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One of the largest California cannabis businesses is accusing the federal government of weaponizing federal tax law and wrongly interpreting the U.S. Constitution when it comes to taxation of the marijuana industry.marijuana business lawyer

As our Los Angeles cannabis business tax lawyers can explain, this is the latest development in a long-running legal battle over the much-derided IRS rule outlined in 280E, which curbs the deduction cannabis companies can take on their taxes.

Dispensary chain Harborside in Oakland is appealing in the U.S. Court of Appeals for the Ninth Circuit following a 2019 ruling by a U.S. Tax Court which ordered the company to pay $11 million in back taxes after wrongly claiming a host of business deductions. Such deductions are available to most businesses in the U.S., but cannabis companies don’t have that luxury, thanks to 280E.


What is Section 280E

The problem for the state-legal marijuana industry is the federal designation of marijuana as a Schedule I narcotic, in the same category as heroin – highly addictive and with no medicinal benefits. It’s an outdated classification, but one to which the federal government has held tight for decades.

Section 280E of the U.S. tax code holds that operations that profit from trafficking illegal drugs can’t turn around and deduct expenses incurred in the production, distribution and sale of those drugs. That means that even operations following their state law to the letter can’t deduct business operating expenses. The law was adopted in the 1980s – long before cannabis was state-legal – to prohibit illegal drug traffickers from claiming tax deductions.

There is an exception for the costs of goods sold, such as costs for seeds, water, nutrients, soil and expenses related to growing and harvesting the plant. Expenses racked up for distributing the product aren’t tax deductible. These include things like labor expenditures, overhead costs, shipping and rent.


What this all translates to are much higher tax bills for the cannabis industry because they are compelled to pay taxes on gross profit instead of their actual net income. For many operations, this can quickly make business unprofitable.

Let’s say a company brings in $2 million in revenue. If they deduct $600,000 in cost of goods sold, their gross profit is $1.4 million. A typical business can deduct expenses associated with sales, administration, etc. (let’s say $1.1 million). That business would have a net income of $300,000, and would be taxed on that amount. A cannabis business, however, would have to pay taxes on the gross profit of $1.4 million, ultimately paying more than $230,000 in additional taxes compared to other companies.

Legal Argument Against Section 280E

Harborside is appealing a tax court ruling that 280E was applicable. In a response filed last fall, the Internal Revenue Commissioner argued for dismissal on the grounds that the constitutional questions being raised by the dispensary chain weren’t previously raised with the lower court.


In a 35-page response, Harborside called the IRS’s position on exclusions “clever, but unconstitutional,” and that it forces companies operating at a loss, without income, to still pay substantial income taxes. Compelling the cannabis industry to acquiesce to a “new method of accounting” both oversteps the Constitution and misconstrues tax law.

The case is being closely monitored by those in the cannabis industry, including our Los Angeles marijuana business lawyers, because it could impact how businesses can deduct expenses on future tax bills.

Central to this dispute is how “income” is defined. The IRS argues that the 16th Amendment is applicable only to income derived from property (i.e., collecting rent) and doesn’t involve business income. Harborside argues this is an inappropriate interpretation of the Amendment, which allows Congress to tax income directly. Further, because the cannabis company was operating at a net loss for the years in question, there was no “income” to tax and the government is trying to impose a tax unlawfully.


So far, at least two amicus briefs have been filed by cannabis industry groups in favor of the dispensary’s position. Oral arguments are slated to begin next month.

The Los Angeles CANNABIS LAW Group represents growers, dispensaries, ancillary companies, patients, doctors and those facing marijuana charges. Call us at 714-937-2050.

Additional Resources:

Harborside Fires Back at IRS, Dec. 9, 2020, By Willis Jacobson, Weed Week

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