There is also a case to be made that the application of Section 280E against cannabis businesses violates the 10th Amendment to the U.S. Constitution. The legal state approved cannabis businesses are being targeted by the federal government for excessive taxation. By definition the 10th Amendment specifically mentions the federal government possesses only those powers delegated to it by the Constitution. All remaining powers are reserved for the states or the people. This aspect can and should be adjudicated in a court of law as 280E applied to cannabis operations is unconstitutional.
Further, the U.S. Supreme Court has ruled that the federal government has a right to regulate and criminalize the sale and use of marijuana, even when a state’s laws permit marijuana to be used for medical purposes. For example, in Gonzales vs. Raich, 2005 where California had passed a law legalizing marijuana for medical use, the Supreme Court held that the Commerce Clause gave Congress authority to prohibit the local cultivation and use of marijuana, despite state law to the contrary.
In the 1981 case Edmondson vs. Commissioner a drug dealer was busted, and then audited. The IRS wanted to tax him on the unreported income from his drug-related activities. He countered that, if he was to be taxed on the income, then he should be allowed to deduct his expenses, including travel expenses, and the purchase of an accurate scale. The Tax Court allowed the deductions.
So in 1982 Congress passed Section 280E of the IRS Code which 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) 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.
However to preclude challenges to the code on constitutional grounds Congress also put in a clause to allow deductions based on Cost of Goods Sold, or COGS.
All deductions and credits for amounts paid or incurred in the illegal trafficking in drugs listed in the Controlled Substances Act are disallowed. To preclude possible challenges on constitutional grounds, the adjustment to gross receipts with respect to effective cost of goods sold is not affected by this provision of the bill.
With the adjudication of the now famous CHAMP – Californians Helping to Alleviate Medical Problems (2012) The Tax Court agreed with the taxpayer in allowing the facility to salvage the deductions attributable to the other related segment of their business. The Tax Court held IRS Code Section 280E would not preclude the taxpayer from deducting expenses as a result of a trade or business apart from that of illegal trafficking in controlled substances, basically because the taxpayer is also engaged in trafficking a controlled substance. Of course, practically speaking, the taxpayer’s characterization of a deduction will not be rubber-stamped by the IRS if it appears to be artificial and cannot be reasonably reinforced by the facts and circumstances of the individual case.
This goes back to the review of case law and 10th amendment.
The powers not delegated to the United States by the Constitution, nor prohibited by it to the states, are reserved to the states respectively, or to the people.
The question is has the Federal government been given the authority to usurp the states right to govern their Medical Marijuana and Recreational Cannabis Industry? In this writer’s opinion NO.