Author: admin

1. INTRODUCTION

The marijuana industry is growing fast; perhaps even faster than the plants it produces. With 28 states having already legalized medicinal marijuana, and an additional 10 states opting to legalize its recreational use, one would have to be stoned not to see that the times, they are a-changin’. However, regardless of changing attitudes at the state level, marijuana remains illegal under federal law, creating a unique hinderance to the marijuana industry. Despite operating legally under state law, for federal income tax purposes, marijuana businesses are considered to be involved in the trafficking of scheduled drugs, and are therefore subject to Section 280E of the Internal Revenue Code. By disallowing deductions for ordinary and necessary business expenses, Section 280E effectively taxes marijuana businesses on their gross income as opposed to their net income. Since its introduction as part of the Tax Equity and Fiscal Responsibility Act of 1982, Section 280E remains one of the greatest barriers to the growth of the legal marijuana industry in this country.

In this paper, I plan to propose an amendment to Section 280E that will better align it with the current attitudes and legislation trends regarding marijuana. However, in order to do so, a greater understanding of Section 280E will be necessary. Part I of this paper will discuss the history of Section 280E in order to develop a thorough understanding of its purpose. This will aid in crafting an amendment that allows the section to retain and accomplish the goals it was originally created for. Part II will consist of an analysis of Section 280E, as well as a discussion of the current effects it has on marijuana businesses. Additionally, these effects will be applied against the original purpose of the section in order to identify and highlight any discrepancies. Finally, Part III will feature a proposed amendment, as well as an analysis explaining how this proposal would work to eliminate or minimize the negative effects of Section 280E, while remaining consistent with its original purpose and the rest of the Tax Code.

While I do not anticipate this proposal will ever be adopted as written, its creation serves two purposes; bringing awareness to the outdated nature of Section 280E and the discrepancies between its original purpose and current effects, and proposing solutions going forward. With Section 280E in its current form, the growth of the marijuana industry will continue to be suppressed. In a time where the legalization of marijuana is spreading across the nation, not to mention the relatively recent nation-wide legalization of marijuana in Canada, it is not only counterproductive to continue to stifle the marijuana industry, but also foolish.

1. PART I: THE HISTORY AND PURPOSE OF SECTION 280E
   1. The Comprehensive Drug Abuse Prevention and Control Act of 1970

The story of Section 280E begins in the year 1970. Richard Nixon had begun his term as the 37^th President of the United States the year prior. Upon taking office, Nixon declared the reduction of recreational drug use one of his top priorities.[1] In what would soon develop into the infamous “War on Drugs,” the Nixon Administration placed a great deal of emphasis on the federal control of dangerous drugs, resulting in the passage of the Comprehensive Drug Abuse Prevention and Control Act of 1970.[2] The roots of Section 280E can be traced back to these laws.

The Comprehensive Drug Abuse Prevention and Control Act of 1970, also known as the Controlled Substances Act, or CSA for short, was enacted in 1970 and codified under 21 U.S.C § 801-971.[3] The idea behind this legislation was to suppress black-market drug activity, while simultaneously creating a comprehensive framework for the federal control of the distribution, production, and possession of drugs, also referred to in the act as “controlled substances.”[4] Under the Controlled Substances Act, each controlled substance is assigned to one of five groups, known as “schedules.”[5] Drugs are assigned to schedules through the consideration of three primary factors; “(1) how dangerous they are considered to be, (2) their potential for abuse and addiction, and (3) whether they have legitimate medical use.”[6] In order to determine how each substance ranked in these categories, different drugs are evaluated based on “actual or relative potential for abuse; known scientific evidence of pharmacological effects; current scientific knowledge of the substance; history and current pattern of abuse; scope, duration, and significant of abuse; risk to public health, psychic or physiological dependence liability; and whether the substance is an immediate precursor of an already-scheduled substance.”[7] Once a substance has been evaluated, it is categorized accordingly in Schedules I-V.

Of the five schedules, substances classified under Schedule I are subject to the highest level of control, while the controls placed on Schedule V substances are the least restrictive. Pursuant to 21 U.S.C.S. § 812, Schedule I currently consists four categories; (a) opiates, (b) opium derivatives, (c) hallucinogenic substances, and (d) cannabimimetic agents.[8] These substances are considered to have the highest potential for abuse, no currently accepted medical use in treatment in the United States, and a lack of accepted safety for use of the drug or other substance under medical supervision.[9] Amongst the many substances listed in Schedule I, marijuana, or “marihuana,” can be found listed as item (c)(10).[10]

With reference to Section 280E, the classification of marijuana as a Schedule I drug is of the utmost importance. Since Section 280E applies to “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),” the fact that marijuana is classified as a Schedule I substance subjects any business involved in the trafficking of marijuana to the prohibitions of Section 280E.[11] This means all marijuana businesses currently operating legally under state law are subject to the prohibitions of Section 280E. However, prior to the enactment of Section 280E in 1982, no such restrictions existed, allowing those involved in the trafficking of drugs to deduct their qualifying expenses under Section 162.

