Possible landmark marijuana tax trial starts Monday

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By John Schroyer

Henry Wykowski scored a big victory for the cannabis industry last month after the Department of Justice dropped its case against one of his clients, California-based Harborside Health Center.

Now the Bay Area attorney has a new federal government target in his sights: Section 280E of the U.S. tax code.

Millions of dollars or more are at stake for individual marijuana businesses – not to mention the untold sums at stake for the industry as a whole. It’s money that’s been going to the Internal Revenue Service’s coffers.

Every plant-touching legal marijuana business in the United States is familiar with the 280E provision, which bars marijuana companies from taking standard tax deductions available to every other law-abiding industry in the country. The provision dates to a 1981 court case which spurred Congress to create 280E.

Starting Monday, Wykowski will embark on a new trial before the U.S. Tax Court on behalf of Harborside, one of the nation’s largest dispensaries. If successful, Wykowski could bring an an end to the IRS’s application of 280E to the legal marijuana industry.

“If the (Tax Court) rules that 280E doesn’t apply to state-sanctioned dispensaries, it would remove that as an issue in all IRS audits, so the IRS couldn’t legitimately raise it with a straight face again,” Wykowski said. “It would basically take 280E off the books.”

And that would be a “massive” win for the industry at large, said William Simpson, the founder and president of Chalice Farms in Oregon, which owns four dispensaries and produces its own edibles and extracts.

“It’d make us profitable. With 280E in effect, we are literally in the red,” said Simpson.

Chalice has already set aside $1.7 million for next year’s federal tax bill because of 280E, Simpson said.

“That would be the profit that we would have,” he said.

Section 280E stems from a 1981 U.S. Tax Court case which allowed a convicted drug trafficker to deduct ordinary business expenses arising from the sale of amphetamines, cocaine and marijuana. Congress reacted by creating 280E to block other drug dealers from doing the same.

Monday’s trial is the culmination of years of back-and-forth between Harborside and the IRS, and is a compilation of three Tax Court petitions filed by the dispensary over tax bills that span six years, from 2007 to 2012.

“The first issue that we’re really going to argue is that 280E was never meant to apply to state-recognized cannabis dispensaries,” Wykowski said.

That particular argument, which is one of four that Wykowski has prepared for the trial, hinges on the language of 280E itself, which states that no tax deductions or credits will be permitted, “if such trade or business… consists of trafficking in controlled substances.”

Wykowski’s angle is the interpretation of that sentence.

“The statute doesn’t say ‘including the sale of controlled substances,’ it says ‘if your business consists of,’ and in the plain meaning of the English language, if the dispensary is selling t-shirts, rolling papers, any non-controlled substances, then we do not believe that 280E should apply,” he said. “This specific issue has never been presented before, and we think it’s ripe in this case.”

Even if the judge doesn’t agree with that argument, Wykowski has three other issues he’s going to bring up to try to mitigate Harborside’s tax bill, which could be upwards of $10 million if they lose. But if the judge agrees with that first point, that would basically remove 280E as a financial obstacle for licensed plant-touching companies.

Wykowski said a favorable ruling from the Tax Court could open the door to federal tax refunds from the IRS for marijuana companies that could run into the “tens of millions.”

“We would go back and argue that all of these people disallowed expenses erroneously, and therefore are entitled to a refund, and we would file refund suits on behalf of (MJ businesses),” Wykowski said.

Some in the industry, however, are a little dubious of both Harborside’s chances and the potential of federal tax refunds.

Bruce Nassau, owner of the Colorado retail chain Tru Cannabis, said that getting 280E tossed would be “fabulous news for the industry,” but thinks it’s more likely that the judge will decide to leave changing the tax code to Congress.

Nassau added that he’s spoken to a lot of accountants about what could happen if 280E is ruled inapplicable to legitimate marijuana companies, and said: “I can promise you, they will not retro this. I’d like to see it. I’ve talked to countless CPA’s, and the consensus is there will be no retro filings permitted.”

“I hate to be a pessimist, but the feds want all the money they can get out of us,” Nassau said.

Wykowski, however, said he’s confident heading into next week that they’ll prevail.

The trial itself will probably take about a week, and will be heard in San Francisco. But the judge likely won’t issue a ruling in the case until much later this year, Wykowski expects, and maybe not until early 2017.

John Schroyer can be reached at johns@mjbizdaily.com