The cannabis industry operates at a disadvantage vis a vis other industries because Section 280E of the Internal Revenue Code prohibits business expense deductions for businesses that “traffic” in federally controlled substances, including cannabis. As a result, cannabis companies pay taxes on gross rather than net profits. In the latest defeat for cannabis companies in the Tax Court, Boulder Alternative Care, LLC (“Boulder”), a Colorado dispensary, lost its bid to obtain ordinary business expense deductions for its legal operations (Docket No. 16495-16). Boulder argued that it was entitled to those deductions because Colorado, not federal, law controls. Boulder’s position was that “[s]ince Colorado law controls, state legal marijuana sales cannot be considered ‘prohibited’ under federal law.” In other words, Boulder argued (unsuccessfully) that because Colorado law permits the sale of marijuana for medical purposes, those sales are exempted from the Controlled Substances Act, and by extension, section 280E.
The Tax Court disagreed, citing a long history of Supreme Court and Circuit Court cases where courts have consistently disallowed deductions under section 280E for cannabis companies, irrespective of any permissive state laws. In rejecting Boulder’s motion, the Tax Court stated that “[i]n ignoring such precedent, petitioner’s arguments are so meritless as to be frivolous.” See the full order here.
However, although they did not make progress in the Tax Court, cannabis businesses are continuing their steady march toward acceptance as a mainstream business. On September 25, 2019, the House approved, in a 321-103 vote, the Secure and Fair Enforcement Banking Act of 2019 (H.R. 1595), which would create a safe harbor for depository institutions to bank the proceeds of state-compliant businesses. It would also remove proceeds of state-compliant cannabis businesses (including ancillary businesses) from the definition of criminal proceeds under federal money laundering laws. See our prior post on the SAFE Banking Act here. Ironically, though in some ways a step forward for the industry, this bill would actually make it easier for the IRS to track cannabis businesses’ unreported income, potentially increasing their tax payments. This is so because it is easier for the IRS to track credit card and check receipts than it is to track cash. Therefore, banking reform without corresponding tax reform will still leave state legal businesses at a competitive disadvantage. While the banking bill won support in the House, proposals to exclude cannabis businesses from the scope of section 280E do not seem to have nearly as much traction. This is partly because the SAFE Banking Act has a compelling safety aspect (forcing businesses to keep their profits in cash rather than in banks makes them ripe targets for robbery) that is not applicable in the tax context. In addition, as one industry lobbyist told us, reforming section 280E is perceived by some as “giving a tax break to drug dealers” – an obviously unappealing political message. However, if enacted, the SAFE Banking Act will increase the number of legal businesses in the industry, thus potentially also increasing the number of stakeholders advocating for tax reform.