1. Sections 162

It would not be possible to fully grasp the purpose of Section 280E without first understanding Section 162 and how the two sections are related. 162 states that “[t]here shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.”[12] Under this general rule, Section 162 allows deductions for eligible business expenses, regardless of the legal status of the activities in which the business is involved. In fact, under Section 162, “courts regularly allowed individuals engaged in illegal business to deduct related business expenses, such as rent and salaries, so long as the expenses met the basic requirements of section 162.”[13] This reflects a long-standing notion that “federal income tax is a tax on net income, not a sanction against wrongdoing.”[14] This is evidenced by the statements of Senator Williams during a 1913 Senate debate regarding the Revenue Act of 1913;

The object of this bill is to tax a man’s net income; that is to say, what he has at the end of the year after deducting from his receipts his expenditures or losses. It is not to reform men’s moral characters; that is not the object of the bill at all. The tax is not levied for the purpose of restraining people from betting on horse races or upon ‘futures,’ but the tax is framed for the purpose of making a man pay upon his net income, his actual profit during the year.[15]

 

As reflected in the Statements of Senator Williams, the tax regime does not concern itself with the morality of the taxpayer.[16] Accordingly, neither do the general provisions of Section 162(a). Section 162(a) simply works to achieve the goal of taxing an individual on their net income without regard to the means by which the income was acquired. This differs greatly from Section 280E, which imposes a penalty for behavior deemed contrary to public policy. In light of this, it becomes clear that Section 280E functions as an exception to the general provisions created by Section 162(a).[17]

The role of Section 280E as an exception, more specifically, a public policy exception, gives some insight into its purpose. It seeks to regulate the behavior, or to use the words of Senator Williams, “reform the moral character,” of the taxpayer. Precedent from before the enactment of Section 280E suggests that “where Congress has been wholly silent, it is only in extremely limited circumstances that the Court has countenanced exceptions to the general principle.”[18] Prior to 1982, Congress was “wholly silent” regarding the tax consequences of drug trafficking, and accordingly, drug traffickers were allowed to take deductions pursuant to Section 162(a), as courts were typically unwilling to impose an exception in drug-related cases. However, by enacting Section 280E, Congress explicitly adopted the position that trafficking in Schedule I and II drugs is strictly against public policy, and that those engaged in such activities would be penalized by the Tax Code. Accordingly, it can be inferred that the purpose of Section 280E, at least at a general level, is to not only dissuade businesses from trafficking in Schedule I and II substances, but also provide punishment for those who choose to do so. However, to fully understand the purpose of Section 280E, it is also necessary to understand the context in which Congress made the decision to impose this penalty.

1. Edmondson v. Commissioner

The seminal 1981 case Edmondson v. Commissioner was a driving force in the enactment of Section 280E. In fact, the enactment of Section 280E, just a year later, was in direct response to this ruling.[19] This case gives some insight into why Congress singled out drug trafficking as an illegal business that should be penalized by the Tax Code, as well as how Section 162 functioned prior to the enactment of Section 280E.

In Edmondson, the court allowed Minneapolis drug dealer, Jeffery Edmondson, to claim various deductions on his 1974 tax return, which the court deemed ordinary and necessary expenses incurred in the operation of his illegal drug business.[20] During the 1974 taxable year, Edmondson sold 1,100,000 amphetamine tablets, 100 pounds of marijuana, and 5 ounces of cocaine.[21] Additionally, Edmondson drove approximately 29,000 miles, two-thirds of which was attributable to his drug business, took a business trip to San Diego, incurred various expenses in relation to weighing and packaging the drugs, and paid $2,360 in rent.[22] In the absence of an explicit exception to the general rule, and operating under the principle that an exception based on public policy concerns should only be applied in extremely limited circumstances, the court declined to impose any exception, and analyzed Edmondson’s deductions without regard to the illegal status of his income. Accordingly, under Section 162, the court determined that Edmondson was able to properly deduct a portion of his rent, as his apartment was his primary place of business, as well as the cost of a “small scale, packaging expenses, telephone expenses, and automobile expenses.”[23]

In response to the decision in Edmondson, Congress drafted Section 280E for inclusion in the Tax Equity and Fiscal Responsibility Act of 1982.[24] This would provide tax courts with an explicit exception to Section 162’s general rule, and prevent future rulings like Edmondson. Congress clarified its intent to disallow deductions for drug traffickers in a 1982 Senate Finance Committee report:

There is a sharply defined public policy against drug dealing. To allow drug dealers the benefit of business expense deductions at the same time that the U.S. and its citizens are losing billions of dollars per year to such persons is not compelled by the fact that such deductions are allowed to other legal enterprises. Such deductions should be disallowed on public policy grounds.[25]

 

This statement further enforces the idea that the purpose of Section 280E is punitive. Congress explicitly states its position that drug trafficking goes against public policy, and as such, those who partake in it should not receive the same benefits as those engaged in law abiding businesses. By creating Section 280E in direct response to Edmondson, Congress was no longer “wholly silent” on the tax consequences of drug trafficking, and was actively seeking to punish drug traffickers through the use of taxation.

In terms of context, it is also important to note that Congress acknowledged that the black-market drug industry was generating billions of dollars. While the case against Jeffery Edmondson gave Congress a specific instance in which to respond, in the grand scheme of things, Edmondson was small time. This statement suggests that the driving force behind Congress’s decision to single out drug trafficking as a pressing public policy concern was more likely a response to Colombian drug cartels who, at the time, were generating billions of dollars per year shipping cocaine into the United States.

