Originally published on Forbes.com.
The Green Solution Retail Inc does not want the IRS poking around in its records. Its appeal to the Tenth Circuit did not go well. Green Solution is located in Aurora, Colorado and it will help you get your marijuana in classy surroundings.
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It is a long way from a cardboard box full of plastic baggies, each holding a purported ounce of marijuana, in somebody’s dorm room. That is how I recall it was done back in the day. Well, you know, that’s what I heard anyway.
The Tax Problem
Although you might read that Washington and Colorado have “legalized” marijuana, that is not strictly true. The Obama administration went with a kind of “fight crime someplace else” approach with states that had dropped marijuana prohibition, but there are indications the Trump administration might take a dimmer view of your Rocky Mountain high. Besides amusing me with the way the left and the right will seamlessly switch between states rights and federal supremacy depending on the issue, there is a tax matter to consider. Code Section 280E, one of the short ones, provides:
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.
The section was added by the Tax Equity and Fiscal Responsibility Act of 1982. That’s getting to be a really long time ago. It makes things really complicated for people in the marijuana business with significant overhead beyond the trunk of a beat up old car or the space below a bed in a dormitory.
The Litigation
Green Solution seems to think that like other arms of the federal government, the IRS should be fighting tax crime elsewhere.
Green Solution sued the IRS and related parties in the United States District Court for the District of Colorado, seeking to enjoin the IRS from investigating whether it trafficked in a controlled substance in violation of federal law, and seeking a declaratory judgment that the IRS is acting outside its statutory authority when it makes findings that a taxpayer has trafficked in a controlled substance. Green Solution claimed it would suffer irreparable harm if the IRS were allowed to continue its investigation because a denial of deductions would (1) deprive it of income, (2) constitute a penalty that would effect a forfeiture of all of its income and capital, and (3) violate its Fifth Amendment rights.
The IRS argued the suit should be dismissed because of the Anti-Injunction Act which bars suits “for the purpose of restraining the assessment or collection of any tax”. The idea is that you fight the IRS in court after they have sent you a bill.
Reilly’s First Law Of Tax Planning
This is one of the best illustrations of my first law that I have seen in a while. The first law is – “It is what it is. Deal with it.” Code Section 280E as applied to state, but not federally, sanctioned marijuana operations has been upheld in Californians Helping to Alleviate Medical Problems Inc and Martin Olive.
Green Solution’s claim that denial of deductions under 280E would constitute a penalty that would effect a forfeiture of its income and capital really overstates the case. Since we have an income tax, not a gross receipts tax, sellers of illegal drugs are allowed a deduction for cost of goods sold. 280E has the effect of denying deductions for administrative and selling costs. There are a variety of solutions to that problem. You can raise prices. Or you can run very lean to minimize nondeductible expenses. Another possibility is to organize as a partnership or possibly a worker owned coop to minimize deductible expenses.
I haven’t been thinking a lot about this issue, but other planners have. You can read 5 Tips for Lowering Your 280E Tax Burden by Bruce Barcott. In Recreational Cannabis – Section 280E and Tax Efficient Structuring, Lewis Horowitz and Justin Hobson write about maximizing the expenses that go into cost of sales take and issue with CCA 201504011 which limits moves in that direction. In Blunting the 280E Blow, Gary Strauss writes about shifting space from retail to storage to increase inventoriable costs and running a second business, such as a yoga studio to absorb some of the overhead.
Green Solution Responds
I heard from Kyle Speidell CEO of TGS Management LLC and president of The Green Solution LLC
We are of course disappointed by the court’s recent decision but we intend to aggressively pursue any and all remedies on this matter in opposition to the IRS. An IRS position we might add which gives full voice to former Supreme Court Chief Justice John Marshall’s admonition that “the power to tax is the power to destroy.” We fully intend to prevail in the court of law as we have and continue to do in the court of public opinion.
It is interesting that he chose McCulloch v Maryland. Not to be petty but the actual quote is “The power to tax involves the power to destroy..” and the holding in McCulloch is supportive of federal supremacy in its sphere. Regardless, I think Mr. Speidell has a point. 280E will not kill organizations that are selling marijuana. It just creates a very strong drive to have a very lean retail operation and that does not appear to be the type of operation that is envisioned by Green Solutions.
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An Audit Free Zone?
Green Solution’s motion for an injunction, while inspired, was really a non-starter when you think about it. If it were granted, operations potentially subject to 280E would not be audited on any issue.
As it happens the court ruled in favor of the IRS.
Thus, because the IRS’s investigation of Green Solution’s business records is an “activity leading up to” an assessment, we conclude Green Solution’s lawsuit was filed for the purpose of restraining any such assessment and is therefore barred by the AIA and DJA.
This decision comes on top of High Desert Relief Inc decided at the end of March in which the District Court for the District of New Mexico upheld 280E’s application to a medical marijuana dispensary.
This Is Unfortunate
It would seem to me that it is probably not in the best interest of sound tax administration for the IRS to make 280E enforcement a high priority. It may turn into another debacle such as the one that Lois Lerner created when she decided that the IRS was the last line of defense against dark money. Reilly’s First Law of Tax Policy is “Make tax policy the Switzerland of the culture war”. The IRS is probably stuck with 280E for the moment, but it does not have to make it a major priority. Maybe conservatives could embrace state rights even when it comes to things that they associate with long-haired hippies, but that might be to much to hope for,
Other Coverage
Natalie Olivo covered the Green Solution decision for Law 360 and had a more in depth discussion of the legal precedents. Ronald Marini had a summary piece titled Summons Rules Applies To Taxpayer’s Marijuana Business.
Leslie Book covered High Desert Relief on Procedurally Taxing highlighting an interesting argument.
A final issue in HDR is worth mentioning. The taxpayer argued that the “federal criminal drug laws with respect to state-legal marijuana sales dead letter.” As such, it looked to old cases under Section 162 that allowed beer and liquor distributors deductions for activities that technically violated state laws, such as gifting beer or providing rebates to distributors. States turned a blind eye to those practices and did not enforce the laws prohibiting them. The main difference is that while Section 162 disallows deductions for activities in violation of state law, the Code itself provides that the limitation on deduction under Section 162 only applies if the state law is “generally enforced.” No such limitation appears in Section 280E.
There is a lament similar to mine.
The tax system thus contributes to the schizophrenic legal approach to the marijuana business. While the federal government is willingly collecting tax revenues and enforcing the internal revenue laws, the marijuana industry operates on a different substantive plane.