Sin and Taxes
The inconsistencies of federal marijuana policy
I'm far from an expert on marijuana and taxes, (though among us friends much more so on the latter than on the former). Nevertheless, I have always found the ambiguity—and friction—in the space academically interesting. As SCOTUS finishes its current session, it also denied cert in Standing Akimbo LLC v. United States (see p. 28 of the June 28, 2021 Order List). The denial itself isn’t particularly newsworthy, certainly for we tax types. The explanation accompanying the denial, well that’s a horse of a different color.
Let’s start with a definition, namely of “denied cert,” which I’ve always thought made the speaker sound as if (s)he were a Mensa member, even if the concept is straightforward enough.
Cases reach the Supreme Court (you’ll sometimes see abbreviated as SCOTUS, for “Supreme Court of the United States,” as I wrote in the first paragraph) in one of three avenues, the most common of which is on appeal from a circuit court. The means by which a party seeks to appeal the circuit court decision is by writ of certiorari (“certiorari” is Latin for “to inform”). Unlike other federal courts, SCOTUS picks and chooses the cases it hears, and it denies far more writs of certiorari than it grants. At least four of the nine justices need to agree to grant cert (if you’re interested, you can take a deeper dive here).
More often than not, the Supreme Court denies cert without explanation (see pages 3-6 of the June 28, 2021 Order List, which also includes the Thomas statement re. Standing Akimbo, serves as an illustration).
The Court denied cert in Standing Akimbo, which meant the Court lacked four Justices who wanted to hear the case. Nevertheless, the statement by Justice Thomas respecting the denial of cert is IMHO worth the read, and I’ll present below what I found the most salient points.
Paraphrasing Justice Thomas, at issue here is 26 U.S.C. §162(a) (trade or business expenses), which allows most businesses to calculate taxable income by subtracting from their gross revenue cost of goods sold and other ordinary and necessary business expenses, such as rent and employee salaries (remembering, of course, that “deductions are a matter of legislative grace” (see Deputy v. Dupont 308 U.S. 488 (1940) and Welch v. Helvering 290 U.S. 111, 115 (1933), both of which are frequent fliers in U.S. Tax Court cases).
But 26 U.S.C. §280E (expenditures in connection with the illegal sale of drugs), a public-policy provision in the Tax Code, restricts deductions for companies dealing in controlled substances prohibited by federal law. Those firms may subtract only the cost of goods sold, not the other ordinary and necessary business expenses.
You can see what I meant by “friction” in my opening paragraph.
Anyhow, Justice Thomas starts his statement thus:
Sixteen years ago, this Court held that Congress’ power to regulate interstate commerce authorized it “to prohibit the local cultivation and use of marijuana.” Gonzales v. Raich, 545 U. S. 1, 5 (2005). The reason, the Court explained, was that Congress had “enacted comprehensive legislation to regulate the interstate market in a fungible commodity” and that “exemption[s]” for local use could undermine this “comprehensive” regime. Id., at 22–29.
And he continues:
Whatever the merits of Raich when it was decided, federal policies of the past 16 years have greatly undermined its reasoning. Once comprehensive, the Federal Government’s current approach is a half-in, half-out regime that simultaneously tolerates and forbids local use of marijuana. This contradictory and unstable state of affairs strains basic principles of federalism and conceals traps for the unwary. This case is a prime example.
Thomas goes on to outline the “mixed signals” from Washington, DC (e.g., “in every year since 2015, Congress has prohibited [DoJ] from ‘spending funds to prevent states’ implementation of their own medical marijuana laws’.”) and the widespread permissive stances of the individual states (“36 States allow medical marijuana use and 18 of those states also allow recreational use”).
The following, of course, makes sense (at least to us tax pros):
Yet as petitioners recently discovered, legality under state law and the absence of federal criminal enforcement do not ensure equal treatment… Under [26 U.S.C. §280E], a business that is still in the red after it pays its workers and keeps the lights on might nonetheless owe substantial federal income tax.
And I also appreciated this reference to cash transactions, which is often lost in the larger conversation vis a vis taxes and marijuana sales, and which is a big, stinkin’ deal in and of itself (even if not strictly a tax issue):
This disjuncture between the Government’s recent laissez-faire policies on marijuana and the actual operation of specific laws is not limited to the tax context. Many marijuana-related businesses operate entirely in cash because federal law prohibits certain financial institutions from knowingly accepting deposits from or providing other bank services to businesses that violate federal law.
And, inexorably coming to his conclusion:
I could go on. Suffice it to say, the Federal Government’s current approach to marijuana bears little resemblance to the watertight nationwide prohibition that a closely divided Court found necessary to justify the Government’s blanket prohibition in Raich… A prohibition on intrastate use or cultivation of marijuana may no longer be necessary or proper to support the Federal Government’s piecemeal approach. [emphasis added]
So, what does this mean? Some (see this Reuters piece and this from Law & Crime) suggest the Supreme Court is giving Congress a clear signal to take care of 26 U.S.C. §280E, asserting the federal government’s position is untenable and counter to federalism. My take is that the incoherence in this space will not hold, though how long a course correction takes is difficult to guess.
“It depends” is a phrase tax pros use often. In this case, it may be a race between Congress on the one hand and a circuit court case with the right fact patterns on the other.
Until then, however, 26 U.S.C §280E is controlling.