest medical cannabis collective in the world. HHC has been open for nearly a decade, and has seen over 112,000 patients since they opened. Presently, HHC grosses around $25 million a year and is the city of Oakland’s second highest tax payer. After a recent audit, the IRS claims that HHC owes them $2.5 million in back taxes as 280E eliminated many standard deductions they had been claiming.

In the words of Harborside founder Steve DeAngelo, “They declared us a drug trafficking operation, and therefore denied all of the standard business deductions that every other business can take, for things like rent and payroll, and they gave us a $2.5 million back tax bill.” DeAngelo continued, “If the IRS is successful in denying all deductions, no cannabis dispensary will remain in business.” To DeAngelo, 280E is the “dagger pointed at the heart of medical cannabis.”

Henry Wykowski is the tax attorney who is representing Harborside in their 280E lawsuit. Wykowski is known in the cannabis industry for being one of the attorneys who helped achieve victory in the CHAMP case, and he is ready for another victory with the Harborside case against the IRS.

Marin Alliance for Medical Marijuana

In 1996, the year Prop 215 was passed legalizing medical cannabis in California, the Marin Alliance for Medical Marijuana (MAMM) opened its doors in Fairfax, and became America’s first legal medical cannabis collective. MAMM operated with the town’s blessings and didn’t create any problems for the city of Fairfax, until 2011, when former Attorney General Melinda Haag initiated her crackdown on medical cannabis collectives in Northern California. MAMM, and Harborside, were two of the higher profile collectives targeted by Haag in an offensive that effected dozens of collectives and thousands of patients.

“We are very sorry to announce that we have shut our doors until we can resolve certain legal issues,” a 2011 post on MAMM’s website said. “The battle is not over, but we must await further court action that will allow us to reopen, hopefully within a month or two.”

It took a bit longer than a couple of months, more like four years, but MAMM got their day in court on Oct. 19, 2015, and won a limited victory. Part of the earlier court proceedings against MAMM included a lifetime ban on their founder, Lynette Shaw, from distributing cannabis; this victory did not lift the injunction but merely made it consistent with the recently passed Rohrbacher-Farr Amendment. Despite the injunction not being lifted, MAMM has a GoFundMe page to raise donations to re-open.

Where is 280E Reform At Today?

While a couple years ago there was a thriving community to reform 280E, being organized through a group called 280E Reform, this community is now largely dormant. The group’s website is now entirely in Japanese and appears to have nothing to do with 280E reform. It is unclear whether this means it was sold or has been hacked, but it does not bode well for the future of 280E reform.

Like much of U.S. law, including the Rohrbacher-Farr Amendment and 280E, the meaning of seemingly simple phrases is still largely up to interpretation with different government agencies defining passages in favor of their own best interests. The gray area around 280E isn’t just stymieing legal cannabis collectives, it is also causing headaches at the IRS (good news for them, cannabis is a great cure for headaches). The best ways to avoid a painful IRS audit are to keep your books in order, keep impeccable records, and always remember, the federal government is underfunded and the IRS is years behind on audits – just because they haven’t gotten to you yet, doesn’t mean they wont.

Has the 280E tax code negatively affected your business? Tell us in the comments below. 

4 Comments

4 Comments

  1. Jon Drucker

    April 4, 2018 at 11:35 am

    The key word in IRC Sec. 280(e) is “trafficking.” Is there any law on whether the definition of the word “trafficking” is limited to the ILLEGAL sale of a controlled substance? If the business in question is selling cannabis LEGALLY– according to STATE law, I think there is a good legal argument to be made that it is not engaged in “trafficking.” After all, Congress could have used the simpler word “sale” if it intended that ALL sales of controlled substances be subject to section 280e.
    If my statutory interpretation is correct, 280(e) would not apply in states where cannabis is sold legally.

  2. Michael davis

    March 14, 2016 at 4:32 pm

    Existing tax court cases stipulate that another business entity can be installed in the same location as the “illegal” cannabis business and is not limited to only marijuana businesses but can be actually any other “legal” business operated in the same location. We have seen a grower establish a used car dealership on his farm with all the deductions attributable to this secondary business deductible against the combined entities.

    • Ryan Cram

      April 24, 2016 at 3:08 pm

      @ Michael Davis. Does this also apply to the combined revenue? In other words does the dual business status also open the door for out of state investors to invest in the legal entity? For instance a real estate play?

  3. James Thompson

    January 30, 2016 at 8:06 am

    I would like to offer some suggestions that apply to this post.. First and foremost is that the US Supreme Court ruled marijuana a religiously protected herb IF Religion develops an interest.. Genesis 1:29 GOD gives man dominion over all things green and seeded and the fruit of the trees for his use, NO RESTRICTIONS, for food, fuel, clothing, construction use, medicine and recreationally; further, the Court MANDATED the full power of the Federal Government to protect Citizen State Constitutional Religious Freedoms. Marijuana is legal refer to GUAM v GIERRERO, 71247,entered May 28, 2002.
    Second. The government has maintained US Patent # 6630507 which is a medical patent for the treatment of a wide range of diseases.

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