If you read my most recent post on Section 280E of the Internal Revenue Code, you might have picked up on my disappointment with the Alpenglow opinion. Whether the conclusion is right or wrong, in my estimation, it could have been much more thoroughly reasoned.
In Alpenglow, the 10th Circuit Court of Appeals was asked, among other less interesting questions, whether the IRS has authority to apply Section 280E if the taxpayer has not been convicted of drug trafficking. The court summarily concluded that the IRS’s authority was not limited to instances involving a conviction. The opinion’s main themes are as follows:
- The IRS has authority to determine whether and when to deny deductions under Section 280E.
- Section 280E has no requirement that there be a criminal investigation or conviction in order for it to apply, and if that was Congress’ intent, they could have easily placed that language in the statute.
- Other courts have upheld tax deficiencies against state-sanctioned cannabis businesses based on application of Section 280E without questioning the IRS’s authority.
If you consider the legislative intent, this historical application, and what is currently taking place in the cannabis industry, it feels like this was a valid argument deserving of more thorough consideration than it received from the court.
The IRS’s Statutory Authority
The court didn’t dwell too much on the IRS’s statutory authority, and for good reason. It felt like a bit of a throwaway. We can all agree that the IRS has the authority to determine whether and when to deny deductions. However, its discretion is not unlimited – the IRS must exercise its authority within the statutory confines of the law. What exactly, those statutory confines are with respect to Section 280E was the very question asked of the court, not whether the IRS had authority.
No Statutory Requirement
Section 280E denies deductions where a trade or business is “trafficking in a controlled substance (within the meaning of Schedule I and II of the Controlled Substances Act) which is prohibited by Federal law.” A court has the duty to give effect, if possible, to every clause and word of a statute in accordance with its meaning. Where Congress has borrowed a term of art defined by legal tradition and long-running practice when drafting a statute, in the absence of a contrary definition, that term of art should be construed in accordance with its widely accepted meaning.
The Alpenglow court failed to give effect to every word and clause of Section 280E. “Trafficking” is a legal term of art that presumes an illegal undertaking and, in many cases, is the criminal charge itself. There seems to be a strong argument here that, in order for a taxpayer to be “trafficking,” a key element for triggering denial of a deduction under Section 280E, he or she needs to have been convicted of the crime of trafficking. It’s almost akin to: “If a tree falls in the forest and no one is there to hear it, does it make a noise?” If a taxpayer engages in all of the elements of illegal drug trafficking, but no one is there to convict them of drug trafficking, are they drug trafficking?
At this point, it feels reasonable to conclude that, at a minimum, the statute is ambiguous, and also to take into consideration congressional intent. The Joint Committee on Taxation’s General Explanation of the TEFRA Act of 1982 provides some helpful background through its “Reasons for Change” and “Explanation of Provision” narratives.
There is a sharply defined public policy against drug dealing. To allow drug dealers the benefit of business-expense deductions at the same time that the U.S. and its citizens are losing billions of dollars per year to such persons is not compelled by the fact that such deductions are allowed to other, legal enterprises. Congress believed that such deductions must be disallowed on public policy grounds.
All deductions and credits for amounts paid or incurred in illegal trafficking in drugs listed in the Controlled Substances Act are disallowed.
Additionally, the Senate Report accompanying the bill that would become the TEFRA Act of 1982 explicitly discusses Edmonson v. Commissioner and Congress’ intent that Section 280E’s enactment preclude such results in the future. Mr. Edmonson had been convicted of drug trafficking and the Tax Court subsequently allowed him to claim certain business expenses related to his trade or business of drug trafficking.
In 1982, state-sanctioned cannabis businesses could not have existed. Whether a taxpayer subject to the application of Section 280E had been convicted of drug trafficking was a foregone conclusion (making it very unlikely that Congress would have considered the need to put any explicit “conviction” language in the statute). Under no other circumstance would a taxpayer be reporting their drug-trafficking business’s taxable income to the IRS. The published cases involving tax years prior to enactment of California’s Compassionate Use Act of 1996 can attest to that. Each such case involves a taxpayer convicted of drug trafficking.
It seems clear that Congress’s intent was to take away the benefit of business expense deductions from illegal drug dealers. Implicit in this was that these taxpayers were convicted drug dealers. The IRS’s current application of Section 280E seems largely inconsistent with the intent of Congress to target illegal drug dealers, and the federal government’s lack of action in policing cannabis companies tends to negate the continued existence of a sharply defined public policy against such operations.
Not Considered by Courts Deciding Other Section 280E Cases
While it may be true, the fact that taxpayers did not raise the issue in other cases (well, other than in The Green Sol. Retail, Inc. v. Commissioner) and, therefore, the courts did not consider it, does not seem to invalidate the argument.
In my opinion, the Alpenglow court’s analysis was inadequate and seemed almost flippant. I look forward to seeing this position put forth again (assuming the Controlled Substances Act isn’t amended to exclude state-sanctioned cannabis operations before another taxpayer has the chance), hopefully resulting in a more thoughtful analysis by the court.
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