1. South Florida Drug Task Force

In response to the rapidly expanding cocaine trade in Miami, in 1982 President Reagan formed the South Florida Drug Task Force.[26] The task force was established to “mobilize against drug traffickers,” and was comprised of “agents from the DEA, Customs, FBI, ATF, IRS, Army and Navy.”[27] This was the first of several task forces established throughout the country.[28]

The fact that the IRS was part of the South Florida Drug Task Force reveals additional context with which to evaluate the enactment of Section 280E. From this, it is reasonable to infer that in addition to responding to the Edmondson ruling, the enactment of Section 280E was driven by the flourishing cocaine industry. In fact, it is plausible that this was the primary reasoning behind Section 280E and Congress’s focus on punishing drug traffickers. Small time drug dealers like Edmondson paled in comparison to drug syndicates like the Medellin Cartel, and with the multi-billion-dollar cocaine industry plaguing the country, it is clear why Congress chose to single out drug trafficking as opposed to one of the many other illegal industries that are allowed deductions under Section 162. Public pressure on the Federal Government to stifle the inflow of cocaine into the United States, as well as the extreme violence that accompanied it, almost certainly influenced the enactment of Section 280E.

The “War on Drugs” was being fought on all fronts, and armed with Section 280E, the IRS played an important part. Understanding Section 280E in this context helps identify the true purpose of the Code section. Section 280E is undoubtedly a punitive tax enacted to punish drug traffickers. However, the section is severely dated by the fact that it was enacted not only at a time where marijuana was illegal on all levels, but also at a time when the Federal Government was employing extensive resources to combat large scale cocaine traffickers.

1. Purpose

By studying the origins of Section 280E, it becomes clear that the purpose of this section is punitive. It functions as an exception to the general provisions of Section 162, finding its basis in public policy concerns surrounding the trafficking of dangerous drugs. By examining the context surrounding the enactment of the Code section, it can be concluded that Section 280E was employed as a tactic in the Federal Government’s “War on Drugs,” in an attempt to combat the cocaine traffickers of the 1980’s.

Since the trafficking of cocaine and other Schedule I and II substances remain a current issue in this country, Section 280E still manages to fulfill its original purpose with respect to nearly all Schedule I and II substances except for one; marijuana. Marijuana has managed to distance itself from other Schedule I and II substances, as evidenced by a growing majority of states legalizing marijuana in one form or another. Marijuana is now the only Schedule I or II substance which has achieved this kind of legal status. Because of these changes, the effect of Section 280E on legal marijuana businesses is no longer in line with its purpose.

• PART II: Current Effects of Section 280E
  1. Section 280E Analysis

In comparison to the rest of the Internal Revenue Code, Section 280E is a short, and fairly straightforward section. 26 U.S.C.S. § 280E states as follows;

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.[29]

First and foremost, Section 280E disallows the deductions for ordinary and necessary business expenses created by Section 162, providing the rest of the section’s requirements are met. The language, “paid or incurred during the taxable year in carrying on any trade or business,” can be found in both Section 280E and Section 162, as the Code applies the same meanings of these terms to both sections.[30] The term “carrying on any trade or business” requires that an entity operate with a primary purpose of profit, and be active and ongoing, operating on a regular and continuous basis.[31] “Paid or incurred during the taxable year” limits any deductions to expenses incurred in the current tax year only. However, Section 162 limits deductions to expenses that are ordinary and necessary, while Section 280E applies to any and all expenses.[32] Regardless of this difference, it should be noted that Section 162 must first apply in order for the Section 280E exception to apply.[33] Where Section 162 does not apply, Section 280E is irrelevant as there is no deduction available to begin with.

Next, Section 280E disallows the deductions granted by Section 162 only if a business or trade consists of trafficking in controlled substances. Additionally, Section 280E imposes the prohibition if any of the activities which comprise the trade or business consist of trafficking in controlled substances. Since a definition of trafficking cannot be found in either the Code, nor the Comprehensive Drug Abuse Prevention and Control Act of 1970, it is necessary to look to the generally accepted meaning of the word. Merriam-Webster defines “trafficking” as “the act of buying or selling usually illegal goods.”[34] However, for Section 280E to apply, the illegal goods which are the subject of the trafficking, must be controlled substances “within the meaning of Schedule I and II of the Controlled Substances Act.”[35] This provision applies Section 280E to trades or businesses involved in the trafficking of all substances listed under Schedule I or II of the Controlled Substance Act. Accordingly, trades or businesses trafficking substances in Schedules III-V are not subject to Section 280E.

Finally, Section 280E states that the trafficking of Schedule I or II substances must be “prohibited by Federal law or the law of any State in which such trade or business is conducted.”[36] The use of the word “or” indicates that the trafficking of controlled substances does not need to be illegal under both Federal law and State law, but as long as it is illegal under one set of laws, Section 280E will apply.

When applied to a state legal marijuana business, the above analysis would proceed in the following manner; first, as with any trade or business, a Section 162 analysis would be conducted. If it is determined that ordinary and necessary expenses have been incurred during the taxable year in carrying on a trade or business, then under the general rule, a deduction would be available. However, since this is a marijuana business, and its activities are inherently comprised of trafficking in marijuana, a Schedule I substance, the Section 280E exception would apply. Because Section 280E does not require that the trafficking of marijuana be illegal under both state and Federal law, it is sufficient that trafficking of marijuana only be illegal under Federal law. This precludes marijuana businesses in states that have legalized marijuana from circumventing the prohibition of Section 280E.

1. Tax on Gross Income

Continuing to apply Section 280E to legal marijuana businesses creates an absurd result unlike anywhere else in the Tax Code. Under Section 280E, marijuana businesses are currently the only businesses legal at a state level that are taxed on their gross income as opposed to their net income.[37] Allowing this practice to continue goes against the purpose of the Tax Code, as discussed by Senator Williams in 1913.[38]

The strict interpretation of Section 280E by the IRS has produced several examples of how courts apply Section 280E to state legal marijuana businesses. The following cases provide specific details on how the IRS interprets Section 280E with relation to marijuana businesses, and perhaps more importantly, they highlight the discrepancies between the section’s intended purpose and current effect.

