Another taxing problem for the marijuana industry

In downtown Washington, D.C., the Department of Justice asserts that marijuana enterprises are free to exist, while immediately across 10th St., the IRS tells those businesses they are illegal drug-trafficking operations ineligible for the benefits other corporate entities enjoy. Which is it? Right now, it is both. This dual status presents commercial challenges for marijuana businesses, carrying serious consequences for individuals, patients, investors, law enforcement, courts, accountants, and others.

Last week, one challenge—the issue of tax deductions for marijuana enterprises—had its day in court. In Olive v. Commissioner of Internal Revenue [CIR], the U.S. Court of Appeals for the Ninth Circuit reviewed whether a medical marijuana enterprise in California—Vapor Room Herbal Center in San Francisco—could deduct business expenses under U.S. tax law (the Internal Revenue Code).

The case made its way to the Ninth Circuit on appeal from a decision from the United States Tax Court. The Tax Court previously ruled in favor of the Commissioner of the IRS because Vapor Room Herbal Center was a business that “consist[ed] of trafficking in controlled substances” (26 U.S.C. § 280E). Section 280E of the tax code limits business from deducting business expenses under such circumstances.

The Ninth Circuit upheld the Tax Court decision. The Appeals Court outlined two clear reasons (among others) why Vapor Room Herbal Center could not deduct business expenses.

  1. The Controlled Substances Act is clear: marijuana is a controlled substance illegal for sale, use, and distribution.
  2. The second reason centers on the purpose of the enterprise in question. The Ninth Circuit and other appeals courts have given leeway to marijuana-related enterprises when those enterprises consisted of ‘multiple income generating activities.’ In this ruling, however, the Ninth Circuit found “that the only income-generating activity in which the Vapor Room engaged was its sale of medical marijuana” (emphasis original) [See Olive v. CIR, p. 6]. The primacy of marijuana sales as the profit-driving activity of the enterprise precluded it from some of the discretion other courts had offered with regard to business expenses.

This ruling was perceived as a setback for the marijuana business community for whom the 280E issue is a serious one from which they actively lobby Congress for relief. However, the reality is that the Ninth Circuit ruling was well-reasoned, consistent with precedent, and reflected the realities of federal law. While the three judge panel included two Republican appointees (Reagan-appointed Alex Kozinski and a George H.W. Bush-appointed, Utah district judge designated to sit on the case Dee Benson), the opinion was written by Susan Graber, a Clinton appointee.

Instead of Olive v. CIR being a bad decision issued by activist judges that usurps federal law, the opinion is a good one that puts a spotlight on the inconsistencies in federal law and the challenges that they present for marijuana users, enterprises, and even regulators.

As I wrote a few weeks ago regarding Coats v. Dish Network— a case where the Colorado Supreme Court ruled that a medical marijuana user could be terminated for using cannabis in a state that allowed it for medical treatment—these problems stem not from the judiciary but from Congress and the President. Under federal law, cannabis is an illegal substance. However, Congress has tried to limit the enforcement of the law in medical marijuana states and the Department of Justice has taken a laissez-faire approach in states with regulated “legal” marijuana systems. Despite the latter two efforts, the federal government is far from offering a holistic legal solution. Instead, it offers a patchwork of fixes, sticking a piece of gum on leaky pipes only to ignore other leaks in the system.

It creates a bizarre legal landscape that both marijuana supporters and opponents should see as disjointed. While the Controlled Substances Act is clear about cannabis, legislative and executive actions have actively encouraged states to experiment with relaxed marijuana policies. That has created a system of marijuana federalism wherein marijuana users get access to state-regulated marijuana (often) from state-legal enterprises. Those policy and commercial sub-systems operate in an environment that some parts of the federal government approve and other parts actively hinder.

Marijuana’s current status under federal law is unsustainable, and frankly difficult to understand. Good public policy should be consistent, treat everyone equally, and provide a navigable process which achieves the ends that policy makers intend. It is unclear what “end” policy makers aim for with cannabis. It should either be illegal or not, but not both.

If you support the liberalization of marijuana laws, there is an easy legislative fix in the context of 280E. Congress could solve the problem facing Vapor Room Herbal Center and thousands of marijuana enterprises across the U.S. It could amend the Internal Revenue Code in a way that provides a further exception under 280E—that a state-sanctioned (medical) marijuana enterprise is eligible to deduct standard business expenses.

And a reform like that should be an easy sell to a Republican Congress! It fosters states’ rights and sovereignty, it lowers tax burdens and effective tax rates, it facilitates free market enterprise by taking government out of business, and it supports the ability of small businesses to employ workers and make profits. A cannabis-related reform to 280E, under any other guise, would be a plank on the Republican Party platform and would breeze through a Republican-controlled Congress.

The reality, of course, is much different. There is little consistency in the federal government’s treatment of cannabis. Congress and the Obama administration offer policy that is bi-polar or tri-polar or sometimes multi-polar. Some parts of policy reflect the interests of communities that oppose marijuana legalization for moral reasons or reasons of public health and safety. Other policies placate supporters of marijuana legalization by allowing marijuana enterprises to be treated as legal in an inconsistent and non-universal way.

As a whole, if Congress and the Obama administration think this is what public policy should look like, they must be smoking something.