US Tax Court rules against use of standard deductions for legal cannabis industry
By Meg Ellis
Dec 05, 2018
According to a recent ruling from the United States Tax Court, the legal cannabis industry cannot make standard business deductions on their organization’s taxes since the federal government still considers these businesses to be little more than drug smugglers and peddlers.
On November 29, the U.S. Tax Court ruled that Harborside Health Center of Oakland, California must pay restitution in the amount of potentially millions of dollars in taxes on disallowed business deductions from the years 2007 to 2012.
One of the largest and most respected cannabis retailers in the world, Harborside stores are known for their curated selection of cannabis products. Some may even recognize the name Harborside for their participation in the Discovery Channel’s documentary series “Weed Wars.”
Harborside founder Steve DeAngelo founded the dispensary in 2006 and appeared in “Weed Wars” with the hopes of providing American audiences with insight into the regulation, taxation, and sale of medical marijuana.
Don’t I know you from some television show?
DeAngelo agreed to appear in “Weed Wars” in 2011. “We wanted to be a model to other dispensaries, most of who have a media phobia. We wanted to tell our story and we gave Discovery complete access so that people could make up their own minds,” DeAngelo told Fox News at that time.
“There are a lot of stereotypes about who comes to these dispensaries, but viewers will see our customers cover a huge cross-section of the population⸺age, race, and economic classes. They will also see how Harborside treats cannabis as a medicine, and we have a high standard of medical care,” DeAngelo continued in his interview with Fox.
When Harborside, specifically the Patients Mutual Assistance Collective Corporation doing business as Harborside Health Center, petitioned the Commissioner of Internal Revenue Services for business expenses, it wasn’t just reality TV watchers who tuned in but legalized cannabis businesses across the nation.
Harborside Health Center vs. the IRS
The U.S. Tax Court ruled against Harborside, rejecting the organization’s argument that they were deducting normally accruing business expenses such as rent, phone bills, and security. In the Court’s ruling, the Court determined that until Congress tells them otherwise, the IRS may continue to treat dispensaries like a local drug-dealer.
“[Harborside] owns what may well be the largest marijuana dispensary in America,” wrote Judge Mark V. Holmes in his opinion. “To the Commissioner that just makes it a giant drug trafficker, unentitled to the usual deductions that legitimate business can claim, unable even to capitalize its indirect costs into its inventory, and subject to penalties for taking contrary positions on its tax returns for the tax years ending July 31, 2007, through 2012.”
The U.S. Tax Court determined that the IRS may continue to disregard the legitimacy of licensed dispensaries due to a 1980s tax code called Section 280E. Section 280E of the US Tax Code states that business selling products deemed illegal by the federal government cannot name normal tax deductions.
As marijuana is still a Schedule I drug, even licensed cannabis businesses cannot pursue tax relief afforded to businesses like tobacco companies or the alcohol industry. Harborside attorney Henry J. Wykowski said that this ruling would only maintain the current high tax-rates on marijuana businesses.
While the court ruled against Wykowski, he commended Judge Holmes for his knowledge on the issue and its nuances. After two and a half years of hearings, Judge Holmes issued the 62-page ruling on November 29.
“I think if you read that opinion, [the judge] concedes it was extremely close, and that other people would have found it the other way,” Wykowski said.
Aside from death and paying taxes...
All businesses depend on tax deductions to help with the daily cost of doing business. Things like the costs for rent, buying inventory, and paying for security are all eligible for tax deductions.
This ruling maintains the IRS’s stance that they do not care if a business is based on illegal trade, they still owe taxes on income. That’s how they got famous mobster Al Capone behind bars: tax evasion.
Section 280E harkens back to the Reagan-era Congress. The law adding to the U.S. Tax Code officially disallowed business deductions for drug trafficking business owners.
At the time, no one could have predicted the medical marijuana movement or the move to end the prohibition of recreational marijuana; however, the U.S. Tax Court has maintained that legalizing marijuana does not exempt patient collectives from federal drug trafficking statutes, and thus, Section 280E remains.
Will this be resolved in time for tax season?
Recent efforts to reform the IRS Section 280E died in the 2018 Congress; however, even the U.S. Tax Court is certain that the issue will be resurrected for the 2019 session.
“Several members of Congress asked the IRS to issue guidance saying that medical marijuana dispensaries aren’t subjection to Section 280E, and the IRS said it couldn’t do that unless Congress amended the Code or the Controlled Substances Act,” the court ruling said.
Wykowski is also certain that the burden placed on licensed cannabis businesses will cause some consumers to remain in the illicit market. High taxes and regulatory fees result in inflated prices. For example, an eighth-ounce of cannabis flower reached an all-time high of $100 in the Bay Area earlier in the fall.
“[Section 280E] is an unfair burden not imposed on any other business operating under state law,” Wykowski said. “It’s unfortunate the federal government does not recognize at this late stage that cannabis has value and should not be punished based on historical inaccuracies.”