As more and more states are allowing legal use of marijuana, medical marijuana businesses are faced with large tax bills because of marijuana's continued classification as a Schedule I controlled substance under federal law. Section 280E of the Internal Revenue Code denies deductions for expenses paid or incurred in the carrying on of any trade or business involving a federal controlled substance. As a result, the Internal Revenue Service's position is that any business that deals with medical marijuana, even if legal under state law, cannot claim tax deductions (included deductions for their operating expenses).

In a recent Tax Court case, Northern California Small Business Assistants Inc. v. Commissioner, a medical marijuana dispensary in California argued that Section 280E was unconstitutional under the Eight Amendment of the Constitution as an excessive penalty. The Tax Court rejected this argument, stating that Section 280E was enacted under the clear authority given to Congress under the Sixteenth Amendment to tax gross income. The Tax Court further noted that there is no judicial authority to hold that the denial of a tax deduction is a penalty. Accordingly, the Tax Court held that Section 280E was not a penalty provision and was not in violation of the Eight Amendment. The Tax Court also rejected the dispensary's argument that Section 280E was limited to Section 162 business deductions and not to all deductions, citing the clear language in Section 280E that "[n]o deduction or credit shall be allowed."

While the Tax Court's decision strikes another blow to the medical marijuana industry in the tax arena, the decision does provide some hope. Judge David Gustafson issued a dissent opinion in which he held that the Sixteenth Amendment did not give Congress the unrestricted power to impose the type of tax liability that arose as a result of Section 280E and thus found that Section 280E was a penalty. Judge Copeland stated that the Court should have allowed the proceedings to continue to address whether the penalty was excessive. Another judge, Judge Elizabeth Copeland, also partially dissented with the Tax Court's majority decision on the ground that she found Section 280E to be a penalty provision, although she held that the dispensary failed to show that the penalty was excessive. While the dispensary was not successful in its challenge in this case, the willingness of several of the judges to find that Section 280E was a penalty provision, and thus potentially subject to the protections of the Eighth Amendment, does provide some much needed hope to an industry facing onerous tax bills that could throttle its growth.

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