California Cannabis Company Fighting the IRS in Tax Case

An Oakland cannabis company’s tax fight with the Internal Revenue Service is being closely watched by industry insiders throughout California. Although it’s been two years since recreational cannabis sales became legal in California, marijuana businesses are still – at least in the eyes of the IRS – sizable drug traffickers.

Our Los Angeles marijuana tax lawyers know that taxes are a major sore point for many pot shops throughout the Golden State – starting with the fact that local and state government taxes have sapped many businesses of the ability to fairly compete with the cheaper, thriving black market.

Taxation by the federal government is a whole different beats entirely. The U.S. Controlled Substances Act still categorizes marijuana as a dangerous Schedule I narcotic, criminalizing marijuana possession, sale and cultivation. This is true regardless of state law, though federal officials have struck a tenuous peace with state-legal operations with annual federal spending bills that stipulate the U.S. Department of Justice isn’t to use taxpayer funds to go after operations in compliance with state cannabis laws. But that doesn’t provide any relief where the IRS is concerned.

Now, everyone’s watching how the U.S. Court of Appeals will handle an appeal from Oakland industry staple Harborside Inc., which in October was ordered by a U.S. Tax Court judge in Washington, D.C. to pay an astonishing $11 million in back taxes for operations from 2007 to 2012.

Unlike virtually every other business in the country, cannabis companies cannot deduct business expenses on their tax returns. Many can’t even use mainstream banks, often turning to credit unions or sometimes even armored trucks packed full of cash and driven by armed security.

But Harborside is a cannabis business, and thus cannot deduct the same kind of expenses on federal tax returns – everything from salaries to supplies to retail space rent. But that leaves Harborside – and other marijuana companies like it – at a significant disadvantage compared to the black market whose operators are unencumbered by the regulation, restriction and financial burdens of legal businesses.

So Harborside is challenging the tax court’s view of tax code Section 280E, which expressly prohibits those in the business of “trafficking” Schedule I and Schedule II narcotics form taking the sort of ordinary deductions any other business can. Specifically, the question is to what extent the ban applies to cannabis companies, and what counts as “cost of goods sold” versus the cost of inventory (the latter being one thing state-legal marijuana companies CAN use to lower the amount of income subject to federal taxes). This has been a substantial area of uncertainty for marijuana business lawyers, tax professionals in the industry and enforcers.

It’s anticipated that California’s legal marijuana growth and sales will climb by nearly 20 percent annually between now and 2025. However, so long as these federal barriers exist, we can expect consumers to continue turning to the black market.

If Harborside can get the 9th DCA to take its side, it would result in a precedent that could be broadly accepted in other sister courts or eventually challenged in the U.S. Supreme Court. Ultimately, the goal is to lower cannabis companies’ tax burden industry-wide.

The Los Angeles CANNABIS LAW Group represents growers, dispensaries, ancillary companies, patients, doctors and those facing marijuana charges. Call us at 949-375-4734.

Additional Resources:

Cannabis Company Keeps Fighting IRS View of Drug-War Era Law, Dec. 3, 2019, By Lydia O’Neal, Bloomberg Tax News