Marijuana Moment: Marijuana Businesses Can’t Force Court To Do ‘Imaginary’ Rescheduling Review To Exempt Them From 280E Tax, IRS Says

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While marijuana may soon be rescheduled under federal law, that doesn’t currently exempt state-legal cannabis businesses from an Internal Revenue Service (IRS) code known as 280E that bars them from taking federal tax deductions, the agency argues in a new filing with the U.S. Tax Court.

In response to a petition to the court filed by the New Mexico marijuana business Ultra Health—which challenged the conventional interpretation of the IRS code, which applies to tax deduction claims connected to the sale of Schedule I and Schedule II drugs under the Controlled Substances Act (CSA)—IRS said the issue has already been soundly settled by Congress and various federal courts.

Those courts “have consistently held that section 280E is constitutionally valid and have created a robust legal authority supporting its validity and applicability to sellers of marijuana,” it said. “Federal courts have addressed the applicability of section 280E in over 40 published orders or opinions. No resulting order or opinion include a ruling or holding that section 280E is unconstitutional or inapplicable to cannabis sellers.”

Ultra Health’s novel argument in support of its alleged eligibility for tax deductions is based on the fact that 280E applies to businesses that sell controlled substances “within the meaning of” Schedule I and Schedule II drugs under the CSA. (Emphasis added.) In its opening brief filed last year, the petitioner said that means the tax court “must determine the ordinary meaning of ‘within the meaning of schedule I and schedule II,'” and that interpretation shouldn’t be based exclusively on whether cannabis is simply listed as Schedule I.

“A list, by itself, has no ‘meaning.’ To speak of ‘the meaning’ of a list is to speak of the characteristics that define it,” Ultra Health argued. “The characteristics that define schedules I and II of the CSA are the three-part classification criteria” that largely concern abuse potential and currently accepted medical value.

“If a substance does not meet the section 812(b)(1) criteria, it does not fall within the statutorily defined meaning of schedule I and thus cannot be placed on the schedule I list. And if a substance on the schedule I list is revealed not to meet the section 812(b)(1) criteria, the CSA provides for its removal from that list,” it said.

To that end, the Drug Enforcement Administration (DEA) and U.S. Department of Health and Human Services (HHS) under the Biden administration completed a review finding that marijuana does not meet the CSA criteria for a Schedule I drug and should be moved to Schedule III, which would make 280E tax restrictions inapplicable.

President Donald Trump in December separately signed an executive order directing the attorney general to finalize the process of reclassifying marijuana—but that hasn’t formally materialized yet. And in the interim, IRS told the tax court that it’s an improper venue to independently make a scheduling-related determination.

“This would create a seismic rift between how substances are controlled and identified under the CSA and how they are applied under tax law, and plainly Congress did not intend to hide this elephant in the mousehole of the ‘within the meaning of’ verbiage,” IRS said in the reply brief, which was filed last week. “Petitioner’s statutory text argument is inconsistent with the text of section 280E, established precedent, and the statutory and administrative framework that Congress created under the CSA and section 280E.”

The petition from Ultra Health, which was also supported by several cannabis trade associations that submitted amici briefs in the case, further maintained that marijuana is not “prohibited” by the CSA and that Congress “has divested itself of Commerce Clause [of the U.S. Constitution] power to regulate marijuana,” IRS said in its latest filing.

But the agency pointed to statute stipulating that only the Drug Enforcement Administration (DEA) or U.S. Department of Health and Human Services (HHS) can initiate a drug scheduling review. And while it acknowledged that DEA is “currently considering rescheduling, it has not yet published a final rule reclassifying marijuana.”

IRS said “marijuana remains a Schedule I controlled substance, and was so during the entire period at issue, July 1, 2017, through June 20, 2020″—a period when Ultra Health argues it should have been eligible to take federal tax deductions despite selling cannabis. “Since marijuana was a Schedule I controlled substance during that period, the Court must ‘apply the law in effect at the time it renders its decision,’ and apply section 280E in those periods.”

“Petitioner’s interpretation ignores the operative fact that marijuana remains a Schedule I controlled substance pursuant to the CSA,” the filing states. “Petitioner’s request that the Court reschedule marijuana pursuant to an imaginary process which is prohibited by the clear procedures of the CSA must be denied.”

IRS also emphasized that the CSA and 280E “are sister statutes, and must not be read to conflict, absent clear congressional intent.”

