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Business owners, including attorneys, know how important the federal tax deduction for “ordinary and necessary” business expenses is to their profitability and survival. The less money a business pays in taxes, the more profits it has with which to fuel growth.
The United States Supreme Court’s recent denial of certiorari in a case concerning the ability of state-legal cannabis businesses to claim this deduction is likely to hamper the growth of those businesses and an entire fledgling industry.
Earlier this summer, the U.S. Supreme Court denied cert in . In its February 2019 Petition for Writ of Certiorari, Alpenglow Botanicals, a Colorado-based medical marijuana business, sought the Supreme Court’s review of a 2018 decision by the U.S. Court of Appeals for the Tenth Circuit that went against the company.
At the center of Alpenglow’s case was Internal Revenue Code section 280E, which prevents individuals and organizations whose businesses involve trafficking in drugs that are illegal under federal law from claiming a federal tax deduction under Internal Revenue Code section 162. Section 162 states that “ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business” are tax deductible.
In its 2018 decision, the Tenth Circuit held that the IRS did not exceed its authority when it denied Alpenglow’s deductions of $53,094 for ordinary business expenses under Section 280E. The IRS denied the deductions after it audited Alpenglow’s tax returns for the 2010 through 2012 tax years. Alpenglow argued that the IRS exceeded its authority because in the course of rejecting the deduction, it implicitly determined that the company trafficked in an illegal drug—even though medical marijuana was and is legal in the state of Colorado.
The Supreme Court did not provide any reasons for its denial of cert. However, by denying cert, the Court appears to have agreed with the Tenth Circuit’s determination that the IRS was merely enforcing the tax law when it denied Alpenglow’s deductions and was acting within its authority by determining what taxpayers can and cannot deduct under the tax laws.
Despite the fact that more states in this country than not have approved some form of legal marijuana, the federal government still views all forms of marijuana as illegal. To date, this has had a detrimental effect on the cannabis industry because it makes it difficult for state-legal cannabis businesses to establish accounts at banks that do business across state lines. But those businesses can find alternatives to banks.
When it comes to state-legal cannabis businesses deducting business expenses from their taxes, the only alternative to the IRS saying “no” is the IRS saying “yes.” But the IRS doesn’t seem likely to change its stance on the subject anytime soon, especially with the Supreme Court offering an implicit endorsement to the IRS’s current position through its denial of Alpenglow’s petition.
The denial of cert in Alpenglow is a problem for state-legal cannabis businesses. Without the business expense deduction, these businesses have to contend with more taxable income, which leads to a higher tax burden and a higher effective tax rate. This reduces the profits available for the businesses to invest in their continued growth.
The existential threat this tax issue poses to state-legal cannabis businesses has not escaped the eye of the National Cannabis Industry Association (NCIA). It considers a "Fair Tax Policy" to be a key issue for the industry and has prepared several white papers on the topic. As the NCIA seeks Congress’s help to amend Section 280E so that state-legal cannabis businesses can be exempt from it, it dangles a tantalizing carrot: an amended 280E could lead to up to $1.55 billion in new federal tax revenue over the next ten years.
Only time will tell if Congress is moved enough by the cannabis industry’s lobbying to exempt state-legal cannabis business activities from coming within the purview of Section 280E.
But unless and until Congress acts, thanks to the Supreme Court’s denial of cert in Alpenglow, state-legal cannabis businesses will have higher tax burdens than their peers in other industries which may impact their ability to thrive—or merely survive.
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