1. CHAMP

In Californians Helping to Alleviate Med. Problems, Inc. v. Comm’r, also referred to as CHAMP, the IRS determined a deficiency in the 2002 Federal income tax of an organization which provided both care-giving services, and medical marijuana to AIDS and cancer patients.[39] The organization was operating legally in California pursuant to the California Compassionate Use Act of 1996.[40] The IRS disallowed deductions totaling $212,958, which the organization claimed were taken pursuant to Section 162(a) as ordinary and necessary business expenses.[41]

In its analysis of the business’s activities, the court determined that the organization was actually conducting two separate trades; care-giving services being one, and the other being trafficking of marijuana within the meaning of Section 280E. Members of the organization were charged a flat fee in exchange for unlimited access to an extensive array of caregiving services, as well as a fixed amount of medical marijuana.[42] Not only were the caregiving services completely unrelated to the dispensing of medical marijuana, but the employees who dispensed marijuana were also completely separate from the employees who provided caregiving services.[43] Additionally, the caregiving services and dispensing of marijuana were primarily carried out in separate facilities, and in the case of the one facility that did dispense marijuana, the area in which marijuana was dispensed comprised only 10% of the total facility.[44]

Accordingly, the court ruled that because the organization was involved in two distinctly separate trades, only the expenses apportioned to the trafficking of marijuana should be disallowed, while deductions attributable to the care-giving services were permissible. In its opinion, the court states,

[s]ection 280E and its legislative history express a congressional intent to disallow deductions attributable to a trade or business of trafficking in controlled substances. They do not express an intent to deny the deduction of all of a taxpayer’s business expenses simply because the taxpayer was involved in trafficking in a controlled substance. We hold that section 280E does not preclude petitioner from deducting expenses attributable to a trade or business other than that of illegal trafficking in controlled substances simply because petitioner also is involved in the trafficking in a controlled substance.[45]

While this ruling does provide minor relief to businesses that supply marijuana as part of their activities, this ruling only applies if the business is actually conducting a trade completely separate from the marijuana portion of the business. This position finds support in a subsequent case, Olive v. Comm’r.

1. Olive v. Comm’r

In Olive v. Comm’r, the owner of a marijuana dispensary called the Vapor Room, attempted to deduct a portion of the business’s expenses under Section 162(a), relying on the ruling in CHAMP. The primary activities of the Vapor Room were the retail sale of medical marijuana pursuant to California law.[46] Patrons of the Vapor Room were able purchase medical marijuana at the Vapor Room and then consume it on the premises.[47] In addition to selling marijuana and providing customers a place to consume it, the Vapor Room also provided minimal activities and services as part of its business including yoga classes, chess and other board games, movies, chair massages, as well as complimentary drinks and snacks. The Vapor Room essentially functioned as a marketplace and community center for the users of medicinal marijuana.[48]

In response to the IRS’s disallowance of his Section 162 deduction, Olive, the owner of the Vapor Room, argued that in accordance with the ruling in CHAMP, he should be allowed to deduct all ordinary and necessary expenses related to the additional activities and services provided by the Vapor Room, as they were separate from the selling of marijuana. Additionally, the petitioner asserted that “the Vapor Room’s overwhelming purpose was to provide caregiving services, that the Vapor Room’s expenses are almost entirely related to the caregiving business and that the Vapor Room would continue to operate even if petitioner did not sell medical marijuana.”[49] The court was not persuaded by these arguments, finding that the petitioner only operated a single business, one which primarily consisted of the trafficking of marijuana.[50]

As well as outlining the extreme differences between the activities of the Vapor room and those of the organization in CHAMP, in its opinion, the court disregarded Olive’s broad reading of the CHAMP ruling stating, “[a] business that dispenses marijuana does not necessarily consist simply of the act of dispensing marijuana, just as a business that sells other goods does not necessarily consist simply of the passing of those goods.”[51] The court concluded that the Vapor Room’s “dispensing of medical marijuana and its providing of services and activities share a close and inseparable organizational and economic relationship,” and as such, the disallowance of all Section 162 deductions taken in relation to the Vapor Room should be upheld.[52] While this decision foreclosed the idea that creative owners of marijuana businesses could circumvent Section 280E by providing minimal additional services, courts have applied the same reasoning even where services are much more substantial.

• Patients Mut. Assistance Collective Corp. v. Comm’r

The 2018 case, Patients Mut. Assistance Collective Corp. v. Comm’r, provides further clarification with respect to how courts handle marijuana businesses that do more than just sell marijuana. This case began as most cases involving Section 280E do; with an IRS audit. The IRS audited the tax returns of Harborside Health Center for the years of 2007 through 2012, determining deficiencies totaling in the tens of millions of dollars.[53]

Harborside is a large-scale marijuana dispensary that aims to represent the “gold-standard” when it comes to dispensaries.[54] The goal of Harborside “was to create a place where marijuana could be distributed responsibly, that was focused on patient care, and that provided benefits to both patients and the community.”[55] Harborside began doing business in 2006, and has been for all relevant times, operating legally pursuant to California law.[56] The court noted that compliance with California law required “getting proper permits, running as a nonprofit, and operating under a ‘closed-loop’ system.”[57] Harborside understood operating under a “closed-loop” system “to mean that all of its marijuana must be provided by its patients; sold exclusively to its patients; handled only by its employees, all of whom were its patients; and not diverted into the illegal market.”[58] It is important to understand the “closed-loop” system in evaluating the activities of Harborside in relation to the activities of the organization in CHAMP.

