The U.S. Ninth Circuit Court of Appeals halted a challenge to industry-hated tax rule 280E over a missed filing deadline.
A Thursday opinion upheld the U.S. Tax Court’s dismissal of challenges to income tax deficiencies issued by the IRS. The companies–Organic Cannabis Foundation LLC and Northern California Small Business Assistants Inc., both owned by Dona Ruth Frank–operated MED dispensaries in California. The Ninth Circuit opinion focuses on the failure of plaintiff’s petitions to reach the tax court by a deadline.
“We’re disappointed” in the decision, said the corporations’ attorney, Douglas Youmans. Youmans said they were reviewing options and had no decision yet on next steps. Possibilities include an appeal to the U.S. Supreme Court or to seek a rehearing with the Ninth Circuit.
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According to the opinion, the IRS notified the corporations in 2015 about deficiencies in 2010 and 2011 related to 280E. That section of the tax code disallows deductions on business related to trafficking controlled substances. For the two years in question, the IRS said both companies owed taxes and penalties because of 280E.
Organic Cannabis’ total was more than $1.3M, in taxes and penalties. For NCSBA, the amount was about $640,000.
The initial notices, sent in January 2015, gave the companies until April 22, 2015 to petition the U.S. Tax Court for redetermination. The companies sought to file those petitions to the U.S. Tax Court on April 22, 2015, via FedEx.
The Ninth Circuit Court opinion notes that the tax code allows taxpayers to use a rule that deems a document filed when sent—but only if the taxpayer uses certain delivery services for that purpose. The attorneys assigned a secretary to send the material. The secretary sent the material via a FedEx service which was not on the list, but was added two week later, the opinion says.
According to the opinion, FedEx apparently prepared a label different from the one the secretary prepared. The new label indicated it was created a day later and the package arrived a day after it was due. FedEx attempted to deliver on the due date but the court was inaccessible.
More than a year later, the IRS filed motions for the tax court to dismiss the petitions because of their late arrival. The tax court concurred, granting the dismissal in 2017.
“This unhappy case presents a cautionary tale about the need for lawyers to ensure that they have done exactly what is statutorily required,” the Ninth Circuit Court opinion states.
The Federal Tax Clinic at Harvard Law School’s Legal Services Center filed a supporting brief for the petitioners, saying the filing was not too late.
Other 280E Cases
The Ninth Circuit’s decision does not address the substance of the case—the 280E tax rule despised by the cannabis industry. But it notes the companies’ petitions challenged both the applicability and constitutionality of 280E.
Youmans said the parties are arguing a number of reasons why the application of 280E is inappropriate in this instance. He declined to go into specifics.
In a separate U.S. Tax Court case involving tax year deficiencies related to 280E, NCSBA had argued against applying the rule. There the IRS said NCSBA owed more than $1.2M for 2012, plus penalties of more than $252,000.
The company argued 280E imposes a gross receipts tax as a penalty and violates the U.S. Constitution’s Eighth Amendment which guards against excessive fines and punishment. The company also argued 280E doesn’t apply to marijuana businesses legally operating under state law.
In that case, an October 2019 decision by the U.S. Tax Court ruled 280E is a tax on gross income and not a penalty—and that disallowing deductions is not a penalty. It also found that 280E does not allow any deductions. Marijuana remains a Schedule 1 controlled substance and the court ruled 280E applies to legal MED operations.
“Congress, rather than this Court, is the proper body to redress petitioner’s grievances,” that ruling states. “We are constrained by the law.”
In a partial dissent, a judge in that case called 280E unconstitutional. The arguments echo those recently raised in the separate 280E case Oakland dispensary Harborside Health Center recently brought to the Ninth Circuit Court.
In his NCSBA dissent, Judge David Gustafson said that a “wholesale disallowance of all deductions transforms the ostensible income tax into something that is not an income tax at all, but rather a tax on an amount greater than a taxpayer’s ‘income’ within the meaning of the Sixteenth Amendment. Accordingly, I would hold that the Sixteenth Amendment does not permit Congress to impose such a tax and that section 280E is therefore unconstitutional.”
Gustafson added that further proceedings are needed to address questions whether 280E is excessive, and if Eighth Amendment protections extend to corporate taxpayers.
Harborside has also argued taxes need to be on income, defined as gain. But 280E forces taxpayers to pay tax even without gain, in years when they lose money.
Industry groups have backed Harborside’s appeal.