Cannabis Law and Policy

In a blow to the American cannabis industry, the United States Tax Court found that Section 280E of the Internal Revenue Code (“IRC”) did not violate the Eight Amendment to the United States Constitution. Northern California Small Business Assistance Inc. v. Commissioner, 153 T.C. 4 (2019). The Petitioner in Northern California was a legal medical marijuana dispensary in California, which challenged the application of Section 280E. Section 280E states:

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) consist 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.

Despite legalization of marijuana use in several states, under federal law marijuana remains a Schedule I controlled substance within the meaning of the Controlled Substances Act.[1] The Petitioner’s challenge to Section 280E was based on three arguments: (1) that Section 280E is a penalty and an unconstitutional violation of the Eighth Amendment; (2) that Section 280E only limits the business deductions under IRC Section 162; and (3) that Section 280E does not apply to a legally operated marijuana business but instead only applies to illegal “trafficking” operations.

In his opinion for the Tax Court, Judge Goeke noted that Congress has the power to lay and collect income taxes under Article I, Section 8 of the Constitution and the Sixteenth Amendment. Additionally, that the United States Supreme Court has held that any deductions from gross income are a matter of “legislative grace” and can be reduced or expanded in accordance with Congress’ policy objectives. [2]  Section 280E was enacted under Congress’ unquestionable authority to tax income pursuant to the Sixteenth Amendment and is directed at persons who operate a business in violation of federal or state law. Judge Goeke stated that he was unaware—and that the Petitioner had not cited—any cases where the disallowance of a deduction was construed as a penalty. Furthermore, the overwhelming precedent holds that deductions for determining income are a matter purely left to congressional discretion and that the disallowance of a deduction is not a penalty.  Accordingly, the Tax Court held that Section 280E is not a penalty provision and consequently does not violate the Eighth Amendment.

Petitioner’s second argument was based on the fact that the language of Section 280E tracks the business deduction language of IRC Section 162, and therefore, the Petitioner argued that the restriction of Section 280E is limited only to the business expenses deducted under Section 162. Judge Goeke disagreed, finding that the broad language of Section 280E leads to the conclusion that it was written to deny all deductions under any IRC section for a business that trafficked in controlled substances. 

The Petitioner’s third argument was that Section 280E only applies to illegal marijuana activities, based on the use of the word “trafficking” in Section 280E.  Again, Judge Goeke disagreed and cited prior Tax Court precedential cases which held that the sale of medical marijuana pursuant to California law still constituted “trafficking” within the meaning of Section 280E.  Lastly, Judge Goeke advised the Petitioner that the Petitioner’s remedy lies with Congress rather than the U.S. Tax Court because of the language of Section 280E.

Most decisions of the U.S. Tax Court are written in the name of only one judge, so it is worth noting that of the 19 Tax Court judges, the Northern California decision cited: (a) the agreement of nine other Tax Court judges, (b) the non-participation of one other Tax Court judge, (c) two concurring opinions (one agreed to by three judges and the second agreed to by another judge) and (d) a concurring in part and dissenting in part opinion. The fact that this opinion was reviewed by the entire U.S. Tax Court and that there were concurring and dissenting (in part) opinions, makes this decision more significant as legal precedent and indicates the importance that the judges of the U.S. Tax Court see in the Northern California case. 

Dealing with Section 280E is a constant battle for American cannabis companies, as it precludes the ability to deduct most normal business expenses. While thoughtful tax planning may be able to mitigate some of the harms caused by Section 280E, it still undoubtedly leads to reduced profitability and lower market valuations. But all hope is not lost. Northern California will likely be appealed to the Ninth Circuit Court of Appeals, and the dissenting opinions from Judges Gustafson and Copeland may provide a roadmap to further legal challenges to Section 280E. In addition, Congress appears primed to move on significant cannabis reform, including the broad reform efforts captured in the S.T.A.T.E.S Act and more limited reform efforts to address banking and the impact of Section 280E specifically.

[1] Pub. L. No. 91-513, Sec. 202(c) and codified as amended at 21 U.S.C. Section 812(c); see also 21 C.F.R. Section 1308.11(d)(23).

[2] See INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1982), and New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).

