Harborside, a California-based cannabis retailer, is back in the news after a recent U.S. Tax Court decision. The Tax Court determined that San Jose Wellness, a Harborside subsidiary, is precluded from claiming deductions for depreciation or charitable contributions under Internal Revenue Code § 280E. In short, Section 280E disallows deductions or credits for businesses “carrying on” in the trafficking of controlled substances (within the meaning of schedule I and II of the Controlled Substances Act).
In the ruling rejecting San Jose Wellness’s arguments, Judge Emin Toro wrote, “[t]he requirements of Section 280E are clear and the hypotheticals posited by S.J.W. (San Jose Wellness) are not relevant to these cases.” Because the deductions were disallowed under Section 280E, San Jose Wellness is required to pay about $2 million in back taxes for the years between 2010-15, as well as a $181,423 penalty connected to a substantial underpayment in 2015.
Harborside, the parent company, was involved in another precedent-setting case in 2018 where the Tax Court held that § 280E prevented Harborside from deducting ordinary and necessary business expenses and required the company to adjust cost of goods sold according to I.R.C. § 471 for resellers. Harborside has subsequently appealed that decision to the Ninth Circuit.
Section 280E continues to be a thorn in the side of cannabis businesses and, at this point, the I.R.S. and courts are holding firm in the application of the law. Many cannabis businesses continue to argue that § 280E, passed in 1982, is due for legislative reform, given that it was meant to address drug traffickers—and not legitimate cannabis businesses operating in states where cannabis is legal. Whether and when that restructuring occurs depends on Congress’s appetite for cannabis reform in 2021.