The ongoing federal prohibition of marijuana has taken on yet another dimension. An U.S. court ruling has determined that the Internal Revenue Service’s (IRS) tax rules prevent state-legal cannabis firms from being eligible to receive refunds from employee retention credit (ERC) which allowed businesses to continue paying employees during COVID shutdowns in early years.
In the decision, the U.S. District Court for the Western District of Washington ruled that “nothing in the plain text of [IRS code] “Section 280E restricts its application to income-tax credits”, rejecting claims from plaintiffs.
The Government, meanwhile, argued that Section 280E prohibited any and all credit, including the refunds of COVID ERCs from the COVID era, which were typically refundable to other businesses.
The court dismissed the case on May 9 after the Government filed a motion. Solstice Holdings v. U.S.
The section 280E prohibits businesses from claiming standard tax deductions or tax credits if they are involved in the trade of substances on Schedule I and II. Even if businesses operate in accordance with state law, they are still subject to the section.
The law firm Holland & Hart said in a post about the new ruling that it appears to be “the first case where a court has addressed the application of IRC § 280E to ERC.”
Another law firm, GreenspoonMarder, noted in post about the district court opinion that many cannabis businesses applied for the ERC during the pandemic—and many received it.
“Some were deemed ‘essential’ and had to stay open during the pandemic despite the higher costs associated with continued operations during the pandemic and various restrictions that rendered it much more difficult to visit their stores,” attorneys Nick Richards and Sabrina Strand wrote recently.
This post explains that when the ERC came out there were questions about whether or not it would be available to marijuana companies, as it created a credit which Section 280E could disallow. The argument was that Section 280E didn’t affect the ERC since it is a part of Section A. [Internal Revenue Code]It is not employment tax but income taxes. A court at least now is in agreement.”
Both firms believe that Washington State’s case sets a precedent for other states in the Ninth Circuit. GreenspoonMarder for instance, claims that the decision “technically” only applies to businesses located within the 9th Circuit.
Lawyers wrote that, because it was the sole opinion available on the subject, the IRS could rely upon this as a source of authority, regardless of whether the taxpayers reside in any of the nine States located within the Circuit.
The ruling, which is a decision of a district trial court and not an opinion published by the appellate court has a limited effect outside of the current dispute. It also does not have any binding force on other courts. It is the only indication so far as to how other courts may rule on similar cases.
Separately last year IRS issued a warning to the cannabis industry, stating that certain marijuana companies, without any “reasonable” basis, had attempted to receive federal tax deductions which they were prohibited by 280E.
IRS stated in that notice certain companies were trying to circumvent federal restrictions by filling out Form 8275, a disclosure statement. This form “is used by taxpayers or tax return preparers in order to accurately disclose any items, positions, etc., which have not been disclosed otherwise on the tax return, to avoid specific penalties.”
The state-licensed marijuana businesses may be eligible to claim broader tax deductions from the federal government if efforts to place marijuana in Schedule III are successful. IRS advised separately last June, however, that even though this possibility was on the horizon it didn’t mean that the cannabis industry could start taking deductions.
However, the IRS 280E rule remains unchanged. Uncertain is the date of implementation for the new federal marijuana regulation. An administrative hearing concerning the proposed rule is underway.
In 2023, then-Rep. Earl Blumenauer (D-OR) reintroduced a congressional bill that would amend the IRS code to allow state-legal marijuana businesses to finally take federal tax deductions that are available to companies in other industries.
The latest notices come three years after the Congressional Research Service (CRS) noted in a 2021 report that the agency “has offered little tax guidance about the application of Section 280E.”
IRS did provide some guidance in an update in 2020, explaining that while cannabis businesses can’t take standard deductions, 280E does not “prohibit a participant in the marijuana industry from reducing its gross receipts by its properly calculated cost of goods sold to determine its gross income.”
The IRS update seemed to be responsive to a Treasury Department internal watchdog report that was released in 2020. IRS was criticized by the department’s Inspector General of Tax Administration for its failure to provide adequate advice on federal tax compliance for taxpayers working in marijuana industries. The agency was also instructed to create and distribute guidance tailored to the marijuana business.
You can find the ruling of the court below.
Can Cannabis Companies really wait for rescheduling to avoid the 280E tax penalty? (Op-Ed)