The Cannabis Conundrum: Constitutional & Policy Concerns in Taxation of the Marijuana Industry

Abstract

The cannabis industry has greatly expanded over the last few years, with a majority of states legalizing cannabis in some form. However, despite the growing popularity of the cannabis industry and more companies entering the market, the Internal Revenue Service (“IRS”) has remained steadfast in denying business deductions for cannabis companies. Under Internal Revenue Code (“IRC”) § 280E, the IRS can disallow all ordinary and necessary business expenses by companies trafficking in illegal drugs. The disallowance of ordinary and necessary business expenses greatly hinders cannabis companies, especially for companies legally operating under state law. Several cannabis companies have also attacked the harsh effects of IRC § 280E on constitutional and public policy grounds. Despite a general shift in medical, legal, and public opinion supporting the full legalization of marijuana, legislation still lags far behind. There is currently pending legislation to address the deductions allowed for marijuana companies and reflects a shift in public policy.

One recent attack on IRC § 280E is that the provision violates the Sixteenth Amendment. Under this theory, cannabis companies argue the definition of income under the Sixteenth Amendment requires gain, and thus the disallowance of ordinary and necessary business expenses imposes a tax on more than a company’s income. For example, the Sixteenth Amendment permits a taxpayer to reduce gross receipts by cost of goods sold before a tax may be imposed. The correct method in calculating cost of goods sold also provides another point of contention between the IRS and cannabis companies. Courts continue to classify cannabis companies as “resellers” instead of “producers,” which reduces the amount that cannabis companies can deduct as cost of goods sold.

Despite the growing popularity of cannabis companies and a growing number of states legalizing marijuana, courts are unlikely to invalidate IRC § 280E as unconstitutional until a sufficient groundswell of support for the policy benefits such a change would permit arises. This article will discuss: (I) a brief evolution of the public support, policies, and rationales behind marijuana legalization and the conflicts arising under the Sixteenth Amendment; (II) competing state and federal laws concerning cannabis regulation; (III) and the constitutionality of IRC § 280E under both the Sixteenth Amendment and the Eighth Amendment; and conclude with (IV) a public policy argument for legislation removing marijuana from the purview of IRC § 280E.