“Petitioner’s argument thus runs afoul of black letter law on interpreting sister statutes harmoniously and presuming that similar terms operate and contain consistent meanings across statutes… Plainly, absent clear intent to the contrary, Congress did not intend for the CSA and section 280E to conflict,” it said. “Instead, the CSA and section 280E must be read in harmony and to avoid inconsistent outcomes; if a substance is currently identified as a Schedule I or II controlled substance under the CSA, then it is a substance ‘within the meaning’ of Schedule I or II for purposes of section 280E.”

The petitioner’s interpretation “effectively bestows rescheduling authority for controlled substances to the Court and creates incongruity between section 280E and the CSA,” it continues. “Petitioner’s argument fails because it ignores this important context within the CSA and would implicitly repeal the administrative process and roles delineated in the CSA for rescheduling substances.”

“Absent clear intent to the contrary, Congress did not intend for the CSA and section 280E to conflict by having conflicting avenues for rescheduling. Instead, the CSA and section 280E must be read in harmony to avoid such inconsistent outcomes and the implicit repeal of the procedures by which a provision might be rescheduled. This conflicting interpretation and inconsistent outcome are not supported by the legislative history of section 280E or case law. The Court does not have authority to undertake an independent evaluation of the CSA scheduling criteria to determine where a drug fits within the Schedules. Such a reading is inconsistent with the plain language of the statute and canons of statutory construction.”

Putting a finer point on the issue, IRS said 280E “should not be interpreted in a way that leads to inconsistent results with the CSA and functionally circumvents its procedural requirements for scheduling.”

As for the scientific review into marijuana conducted by HHS and the Food and Drug Administration (FDA) that led to a rescheduling recommendation under former President Joe Biden, Ultra Health’s argument that the agencies’ conclusion should factor into its eligibility under 280E is “irrelevant” because “DEA is ultimately responsible for rescheduling,” IRS said in the filing, which was noted earlier by Law360.

“Moreover, even when rescheduling occurs, there is no authority for the proposition that it would be retroactive to the tax years at issue,” it said. “Marijuana was ‘within the meaning of schedule I and II’ during the tax years at issue and still is today.”

Further, the petitioner’s claim that a congressional spending bill rider preventing DOJ from using its funds to interfere in state medical marijuana programs is “misplaced and confuses funding priorities with the conduct Congress has clearly prohibited,” IRS said. “Section 280E provides that no deduction is allowed for amounts paid in carrying on any trade or business if such business consists of trafficking in controlled substances which is prohibited by state or federal law.”

“If medical marijuana is not ‘prohibited’ by the CSA because Congress limited DOJ’s funding in one year, it would retroactively become prohibited if, in a subsequent year, DOJ funding were to be reinstated. And this still cannot explain how this would apply in partial year funding scenarios, or if Congress were to again subsequently restrict DOJ enforcement funding. This miasma of a system is, of course, easily avoided by applying the CSA (and appropriation riders) as written, which is the only permissible approach to statutory construction; selling marijuana is prohibited by the text of the CSA, and the appropriations riders’ only impacts are, as their texts say, to limit funds being used for limited purposes during limited periods of time.”

Put simply, “the CSA clearly prohibits the sale of marijuana, and section 280E has a clear and consistent meaning when read as a whole. Accordingly, the judicial inquiry is at an end,” it said. “Unless Congress or the DEA reschedule marijuana, or Congress amends section 280E, we must conclude that Congress intended to prohibit marijuana traffickers from taking deductions and credits.”

“It follows that section 280E applies to petitioner to disallow deductions in the tax years at issue,” IRS said.

The Congressional Research Service (CRS) has separately discussed prior attempts to challenge 28oE as it applies to state-legal marijuana businesses. In a report published last month, CRS pointed out that judges in the Tax Court issued a majority opinion upholding 280E and determining that the statute doesn’t violate the U.S. Constitution “because the disallowance of deductions does not constitute a ‘penalty’ for the purposes of the Eighth Amendment.”

Meanwhile, IRS in 2024 warned the marijuana industry that some companies have, without a “reasonable basis,” filled out a supplementary form in an attempt to take federal tax deductions that they’re prohibited from receiving under a provision known as 280E.

Of course, the federal tax issue may ultimately be resolved if the Justice Department follows through on Trump’s rescheduling directive, but despite a mandate to finalize the rule “in the most expeditious manner,” there haven’t been any updates on the status of that process in the weeks since the president signed the order.

The post Marijuana Businesses Can’t Force Court To Do ‘Imaginary’ Rescheduling Review To Exempt Them From 280E Tax, IRS Says appeared first on Marijuana Moment.

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