Bloomberg Photo Service 'Best of the Week': U.S. Department of the Treasury Internal Revenue Service (IRS) 1040 Individual Income Tax forms for the 2012 tax year are arranged for a photograph in Tiskilwa, Illinois, U.S., on Thursday, April 11, 2013. The deadline for filing 2012 U.S. taxes is April 15. Photographer: Daniel Acker/Bloomberg

Colorado marijuana dispensary challenges IRS in U.S. Tax Court

As marijuana tax reform efforts petered out on Capitol Hill, another endeavor is before the U.S. Tax Court to let state-legal cannabis businesses take deductions and credits.

The owners of a marijuana dispensary in Palisade, Colo., claim their income was unjustly taxed twice because of the Internal Revenue Service’s application of Section 280E, a tax code that disallows credits and deductions from income generated by sales of controlled substances.

Jesse and Desa Loughman, owners of Colorado Alternative Health Care, recently filed a brief in U.S. Tax Court, challenging the IRS’ determination of taxes owed for 2010, 2011 and 2012.

“It’s an example of some of the absurdity that results when you take a 1982 tax law that was passed not based on accounting principals, but based on a concept that drug dealers were bad and that public policy didn’t allow regulated (cannabis operations),” Rachel Gillette, the GreenspoonMarder P.A. attorney representing the Loughmans, told The Cannabist.

“While I understand it’s not the sexiest issue, it is the illustration of why the application of 280E is antiquated in this industry.”

In the Nov. 17 petition, Gillette presented the Loughman’s case:

  • During the tax years of 2010, 2011 and 2012, Colorado Alternative Health Care was classified for tax purposes as an S Corporation, an entity that allows for income and the tax liability to flow through to shareholders — in this case, the Loughmans.
  • The Loughmans elected to classify their business as an S Corp benefit of S Corp
  • As an S Corp, the business is required to classify officer salary as “reasonable wages;” and when the Loughmans calculated their taxes, all of the income from the business flowed through on their wage income — listed on line 17 of form 1040 and taxed on line 7 of the 1040 form
  • The IRS made a determination to allocate the “trafficking” portion of the Loughmans’ “reasonable wages” as an expense and disallow it as a deduction under Section 280E.
  • As a result, the Loughmans claim the same income was taxed twice: once as wages and a second time as part of S Corp earnings.

“(The IRS’ application of 280E runs counter to the plain language, intent and purpose of Subchapter S because it produces the absurd result of taxing petitioners twice on the same income, creating a disparate negative tax treatment as between S Corps and unincorporated entities operating a legal marijuana business,” attorneys for the Loughmans wrote in the Nov. 17 brief, the latest move in a tax court challenge that started with a petition in 2015.

The latest petition comes just weeks after a U.S. Tax Court judge sided with the IRS on a 280E case brought by the former owners of Denver dispensary Total Health Concepts.

Judge Kathleen Kerrigan, in an Oct. 23 opinion, wrote that Total Health Concepts’ owners did not meet the “burden of proof” for the case because they failed to provide business records or other evidence to support the deductions claimed.

Referencing 280E, Kerrigan wrote:

“We do not need to address whether section 280E applies because petitioners have failed to substantiate any expenses for which respondent disallowed deductions. Petitioners did not produce any business records or any other supporting documents. They have not met their burden of proving respondent’s determinations in the notices of deficiency are incorrect. Respondent’s determinations will be sustained.”

James Thorburn, an attorney representing Total Health Concepts owners Neil and Andrea Feinberg, could not be reached for comment.

Gillette said she hopes her clients’ case could be a “toe in the door” in the broader discussion of how 280E is applied to regulated cannabis businesses.

“(280E) is merely a punitive effect to people who play by the rules,” she said. “If we win on this issue, it solves one small problem of a myriad of problems.”