Another day, another (tax) dollar.
The U.S. Tax Court again addressed IRC §280E in the recent case Canna Care, Inc. v. Commissioner, disallowing all of the California’s dispensary’s “operating deductions” under IRC §280E. Unlike prior cases, the Tax Court in Canna Care does not address the computation of COGS, but rather the deduction of regular business expenses, such as salaries.
Overall, this case does not change the holdings in CHAMP or Olive. [For those of you that need a quick refresher, CHAMP held that where CHAMP was essentially engaged in two separate businesses, one legal (caregiving) and one illicit (dispensing MMJ), it was entitled to deduct COGs for the caregiving portion of its business; Olive applied CHAMP to less favorable facts, holding that where Olive’s primary business was selling marijuana, and its other services amounted to mere “amenities,” Olive was unable to claim any deduction.] What’s notable about Canna Care is the taxpayer’s direct attack on the application of IRC §280E.
Like the taxpayers under scrutiny in both Olive and CHAMPS, Canna Care was a medical marijuana dispensary. Canna Care was organized as a California mutual benefit corporation, and as such, was considered a non-profit entity under California law. Canna Care took care in emphasizing that it operated at a deficit. However, the Tax Court noted that the officers and directors were paid salaries that “far exceeded the salaries paid to any other employee,” an indicator that Canna Care was perhaps not so altruistically motivated. In addition, the Tax Court noted that corporate funds were used to pay for officer’s automobiles. Importantly, Canna Care highlighted to the Tax Court its involvement with the community including: involvement in cancer and diabetes walks; the hosting of regular meetings for Americans for Safe Access, a medical marijuana advocacy group; and, the offering of prayer and counseling services. Even that community emphasis was not enough to save Canna Care.
Taxpayer advanced three arguments, all of which were rejected by the Tax Court.
First, that medical marijuana is not a Schedule I controlled substance. The Tax Court indicated that Taxpayer “advanced numerous arguments” as to why medical marijuana should not be considered a Schedule I controlled substance. The Tax Court did not elucidate any of these arguments and summarily rejected them.
Second, that Canna Care was not “trafficking” for purposes of IRC §280E because its activities were not illegal under the California Compassionate Use Act of 1996. Taxpayer cited the Cole Memo as well as the 2014 FinCEN Memo as support. The Tax Court, citing both Olive and CHAMP rejected this argument. In summary, the Tax Court held that the sale of cannabis is always considered trafficking for purposes of IRC Sec. 280E, even when permitted by state law.
Finally, that CHAMP was incorrectly decided. Canna Care argued that CHAMP really was not involved in two trades or businesses but one. Canna Care argued that the taxpayer in CHAMP was not allowed to perform “caregiving services” under California Law; therefore, the taxpayer in CHAMP was merely a single entity doing charitable work. Canna Care argued it was a charitable entity similar to the taxpayer in CHAMP, and therefore was entitled to a full deduction of operating expenses.
The Tax Court disagreed, stating that “CHAMP did not involve a determination as to whether the taxpayer qualified as a caregiver for purposes of California law.” The Tax Court noted that the critical determination in CHAMP was that taxpayer was engaged in two separate trades or businesses. The Tax Court noted that Canna Care stipulated that it was in the business of distributing medical marijuana. The Tax Court noted that Canna Care received income from the sale of books and T-shirts. However, the evidence presented did not allow the Tax Court to determine what percentage of income was derived from sale of books versus the sale of cannabis. As such, the Tax Court held that Canna Care was engaged only in the sale of medical marijuana. Therefore all operating expenses were disallowed under IRC § 280E.
The Tax Court did not outline the taxpayer’s numerous arguments in any detail, so it is difficult to dismiss those arguments out of hand. We can safely say, however, that this case clarifies several points.
- First, the argument that the sale of cannabis is not trafficking for purposes of IRC 280E will be difficult to sustain.
- Second, CHAMPS and Olive are the current templates in determining whether an expense is deductible under IRC §280E. Good works or community involvement are not sufficient, by themselves, to support a tax deduction outside the application of IRC §280E. In order to be deductible, such activity must be considered a separate trade or business entered into with a profit motive.
- Third, the case once again highlights that the essence of a successful IRC §280E argument is the substantiation and development of facts. Because the taxpayer had, in the court’s view, insufficient evidence to carve out two separate trades or businesses, the taxpayer was unable deduct any operating expenses.
- Finally, so long as IRC § 280E is on the books, the cannabis industry will suffer. The industry would be well-served to support aggressively the passage of the Small Business Tax Equity Act of 2015 or other legislation repealing IRC §280E. I believe it can, and must, be done.