Cannabusiness Advisory

Making Sense of Internal Revenue Code Section 280E – Part I

August 22, 2018


It’s been a busy summer for cannabis business Section 280E controversy, with three published cases (Alterman v. Commissioner; Loughman v. Commissioner; and Alpenglow Botanicals, LLC v. U.S.) construing the statute, and generally not in favor of the taxpayer-cannabis business. The limitations of Section 280E and their effects on after tax profits should be fairly familiar to cannabis entrepreneurs, but to keep things fresh in your minds, the statute provides:

[n]o deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of Schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.

What does that single, parens-laden sentence really mean? When it comes to the Internal Revenue Code, one sentence can leave much to unpack. Take Section 482, for example—not a very relevant Code section, unless you’re taking your cannabis business cross-border (maybe into Canada?), but, nevertheless, illustrative. One sentence in Section 482 triggered a proliferation of explanatory treasury regulations spanning nearly 250 pages of tiny print; hundreds (if not thousands) of cases, rulings, and administrative publications; and an entire advisory market on its own. While Section 280E will likely never reach those heights, there is still a lot to sort through, and with these three cases, two key earlier cases, and one important piece of administrative guidance, we now have a good sense of what the single-sentence Section 280E means. So without further ado, let’s dive in.

Section 280E has been on the books since 1982, and was largely a public policy response (possibly explaining the lack of any explanatory regulations) to the Tax Court’s decision in Jeffrey Edmondson v. Commissioner. However, California’s passage of the California Compassionate Use Act of 1996, legalizing the use of medical marijuana, gave Section 280E true purpose, and it quickly became an invaluable tool for IRS examiners auditing cannabis businesses. The first cannabusiness Section 280E cases began hitting the Tax Court docket in the mid-2000s, and as more states have gotten on the marijuana bandwagon, the volume has ticked upward.


Californians Helping to Alleviate Medical Problems (CHAMP), Inc. v. Commissioner is a Section 280E case from 2007 that has proven significant because it provides a strong position for claiming expenses related to business segments that are not “trafficking in controlled substances,” but may be related or complimentary and operated in tandem. Essentially, CHAMP tells us that operating a cannabis business does not necessarily have to result in the absolute disallowance of every expense incurred by that business.

CHAMP operated a facility where individuals with debilitating diseases could receive counseling and other caregiving services. Access to these services was based on membership, and each member paid a monthly fee that was set based on the recovery of costs for services. As part of its broader caregiving program, CHAMP provided members medical marijuana. On examination, the IRS determined that CHAMP was trafficking in a controlled substance and, as a result, all of its otherwise allowable business expenses were precluded by Section 280E. The IRS assessed a deficiency reflecting the addback to taxable income of CHAMP’s disallowed business expense deductions.

CHAMP contended that it was engaged in two separate “trades or businesses,” caregiving services and supplying medical marijuana, and that only expenses allocable to the medical marijuana segment were subject to limitation under Section 280E. The court agreed with CHAMP, finding two separate trades or businesses, with the caregiving services business being CHAMP’s primary business. In so doing, the court analyzed Section 280E’s legislative history and determined that Congress’ intent was to disallow only expense deductions associated with a trade or business of trafficking in controlled substances. The court analyzed the facts closely, and its opinion puts emphasis on the predominant nature of the caregiving services, as well as their quality and quantity. It was apparent on the facts that CHAMP’s caregiving segment was bona fide and, therefore, qualified as its own separate trade or business, and that Section 280E could not be applied to limit otherwise allowable business expenses attributable to that trade or business.


Olive v. Commissioner is another earlier (2012) Section 280E case, and is valuable in that it conveys a strong message about the importance of books and records—they are key, unless you prefer to pay tax on gross receipts, rather than gross income. If step one in the IRS playbook for cannabusinesses is to deny necessary and reasonable business expenses under Section 280E, step two is most certainly going to be “show your books and records substantiating cost of goods sold.” In many ways, Olive is the contra-CHAMP when it comes to establishing a bona fide separate, non-controlled-substance-trafficking trade or business.

There isn’t a lot of value in summarizing the case beyond pointing out two key takeaways. First, a cannabusiness must keep solid books and records, and they should be kept contemporaneously. Cobbling something together after the fact likely won’t work, as the taxpayer in Olive can attest. The IRS almost expects that a cannabis business won’t have them—don’t give the IRS examiner that satisfaction. Second, the CHAMP separate trade or business position is great, but there needs to be a bona fide separate business for it to work. Comfortable couches, video games, and selling a small volume of pipes, papers, and other paraphernalia don’t count. A good rule of thumb might be to ask yourself: If I took away the marijuana, could this stand on its own as a viable business?

This is a good start, but we’re not done yet…come back next week for Part II!

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