The Application of Internal Revenue Code Section 280E to Marijuana Businesses: Selected Legal Issues

The marijuana industry has grown as an increasing number of states have relaxed state law prohibitions on the use of marijuana for medical and recreational purposes. Under federal law, marijuana remains classified as a Schedule I controlled substance under the Controlled Substances Act (CSA), meaning that the production, distribution, and possession of marijuana remains illegal, except in the narrow context of federally approved research studies. Regardless of marijuana’s status under federal or state law, marijuana businesses are subject to the federal income tax. The Schedule I status of marijuana means that marijuana businesses are treated differently from many other businesses for tax purposes. Internal Revenue Code (IRC) Section 280E (Section 280E) denies deductions and credits for amounts paid or incurred in carrying on the trade or business of trafficking in controlled substances (within the meaning of Schedules I and II of the CSA) in violation of federal or state law. Consistent with marijuana’s classification as a Schedule I controlled substance, Section 280E disallows taxpayers from taking tax deductions and claiming tax credits attributable to marijuana businesses. Nonetheless, for reasons related to constitutional concerns raised at the time of Section 280E’s enactment regarding the scope of Congress’s Sixteenth Amendment power to tax “income,” businesses subject to Section 280E may offset gross receipts by the cost of goods sold when determining their gross income. Outside this general convention, there is little tax guidance concerning the application of Section 280E. Marijuana businesses have generally been unsuccessful in challenging the Internal Revenue Service’s (IRS’s) application of Section 280E and likewise have not succeeded in their attempts to challenge Section 280E on constitutional grounds. Congress has broad authority to alter the tax treatment of marijuana businesses. The legislative history of Section 280E indicates that Congress enacted the provision to codify a sharply defined public policy against drug dealing. Recent legislative and administrative proposals aim to relax federal restrictions on marijuana or to mitigate the disparity between federal and state marijuana regulation. Many of these proposals would alter the tax treatment of marijuana businesses by rescheduling or descheduling marijuana under the CSA or by making marijuana-specific exceptions. Under these proposals, Section 280E would no longer prohibit marijuana businesses from taking deductions and credits.