Cannabis (or marijuana) dispensaries have long stated that they are subjected to harsher tax consequences under the Internal Revenue Code (“IRC” or “Code”) than their “legal” counterparts. Specifically, they have argued, in and out of court, that their businesses pay tax on what may otherwise be losses for other businesses but are considered income due to IRC § 280E. At the end of May, however, Harborside Health Center (“Harborside”) filed its appeal brief to the Ninth Circuit Court of Appeals with the hopes of ending this disparate treatment.
Harborside’s brief launches an interesting salvo against section 280E in an attempt to overturn the Tax Court’s final judgment that Harborside is liable for approximately $11 million in taxes. It argues that (1) § 280E is unconstitutional because it does not tax “income” as required by the Sixteenth Amendment of the United States Constitution and (2) the Tax Court improperly classified its cost of goods sold (“COGS”). Its arguments in the appeal, to a degree, appear to be based on the Tax Court Judge Gustafon’s dissent in Northern California Small Business Assistants Inc., v. Comm’r, 153 T.C. 4 (2019).
Harborside’s constitutional argument consists of two important points, the second of which takes aim at a commonly-recited statement by tax practitioners. Harborside first states that IRC 280E is unconstitutional under the Sixteenth Amendment of the United States Constitution because the term “income” under the Sixteenth Amendment means “gain” rather than gross income. This argument is then buttressed against its point that the classic tax adage “deductions are a matter of legislative grace”, as stated in New Colonial Ice Co. v. Helvering, 292 U.S. 435 (1934), is meant to, and should, only apply certain items that do not directly relate to the cost of an item sold. These would include items such as the personal exemption, deductions for taxes paid, and losses sustained in unrelated business transactions.
Harborside’s second argument is that its cost of good sold (COGS) should be determined in the same manner as a grocery store rather than a “reseller.” It compares itself to a grocery store that has to prepare and package beef to sell to the consumer, in contrast to a department store where the product arrives in a final state and is immediately put out for sale to consumers. Thus, it should be able to include costs such as procurement, quality control, curing, storage and security, employees, and others in its calculation of COGS.
These arguments, effectively echo what many cannabis businesses have been saying for years: that they are excessively taxed in an absolute and relative sense when compared to other “legal” business. It will be interesting to see how the government responds to Harborside’s arguments in the coming months, and, of course, how the appellate court rules in the case.
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