Over the course of its operation, Harborside became extremely successful, experiencing upwards of 100,000 patient visits per year, and during the years at issue, it generated over $100 million in revenue.[59] In addition to selling medical marijuana, Harborside also sold non-marijuana products and provided a variety of services to its patients at no additional costs. These activities included among other things, various types of therapy sessions, yoga classes, grow classes, support groups, and addiction treatment counseling.[60] In providing these services, Harborside informed its patients at various stages that a portion of the purchase price of marijuana would be used to pay for these services, but a patient did not need to purchase any marijuana in order to partake in the services.[61] In other words, a patient would be able to participate in a free yoga class despite whether they had purchased any marijuana that day.

In opposing the IRS’s disallowance of its deductions, Harborside made essentially the same arguments as the petitioner in CHAMP. Relying on the CHAMP ruling, Harborside claimed that its business consisted of four separate activities; the sale of marijuana or products containing marijuana, sales of products with no marijuana, therapeutic services, and brand development.[62]

With respect to the sale of marijuana and products containing marijuana, the court had no difficulty concluding that this was an activity to which Section 280E applied. In its opinion, the court noted the significance of this activity in the scope of the business and with relation to the other activities. Specifically, the court noted that during the years at issue, 60% of the members who visited Harborside were there to buy marijuana or products containing marijuana; 75% of Harborside’s sales floor consisted of marijuana and marijuana products; Harborside’s employees spent approximately 80-90% of their time dedicated to purchasing, processing, or selling marijuana or marijuana products; and that the sales of marijuana or marijuana products generated a minimum of 98.7% of Harborside’s total revenue.[63] Accordingly, the court determined any and all deductions relating to this portion of the business were properly disallowed by the IRS pursuant to Section 280E.

Next, the court considered whether Section 280E applied to the sale of nonmarijuana products “such as branded clothing, hemp bags, books about marijuana, and marijuana paraphernalia such as rolling papers, pipes, and lighters.”[64] In its analysis of this activity, the court determined that the sale of nonmarijuana products only constituted 0.5% of Harborside’s total revenue.[65] Additionally, the employees who also sold marijuana and products containing marijuana, were the same employees who sold the nonmarijuana products.[66] While nonmarijuana products comprised 25% of the sales floor, they were sold in the same area as marijuana and marijuana products, and as such, in order to access that area, a customer would need to be a patient who is legally allowed to purchase medical marijuana.[67] This means these products were not available to people who were not able to purchase marijuana legally. In light of these facts, the court concluded that the sale of nonmarijuana items had a “’close and inseparable organizational and economic relationship’ with, and was ‘incident to,’ Harborside’s primary business of selling marijuana.”[68] Accordingly, the court did not recognize this activity as a separate trade and upheld the disallowance of deductions for expenses related to this portion of the business.

The court then moved on to analyze the portion of the business relating to the provision of therapeutic services. Here the court took the opportunity to further distinguish Harborside from CHAMP, noting that the business in CHAMP provided unlimited access to a wide range of services and a fixed amount of marijuana for a set fee, where Harborside would use a portion of each marijuana sale to pay for the services it provided.[69] The court found Harborside’s operations much more analogous to the Vapor Room, in the sense that customers paid “according to the amount and type of marijuana they wanted and in return gained access to incidental services.”[70] Harborside’s argument that it provided services on a much greater scale than the Vapor Room was unpersuasive, as the court found that regardless of the level of services provided, they were still incidental to the sale of marijuana.[71] As such, the court also declined to find the provision of therapeutic services to be a separate trade.[72]

Finally, the court discussed the brand development operations of Harborside, ultimately determining that these activities were also substantially related to the sale of marijuana.[73] Because Harborside’s branding was carried out by the same entity, management, capital structure, employees, and facilities, and there was a complete lack of evidence suggesting that brand development activities were in any way separate from the rest of the business, the court found no reason to consider this activity a separate trade, or allow deductions relating to these activities.[74]

Overall, the court concluded that Harborside was engaged in a single trade or business for which the primary purpose was the selling of marijuana.[75] All activities that were not the actual sale of marijuana were in fact substantially related to the selling of marijuana, and therefore all deductions under Section 162 were properly disallowed by the IRS.[76] This case is important, not only because it is one of the most recent cases on the matter, but also because it provides an in-depth analysis of the IRS’s narrow reading of the CHAMP ruling, and what it means to actually conduct a separate trade or business with respect to the marijuana industry.

1. Discrepancies Between Purpose and Effect

As outlined by the previous cases, it becomes clear that various discrepancies exist between the intended purpose of Section 280E and the current effects it has on marijuana businesses. Due to changing attitudes, legislature trends, and developments in knowledge surrounding the use of marijuana, when applied to marijuana businesses, the effects of Section 280E are no longer in line with its purpose.

First and foremost, marijuana is no longer considered to share the same characteristics as other Schedule I drugs. The legalization of marijuana, both recreationally and medicinally, in a growing majority of states shows that it is no longer considered to have the highest potential for abuse. Marijuana is the only Schedule I substance that has achieved legalization at this level. This can be attributed to a greater understanding of the substance and shifting attitudes regarding the dangers involved with its use. Additionally, state legal medical marijuana programs refute the positions that marijuana has no currently accepted medical use in treatment in the United States, and that there is a lack of accepted safety for use of marijuana under medical supervision. This is also evidenced by the Federal Government’s unwillingness to pursue any other action against state legal medical marijuana programs. If marijuana were reevaluated for scheduling in current times, it is not only probable that it would not be categorized in Schedule I or II, but highly likely. As such, applying Section 280E in its current form to a substance which no longer is considered to be highly dangerous, contributes significantly to the discrepancies between Section 280E’s effects and purpose.

