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A Cannabis Tax Revolt - By - June 8, 2016 - SF Weekly
SF Weekly

A Cannabis Tax Revolt

This story has been updated.

At least one part of Scarface is accurate — the part when cocaine dealers amass ungodly sums of money and use it to transform the Miami skyline. So much cash was flowing into southern Florida in the late 1970s that, according to a U.S. Treasury analysis, the country's entire currency surplus could be traced to Miami banks.

To try to put a stop to this — or to at least grab a cut of the action — Congress amended the federal tax code in 1982 to include a section called 280E, which bars anyone dealing in controlled substances from claiming the cost of the drugs on their federal taxes.

It sounds absurd — did the Cocaine Cowboys really keep receipts for each cigarette boat shipment, and did they hire an accountant every April? — and maybe it was. (We have a Minneapolis-area drug dealer named Jeff Edmondson to thank for it. In 1975, convicted of trafficking, Edmondson filed a tax return listing the cost of 13 ounces of cocaine, 100 pounds of marijuana, and over 1 million hits of amphetamine. Unsatisfied with his tax lien after his bust, he challenged his tax bill in court, lost, and led Congress to add 280E so nobody ever tried to dodge drug taxes again.)

But 280E has had a lasting impact. And for this reason, it's not true to say the federal government hates weed. The feds love cannabis — or at least the taxman does.

More than 30 years later, 280E continues to cause problems for the modern-day cannabis industry. Since cannabis remains a Schedule I controlled substance, it remains controlled by 280E. This means any business that touches the marijuana plant can't claim costs associated with selling marijuana plant products. (In a confusing twist, a tax court case from the early 2000s allows dispensaries to claim the cost of the cannabis itself, just not other costs — employee salaries, utilities — associated with selling it.) Cannabis businesses unaware of this have been hit with severe penalties from the IRS.

While a serious threat to business, for a long time 280E was low on the list of priorities for the cannabis industry. Who can bother with tax court when there's a real risk of a law enforcement raid? But now that the legalization fight is slowly being won — and now that Congress has barred the DEA and other federal Justice Department officials from interfering with state-legal cannabis — the weed industry is challenging 280E.

In 2010, Oakland's Harborside Health Center — by reputation the nation's biggest cannabis dispensary — received a bill from the IRS for $2.4 million in back taxes, income it claimed on federal tax returns but couldn't under 280E. (Dispensary operators told Forbes that without being able to claim the cost of goods sold, the effective tax rate is between 60 and 90 percent.)

Fresh from winning a case against the Justice Department, which had been trying to shut the dispensary down since 2012, Harborside has been in court all week, trying to get a U.S. Tax Court judge to rule that a legal cannabis dispensary can claim the cost of goods on its taxes.

To do that, San Francisco attorney Henry Wykowski is going to raise a few arguments. For starters, he'll argue that 280E was never meant to apply to state-licensed cannabis dispensaries. (He has a point there, as they did not exist in 1981.)

“Ignoring the intent of Congress, the IRS has chosen to apply 280E to legitimate cannabis businesses,” says Wykowski, who also points to a certain line in 280E that would seem to exclude a business that sells other, legal items as well as cannabis.

That may seem like a technicality — and it is. But that's what the tax code is all about.

Harborside has a few supporters, including the original sponsor of 280E. Before he left government, former U.S. Rep. Pete Stark argued on the floor of Congress that the IRS is willfully misinterpreting 280E by applying it to cannabis dispensaries.

If Wykowski wins and Harborside's tax bill is thrown out, it will be expensive for the government. It would mean Harborside does not owe the $2.4 million from 2010 — and it also means the dispensary, and every other dispensary in the country, could file for refunds on past taxes paid, Wykowski says. (If he loses, it could also be very expensive: Harborside would be on the hook for $10 million in back taxes, including the years since the original appeal was filed, he told Marijuana Business Daily.)

Other observers say it's most likely the tax court will do what most other courts have done on marijuana — kick the ball back to Congress, California U.S. Reps. Barbara Lee (D-Oakland) and Dana Rohrabacher (R-Huntington Beach) — the latter of whom became the first U.S. elected official to publicly say he uses medical marijuana — have had a 280E reform bill blocked in a Congressional committee.

That would mean no dispensaries could file for back taxes.

The trial is expected to run through Friday, though a decision may not come until 2017. By that time, cannabis could be legal throughout California — everywhere, except on tax returns.