A recent 1st U.S. Circuit Court of Appeals ruling upheld a lower court decision that the Controlled Substances Act (CSA) does not violate federal law. The decision stems from Canna Provisions’ lawsuit against the government alleging that scheduling cannabis under the CSA was unconstitutional. Despite the decision, taxpayers may still be able to make credible arguments for deducting cannabis-related expenses under Section 280E of the Tax Code.
1st Circuit Court’s decision
The court was not persuaded the CSA limits interstate commerce even when sales were purely within a single state. The court also held that the CSA does not violate the due process clause of the Fifth Amendment because there is no fundamental right to grow and cultivate cannabis.
A win for Canna Provisions would have meant the end of Section 280E and federal prohibition of cannabis. But the loss (while we wait to see if the case ends up in the hands of the Supreme Court) does not necessarily strengthen Section 280E.
Refunds under Section 280E
Taxpayers have taken aggressive positions in claiming refunds under Section 280E. And some have been successful. For example, it was reported that in early 2024 a large multistate operator received over $100 million in Section 280E-related refunds. Since then, the IRS has tried quell potential refund claims by clarifying through a June 2024 news release that Section 280E still applies to cannabis companies.
From an industry perspective, this IRS clarification is just one part of a broader shift. Many cannabis operators have grown skeptical that federal reform will arrive soon enough to solve the immediate burdens of 280E. What is changing, however, is their willingness to push back. Refund claims, litigation and structural strategies are becoming more common, particularly in light of recent refund victories. The fact that a major multistate operator reportedly secured a $100 million refund has not gone unnoticed. For many in the industry, aggressive tax positions are no longer viewed as fringe tactics, but as a calculated business strategy in an evolving legal landscape.
Even with this IRS pronouncement, a Section 280E refund claim could still prove fruitful in two scenarios. First, if a product is hemp-based, even if it contains synthetic cannabinoids, at least two courts have held that the product is not a Schedule I controlled substance under the 2018 Farm Bill. While the IRS may not love this position, there is no doubting the taxpayer favorable case law. Second, even if a product falls under the CSA, there are arguments that may play out more favorable in court than in front of the IRS, such as DOJ’s policy of not enforcing the CSA with respect to cannabis. Such a policy could be seen as either a waiver of DOJ’s authority, or the federal government’s implicit view that it is a state law issue. And surely a court should have a problem with the equitable issue of the federal government taxing cannabis derived income but not allowing deductions for corresponding expenses.
Taxpayer options
Outside of a refund claim, there are options for taxpayers as well. For example, a taxpayer can change its accounting method to treat cannabis-related expenses as cost of goods sold. The IRS’s June 2024 newsletter makes clear that cannabis companies can claim expenses as cost of goods sold. Perhaps this is the IRS’s olive branch to solve for the inequitable nature of Section 280E.
Regardless of approach, taxpayers considering aggressive refund positions under 280E must act quickly, as the statutes of limitations to file refund claims is limited.
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