Next, Section 280E was enacted at a time where marijuana was illegal on all levels. There were no legal marijuana businesses, and the very idea that there one day may be legal marijuana was farfetched in the eyes of many. There was no reason for Congress to consider implications on businesses legally trafficking in Schedule I or II substances since no businesses of the kind existed. However, with current legalization trends, Section 280E is no longer just punishing criminals, but also law-abiding citizens. In its 1982 Senate Finance Committee report, Congress made the explicit distinction between drug dealers and legal enterprises.[77] While traffickers of cocaine still remain drug dealers, those engaged in marijuana businesses now fall into the category of legal enterprises, at least in the eyes of the state. In accordance with Congress’s own statement, these legal enterprises should be allowed to deduct their business expenses. However, the unwillingness by Congress to either reschedule marijuana under the Controlled Substance Act, or provide relief to these legal enterprises under Section 280E, creates a direct contradiction between the purpose and effect of the Code section.

Finally, and perhaps most importantly, the public policy concerns surrounding drug trafficking that drove the enactment of Section 280E were in response to the trafficking of cocaine, not marijuana. All evidence points to the conclusion that Congress’s decision to single out drug traffickers with Section 280E was due to public pressure surrounding the cocaine trade. Not only was the cocaine trade generating billions of dollars in profits per year for large scale Colombian drug trafficking operations, but the level of violence that accompanied the cocaine flowing into the United States was unparalleled.

When applied to cocaine trafficking, Section 280E still retains its purpose and accomplishes the goals it intended. No level of government in the United States has shifted its perception regarding the dangers surrounding cocaine. However, the legalization of marijuana provides ample evidence that it should no longer be treated the same as cocaine under the Tax Code. Not only have a majority of states legalized marijuana in some form, but as mentioned previously, the Federal Government is unwilling to take action against marijuana businesses that are legal at a state level.[78] This shows that the Federal Government is no longer concerned with marijuana, and understands the risks posed by marijuana businesses to be minimal at best. Accordingly, it is no longer appropriate to apply a punitive measure intended to harm large scale cocaine traffickers, to legal enterprises who wish to pay taxes and comply with the laws of this country.

1. Tax Policy Argument

In addition to the effects of Section 280E being out of line with its own purpose, Section 280E is also out of line with the tax policy principles upon which a tax system should be based. The guiding principles of fairness, efficiency, and neutrality are key to creating an effective tax system.[79] As it currently stands, when applied to legal marijuana businesses, Section 280E is not fair, efficient, or neutral, thus providing further persuasive reasoning in favor of change.

The principle of fairness is typically discussed in terms of horizontal and vertical equity, meaning that those in similar tax situations should be taxed similarly (horizontal equity), while those in different tax situations should be taxed differently (vertical equity).[80] With reference to legal marijuana businesses, at the state level there is no tax difference between a marijuana business operating in accordance with state law and any other law-abiding business. As such, under the principle of fairness, horizontal equity should apply. However, Section 280E prevents marijuana businesses from being taxed like other similarly situated businesses. Where other legal businesses are taxed on their net income, marijuana businesses are taxed on their gross income. Accordingly, when applied to legal marijuana businesses, Section 280E does not follow fairness principle.

The principle of efficiency dictates that a tax system should seek a balance between “maximizing tax revenues and minimizing the social costs of taxation.”[81] In other words, a tax system should provide sufficient funding for the government to operate without placing too large a burden on activities which benefit the economy.[82] In the case of legal marijuana businesses and Section 280E, this balance is far from achieved. Operating a legal marijuana business is an economic activity which is just as beneficial as operating any other legal business. However, the burden placed on marijuana businesses is so large that many marijuana businesses are not able to continue operations because of the extremely heavy burden imposed by Section 280E. This is a textbook example of stifling a beneficial economic activity. Additionally, as a result of stifling of legal marijuana businesses being stifled, Section 280E also fails to maximize tax revenue. Because only a small portion of legal marijuana businesses are able to succeed in the current tax system, the IRS is missing out on a potentially massive amount of revenue that could be generated by allowing the marijuana industry to grow. As such, Section 280E in its current form also fails to conform with the principle of efficiency.

The principle of neutrality “holds that the tax system should avoid unnecessarily shaping economic behavior.”[83] This principle has lost some footing over time, as there are currently many Tax Code provisions that encourage or discourage certain economic behaviors.[84] However, many of these provisions are seemingly based on what public policy dictates are behaviors that should be encouraged or discouraged. As I will discuss in greater detail later in this paper, public policy no longer dictates that trafficking in marijuana, providing it is done so in accordance with state law, goes against public policy. This is evidenced by legalization trends in a majority of states. Due to this change, the effects of Section 280E on legal marijuana business fall out of line with public policy, and as such should be seen as “unnecessarily shaping economic behavior” in direct contrast to the principle of neutrality.

1. PART III: Proposed Amendment to Section 280E
   1. Proposal

First off, it is necessary to acknowledge that perhaps the most straightforward solution to the problem at hand would be to simply reschedule marijuana, placing it somewhere in Schedule III-V. By doing so, no amendment would be needed to Section 280E in order to allow the fair treatment of marijuana businesses, as Section 280E only applies to Schedule I and II substances. This would be a non-tax solution that would effectively accomplish the same goals of the amendment I am going to propose. However, in the event a tax solution is necessary, I propose that Section 280E be amended in the following manner;

• 280E. Expenditures in connection with the illegal sale of drugs

(a) In general. 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.