On July 23, 2019 at 1:00 p.m. in the West B & C Room, 31st Floor, Riffe Building, 77 South High Street, Columbus, Ohio 43215, there will be a public hearing concerning the Ohio Department of Commerce’s (“DOC”) proposed updates to the regulations of the Ohio Medical Marijuana Control Program. The updates consist of six proposed amendments to existing rules and one proposal for a new rule. With these amendments and new rule, State regulators appear to be lessening administrative controls over some aspects concerning the operations of medical marijuana facilities.

The first amendment is to the cultivator certificate of operation rule. The proposed amendment provides that the cultivation of marijuana is not “agriculture” for the purposes of R.C. 3781.061, which provides exemptions for agricultural buildings from certain buildings standards. The intent of the amendment is to establish a more uniform safety standard under the relevant building code. Although this is a codification of the existing practice, it may result in increased costs for cultivators in order to become compliant with applicable building and fire codes.

The next three proposed amendments remove the option of disposal by surrender that resulted in the DOC taking possession of and destroying medical marijuana waste material. The DOC does not have the appropriate means to dispose of the waste and this amendment would give sole authority to the licensees to dispose their waste. Additionally, the amendments to the cultivator, processor, and testing laboratory waste disposal rules would expand the types of employees who can supervise the disposal of waste from only Type 1 Key Employees, to any Type 1 Employee. The DOC expects these amendments to decrease the costs of disposal by relaxing the requirements for waste disposal and granting more autonomy to the facilities. 

The next proposed amendment revises the rule for employee identification cards. Specifically, the amendment removes the following requirements for submission: a copy of the applicant’s social security card, documentation verifying the applicant’s principal place of residence, a sworn statement that the applicant has not been convicted of a disqualifying offense, verification that the background check has been conducted, and verification that the applicant had not been convicted of a qualifying offense. The mandated initial background check already provides much of this information, so these requirements were burdensome and duplicative. The DOC believes that the amendment will decrease the costs associated with application, although the $100 application fee, costs of the background check, and administrative costs are still required.

The last proposed removes the requirement that information obtained by the DOC is only disclosed to its employees, law enforcement, or any person deemed necessary, and language regarding the potential discipline to DOC employees if they violated this requirement. The intent of this is to harmonize the management of information from applicants and licensees with Ohio’s public records laws by narrowing the scope of confidentiality. The only costs that could result from this change would be the costs of investigation, enforcement, and legal action against a licensee for noncompliance.

The proposed new rule grants the DOC the authority to grant variances from the rules of the Medical Marijuana Control Program. The rule is limited to instances in which the variance is in the interest of the public, the provision is not statutorily mandated, and the rule from which variance would be granted is not unreasonable or unnecessarily burdensome. The proposal appears to be in response to issues that the DOC has encountered with provisional licensees and entities who have received certificates of operation. Given that this is a new industry, the DOC found this rule to be necessary in order to address unforeseen issues that are contrary to the intent of the Program.

This new rule on granting variances may result in a need for further clarification to determine what is in the “interest of the public” regarding the medical marijuana industry, and what constitutes unreasonable or unnecessarily burdensome regulations. The language may give the Department of Commerce the leeway that it wants in justifying the granting or denial of potential variances from the regulations.

A package with these rules had been sent to the Common Sense Initiative Office (“CSIO”) on March 8, 2019, when the comment period began. After the comment period closed, the CSIO concluded that it did not have any changes to the proposed rules. Now, the DOC has filed the notice of public hearing with amended rules and new rule with the Joint Committee on Agency Rule Review (“JCARR”). Before these amendments and new rule are adopted, they, along with the public notice, must be in front of JCARR for at least 65 days. JCARR may not invalidate rules, but may report to the General Assembly that the rules do not meet certain criteria. If JCARR approves, then the DOC must file the rules in the Electronic Rule Filing System (“ERF”). The rules’ effective date must be at least 10 days from the final filing date in the ERF.  Even if everything moves along, these amendments and new rule would not become effective until September 3, 2019.

Over the past several months, we have been meeting with Ohio policymakers to assist in the development of sound hemp policy in Ohio. This work is starting to bear fruit. We predicted last week that legislation would be introduced soon in the General Assembly, and that has now happened. A new bill to legalize and regulate hemp in Ohio was introduced in the Ohio Senate this morning.

We are reviewing and analyzing this formal draft, but even after a brief review it is apparent that the goal is to take a free market approach to hemp in Ohio, legalizing not only hemp cultivation but also the extraction and distribution of CBD and other hemp extracts in the Buckeye State. 

To read the draft hemp legislation, please click here. We will post another update with a more detailed analysis in the coming days.