Posted by: jkalinski | October 31, 2019

Tax Court Update: Majority Holds Section 280E Is Constitutional, But Three Judges Join In Persuasive Dissent by Jonathan Kalinski


In a court reviewed opinion[1], a divided Tax Court held that IRC section 280E is not a penalty and therefore does not violate the Eighth Amendment prohibition on excessive fines.  This case provided a different spin on the usual 280E challenges and although the Court ruled that 280E was constitutional, there were three judges who dissented and would require additional arguments on whether 280E violated the Eighth Amendment.[2]

Petitioner operates a medical marijuana dispensary in Northern California, and the parties agreed that Petitioner was legal under California laws.  Petitioner made several arguments attacking the validity of 280E.  For those not familiar with IRC section 280E, it disallows ALL deductions or credits in carrying on a trade or business that consists of trafficking in a Schedule I or II controlled substance (which includes marijuana).

The primary argument was that 280E violated the excessive fines clause of the Eighth Amendment.  The majority rejected this argument using the age-old language that deductions are a matter of legislative grace and that disallowing a deduction is not a punishment or penalty.  Congress has the power to tax income under the Sixteenth Amendment, and any deduction is up to Congress.  Congress passed 280E to limit and deter trafficking in controlled substances and therefore prohibiting deductions is within its power.  The Court notes that in the 37 years since 280E was passed, there has been no case holding that a prohibition on a deduction was a penalty.  At the end of the opinion the majority notes that it is up to Congress to change 280E.

Judge Gustafson, joined by Judges Gale and Copeland, disagreed with the majority and wrote that 280E was a fine and penalty and subject to an Eighth Amendment challenge.[3]  His opinion gives strong support for an appeal and suggests that its argument might find some success in different courts.  He criticizes the majority holding, which relies on Congress’ power to tax incomes.  Section 280E he argues, by disallowed ALL deductions, is a tax on something other than income.  It should be noted, however, that marijuana businesses otherwise subject to 280E can still deduct cost of goods sold.

Professor Bryan Camp Texas Tech in an excellent analysis of the opinion writes that the main difference between Judge Goeke’s majority opinion and Judge Gustafson’s dissent is the baseline.  The majority looks at deductions as all a matter of legislative grace, whereas the dissent starts at deductions that are allowed and sees the disallowance as punishment.  In Professor Camp’s view, adopting Judge Gustafson’s approach would open up all sorts of tax protestor type arguments to Eighth Amendment challenges.  Instead of an Eighth Amendment argument, he believes Petitioner is really making an equal protection argument that would lose.

Another point of contention for Judge Gustafson is that even if Congress has the power to disallow all deductions, it cannot do so in ways that violate other constitutional limits like the Eighth Amendment or First Amendment.  Here he persuasively argues that laws favoring deductions for one religion over another would be unconstitutional as a First Amendment violation.  He reasons that the limit on deductions cannot violate the Eighth Amendment as well.

This case further illustrates that even state legal cannabis businesses are playing on different field with a different set of rules than just about any other business.   The disfavored status of cannabis businesses may be a generational issue and as attitudes towards cannabis change, we will see marijuana either became Federally legal, or 280E amended to allow deductions for marijuana businesses.

In California, Governor Gavin Newsom recently signed legislation (AB 37) which allows state legal cannabis businesses to deduct expenses and explicitly disavows IRC section 280E.  The tide is turning, and it is likely only a matter of time before legal marijuana businesses can deduct expenses, just like everyone else.  If other courts accept Judge Gustafson’s reasoning, it might happen sooner than many think.

Jonathan Kalinski is a principal at Hochman Salkin Toscher Perez, P.C. and specializes in both civil and criminal tax controversies as well as sensitive tax matters including disclosures of previously undeclared interests in foreign financial accounts and assets and provides tax advice to taxpayers and their advisors throughout the world.  He handles both Federal and state tax matters involving individuals, corporations, partnerships, limited liability companies, and trusts and estates.

Mr. Kalinski has considerable experience handling complex civil tax examinations, administrative appeals, and tax collection matters.  Prior to joining the firm, he served as a trial attorney with the IRS Office of Chief Counsel litigating Tax Court cases and advising Revenue Agents and Revenue Officers on a variety of complex tax matters.  Jonathan Kalinski also previously served as an Attorney-Adviser to the Honorable Juan F. Vasquez of the United States Tax Court.


Tags: Tax Court, Cannabis, 280E, Marijuana, Deductions, Eighth Amendment


[1] Northern California Small Business Assistants, Inc. v. Commissioner, 153 T.C. No. 4 (2019).

[2] The Court was unanimous in denying Petitioner’s motion for summary judgement.  Three judges concurred in the result, but disagreed with the central holding that IRC section 280E was not a fine or penalty and therefore not subject to an Eighth Amendment analysis.  The three judges concurred in the result because they believed a factual argument existed as to whether the fines were excessive.

[3] Judge Copland wrote a separate opinion concurring in part, dissenting in part agreeing with Judge Gustafson that IRC section 280E was a penalty.

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