(b) Trades or businesses trafficking in marijuana in compliance with State law. Subsection (a) shall not apply 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 legally trafficking in marijuana in full compliance with the relevant laws of any State in which such trade or business is conducted. In accordance with this subsection, deductions shall be allowed to the extent that they meet the requirements of section 162.

1. Analysis

My proposed amendment to Section 280E would function to provide relief to marijuana businesses operating legally and in accordance with all relevant laws of the State in which they operate. By adding my amendment under subsection (b) and making the existing text of Section 280E into a general provision under subsection (a), the amendment is represented clearly as an exception to the general provision, and follows the formatting of the rest of the Code.

By using the same language found in the general provisions of Section 280E(a) and Section 162(a), I intended the same meaning be applied to these terms in my amendment. The purpose of using terms such as “carrying on any trade or business” is to achieve consistency with the already existing Code sections. Additionally, I wanted to encompass the entire scope of activities prohibited by Section 280E(a) in order to provide the same scope to the exception with regards to marijuana. I believe that by using the language of Section 280E(a), I have achieved this goal, allowing eligible marijuana businesses a full exception to the prohibition imposed by Section 280E(a).[85]

In drafting this amendment, it was necessary to consider the nature of Section 280E as an exception to Section 162, and how my amendment would function with reference to the rest of the Code. There are in fact several exceptions to Section 162, some of which are listed in the subsections of Section 162 itself, and others which are listed in Sections 261 through 280H.[86] Like Section 280E, many of these exceptions find their basis in public policy. In order for my amendment to stand, it is necessary that it distinguishes itself from these other exceptions so as not to be invalidated by courts on the grounds that it frustrates a sharply defined public policy.

I believe this is accomplished due to the fact that the exceptions listed in Section 162, as well as those listed in Sections 261 through 280H, all are based on currently valid public policy.[87] The same is not true for Section 280E when applied to legal marijuana businesses. For example, there has been no shift in perception towards the illegal kickbacks, bribes, and other payments which are disallowed under Section 162(c). These types of payments have always been considered contrary to public policy, and remain so to this day. Additionally, under Section 269, acquisitions made to evade or avoid income tax not only violate the public policy that citizens should pay the taxes they owe, but also works against the goal of taxing individuals on their net income. As such, the public policy concerns surrounding Section 269 remain firmly in place.

As discussed at great lengths in this paper, the shifting perception with regards to marijuana invalidate the public policy reasoning behind Section 280E when it is applied to state legal marijuana businesses. In fact, the public policy surrounding marijuana has shifted so drastically over the years, that not only does my amendment to Section 280E distinguish itself from the rest of the public policy exceptions, but continuing to apply Section 280E to state legal marijuana businesses works to frustrate public policy as it currently stands.

1. Purpose and Effect

The purpose of my amendment to Section 280E is fairly obvious given the context of this paper; to create an exception which would align Section 280E with current attitudes and perceptions regarding marijuana while retaining the original purpose and goals of the Code section, and to eliminate or minimize the negative effects Section 280E currently has on legal marijuana businesses. I believe that my proposed amendment would accomplish this purpose.

By allowing deductions under Section 162 to marijuana businesses that are operating in full compliance with state law, the marijuana industry would have the same opportunity for growth that every other legal industry in the country has. This would provide relief to marijuana business owners who are currently struggling to stay afloat while being taxed on their gross income, while also encouraging other entrepreneurs to join the market. Additionally, it would eliminate the disincentive to pay taxes that marijuana businesses currently face, and allow marijuana businesses the legitimacy that they seek. It is clear from legalization trends, the current public perception of marijuana, and the sheer amount of revenue generated by legal marijuana businesses every year, that this is not a result which is disfavored by the public. As such, it is highly likely that eliminating punitive taxation for marijuana businesses would produce an astonishing amount of tax revenue for both State and Federal Governments. While the Federal Government would initially take a hit in the sense that they would be receiving less from each taxpaying marijuana business, the potential growth of the industry would likely make up the difference in a short period of time, in addition to providing other opportunities for the Federal Government to tax and regulate marijuana in a similar fashion to alcohol.

1. Conclusion

In the words of the great Steppenwolf, “don’t step on the grass, Sam.” In a time where Section 280E functions as a metaphorical foot on the throat of the marijuana industry, such a sentiment has never rung truer. Drastic shifts in public perception have rendered Section 280E’s application to marijuana businesses contrary to not only its own purpose, but to broader public policy. I believe my proposed amendment to Section 280E would remedy the negative effects of this outdated Code section, providing the marijuana industry with the chance to thrive. While there are certainly other solutions to this issue, the manner in which it is solved matters very little. The importance lies in the result. To continue to suppress the legal marijuana industry is to continue to ignore the developments of an everchanging society.

[1] Drug Enforcement in the United States: History, Policy, and Trends, https://fas.org/sgp/crs/misc/R43749.pdf, at 5.

[2] Id.

[3] Internal Revenue Service Memorandum, No. 201504011, https://www.irs.gov/pub/irs-wd/201504011.pdf, at 2.

[4] Drug Enforcement in the United States: History, Policy, and Trends, https://fas.org/sgp/crs/misc/R43749.pdf, at 6.

[5] Internal Revenue Service Memorandum, No. 201504011, https://www.irs.gov/pub/irs-wd/201504011.pdf, at 2.

[6] Drug Enforcement in the United States: History, Policy, and Trends, https://fas.org/sgp/crs/misc/R43749.pdf, at 6.

[7] Id.

[8] See generally, 21 U.S.C.S. § 812.

[9] See generally, 21 U.S.C.S. § 812.

[10] Id.

[11] 26 U.S.C.S. § 280E.

[12] 26 U.S.C.S. § 162(a).

[13] Note: Section 280E of the Internal Revenue Code and Medical Marijuana Dispensaries: An Interpretation Based on Statutory Purpose, 84 Geo. Wash. L. Rev. 249, 254.

[14] Commissioner v. Tellier, 383 U.S. 687, 691 (1966).

[15] Id. at 691-92.

[16] Note: Section 280E of the Internal Revenue Code and Medical Marijuana Dispensaries: An Interpretation Based on Statutory Purpose, at 254.

[17] NOTE: Pass the Revenue: How Section 280E is Harming the Medical Marijuana Industry, 2 Cardozo J. Int’l & Comp. L. 850, 851.

[18] Commissioner v. Tellier, 383 U.S. at 693-94.

[19] Note: Section 280E of the Internal Revenue Code and Medical Marijuana Dispensaries: An Interpretation Based on Statutory Purpose, at 258.

[20] Edmondson v. Commissioner, Docket No. 4586-76., 1981 Tax Ct. Memo LEXIS 118, at *9 (T.C. Oct. 26, 1981).

[21] Id. at *3-4.

[22] Id.

[23] Id. at *9.

[24] Note: Section 280E of the Internal Revenue Code and Medical Marijuana Dispensaries: An Interpretation Based on Statutory Purpose, at 259.

[25] ARTICLE: POWERLESS TO PENALIZE: WHY CONGRESS LACKS THE POWER TO PENALIZE MARIJUANA BUSINESSES THROUGH § 280E OF THE INTERNAL REVENUE CODE, 59 Ariz. L. Rev. 1081, 1086.

[26] Thirty Years of America’s Drug War, PBS, http://www.pbs.org/wgbh/pages/frontline/shows/drugs/cron/.

[27] Id.

[28] Id.

[29] 26 U.S.C.S. § 280E.

[30] 26 U.S.C.S. § 162(a).

[31] Id.

[32] It is currently unclear if Section 199A is subject to the Section 280E disallowance due to a lack of currently available case law or official positions given by the IRS, however it is likely that Section 280E would apply to Section 199A.

[33] It is important to note that Section 280E disallows all deductions and credits available to marijuana businesses, and as such, will affect the availability of other Code sections. However, because the majority of case law currently available revolves around Section 162 deductions, only the effects of Section 280E in relation to Section 162 deductions will be discussed in this paper.

[34] Legal Definition of Trafficking, Merriam-Webster, https://www.merriam-webster.com/legal/trafficking.

[35] 26 U.S.C.S. § 280E.

[36] Id.

[37] Due to Constitutional concerns, under Section 280E, a taxpayer is allowed to reduce their gross income in relation to their cost of goods sold. See, NOTE: Pass the Revenue: How Section 280E is Harming the Medical Marijuana Industry, 2 Cardozo J. Int’l & Comp. L., at 858.

[38] Commissioner v. Tellier, 383 U.S. at 691.

[39] Californians Helping to Alleviate Med. Problems, Inc. v. Commissioner, 128 T.C. 173, 173 (2007).

[40] Id.

[41] Id. at 177-78.

[42] Id. at 176.

[43] Id. at 178.

[44] Id. at 176.

[45] Id. at 182.

[46] Olive v. Commissioner, 139 T.C. 19, 19 (2012).

[47] Id. at 23.

[48] See generally, Id.

[49] Id. at 39.

[50] Id.

[51] Id. at 40.

[52] Id. at 41.

[53] Interesting New Tax Court Decision on Section 280E, https://my.vanderbilt.edu/marijuanalaw/2019/01/564/.

[54] Patients Mut. Assistance Collective Corp. v. Commissioner, Nos. 29212-11, 30851-12, 14776-14, 2018 U.S. Tax Ct. LEXIS 54, at *2 (T.C. Nov. 29, 2018).

[55] Id. at *2-3.

[56] Id. at *3.

[57] Id. at *3-4.

[58] Id.

[59] Id. at *3.

[60] Id. at *9.

[61] Id.

[62] Id. at *35.

[63] Id. at *35-36.

[64] Id. at *36.

[65] Id.

[66] Id.

[67] Id.

[68] Id. at *36-37.

[69] Id. at *38-39.

[70] Id. at *39.

[71] Id.

[72] Id. at *40.

[73] Id. at *42.

[74] Id.

[75] Id.

[76] Id.

[77] ARTICLE: POWERLESS TO PENALIZE: WHY CONGRESS LACKS THE POWER TO PENALIZE MARIJUANA BUSINESSES THROUGH § 280E OF THE INTERNAL REVENUE CODE, at 1086.

[78] Patients Mut. Assistance Collective Corp. v. Commissioner, 151 T.C. at 177.

[79] John A. Miller & Jeffery A. Maine, The Fundamentals of Federal Taxation, 5 (5^th ed. 2018).

[80] Id.

[81] Id. at 6.

[82] Id.

[83] Id.

[84] Id.

[85] Through the use of the language “any amount paid or incurred,” I intended the exception to allow all other deductions and credits previously unavailable to marijuana businesses, not just limiting the exception to allow Section 162 deductions.

[87] See Generally, 26 U.S.C.S. §§ 162, 261-280H.