N. Cal. Small Bus. Assistants Inc. v. Comm'r, 153 T.C. No. 4

CourtUnited States Tax Court
Writing for the CourtGOEKE, Judge
Decision Date23 October 2019
Docket NumberDocket No. 26889-16.,153 T.C. No. 4


153 T.C. No. 4
Docket No. 26889-16.


October 23, 2019

P is a California corporation that operates a medical marijuana dispensary legally under California law. R argues that P is subject to the limitations of I.R.C. sec. 280E, which disallows all deductions for a business that consists of trafficking in a controlled substance within the meaning of Schedule I or II of the Controlled Substances Act. P argues that I.R.C. sec. 280E imposes a gross receipts tax as a penalty in violation of U.S. Const. amend. VIII. Further, P argues, even if I.R.C. sec. 280E is constitutional, it only bars ordinary and necessary business deductions under I.R.C. sec. 162 and does not apply to other distinct sections of the I.R.C. Finally, P argues that it is not subject to I.R.C. sec. 280E because its business, legally operated under California law, does not consist of "trafficking" in a controlled substance.

Held: I.R.C. sec. 280E is not a penalty provision and therefore does not violate the prohibition on excessive fines in U.S. Const. amend. VIII.

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Held, further, I.R.C. sec. 280E is not limited to deductions claimed under I.R.C. sec. 162 but applies to bar all deductions claimed by P.

Held, further, P has provided no compelling argument to overrule our precedent holding that I.R.C. sec. 280E applies to businesses operating legally under State law, notwithstanding its use of the word "trafficking".

Robin Lesley Klomparens, Douglas L. Youmans, Christian A. Speck, and Matthew D. Carlson, for petitioner.

Patsy A. Clarke and Melissa D. Lang, for respondent.


GOEKE, Judge: This case is before the Court on petitioner's motion for partial summary judgment filed pursuant to Rule 121,1 to which respondent objects. Respondent determined a deficiency in petitioner's 2012 income tax of $1,264,212 and an accuracy-related penalty under section 6662(a) of $252,842.40. Petitioner argues that section 280E--which bars deductions for a business that

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traffics in a controlled substance--as applied in this case is invalid. For the reasons stated herein, we will deny petitioner's motion.


The relevant facts are not in dispute. Petitioner is a California corporation solely owned by Dona Ruth Frank. Petitioner and Ms. Frank jointly own additional California entities.

On September 20, 2016, respondent issued a notice of deficiency to petitioner for its 2012 tax year determining adjustments related to income and expenses from passthrough entities.2 On December 16, 2016, petitioner timely filed a petition with this Court. Respondent's notice of deficiency asserts in part:

You operated a medical marijuana dispensary. Thus, it is determined that your business consists of trafficking in marijuana, a controlled substance within the meaning of schedule I or II of the controlled substance [sic] Act. Accordingly, you are subject to the limitations of IRC 280E, which disallows all deductions or credits paid or incurred during the taxable year in carrying on a trade or business that consists or [sic] trafficking in controlled substance [sic].

Petitioner does not dispute that its business consists of operating a medical marijuana dispensary; however, petitioner contends that its operations are legal under California State law. On July 12, 2018, petitioner filed its motion for partial

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summary judgment pending before the Court in which it alleges that section 280E: (1) imposes a gross receipts tax as a penalty in violation of the Eighth Amendment to the Constitution; (2) eliminates only ordinary and necessary business deductions under section 162 and does not apply to other distinct sections of the Code; and (3) does not apply to marijuana businesses legally operated under State law. We reject each of petitioner's arguments and will deny its motion for partial summary judgment.


I. Summary Judgment

Rule 121(a) provides that either party may move for summary judgment upon all or any part of the legal issues in controversy. Summary judgment may be granted only if it is demonstrated that there is no genuine dispute as to any material fact and a decision can be rendered as a matter of law. See Rule 121(b); Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff'd, 17 F.3d 965 (7th Cir. 1994). A partial adjudication may be made which does not dispose of all issues in the case. Rule 121(b).

When considering a motion for summary judgment, we view all facts and inferences in the light most favorable to the nonmoving party. Naftel v.

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Commissioner, 85 T.C. 527, 529 (1985). Therefore, we will view respondent's allegations as true and limit our analysis to the legal dispute.

II. Section 280E

Section 280E was enacted in response to a decision by this Court and provides:3

No 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.

Section 280E applies only to deductions attributable to a taxpayer's drug-related trade or business and does not generally disallow deductions attributable to a taxpayer's non-drug-related business. Californians Helping to Alleviate Med. Problems, Inc. v. Commissioner (CHAMP), 128 T.C. 173, 182 (2007). Although petitioner references gross receipts, section 280E is a tax on gross income. Despite efforts by several States to legalize marijuana use to varying degrees, it remains a Schedule I controlled substance within the meaning of the Controlled

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Substances Act, Pub. L. No. 91-513, sec. 202(c), 84 Stat. at 1249 (1970) (codified as amended at 21 U.S.C. sec. 812(c) (2018)). See 21 C.F.R. sec. 1308.11(d)(23) (2019). Consistent with this designation, we have held that the limitations imposed by section 280E are applicable to the ever-increasing number of marijuana businesses operating legally under State law. Olive v. Commissioner, 139 T.C. 19, 38 (2012), aff'd, 792 F.3d 1146 (9th Cir. 2015); CHAMP, 128 T.C. at 182-183.

III. Petitioner's Eighth Amendment Argument

Petitioner urges us to hold that section 280E, as applied in this case, is unconstitutional under the Eighth Amendment to the Constitution, which provides: "Excessive bail shall not be required, nor excessive fines imposed, nor cruel and unusual punishments inflicted." To conclude that section 280E violates the Eighth Amendment's Excessive Fines Clause, we must accept that the Eighth Amendment applies to corporations, that section 280E operates as a penalty, and that the penalty in this case is excessive. Because we find that section 280E is not a penalty provision, we will not address petitioner's other arguments.4

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The Eighth Amendment's "protection against excessive fines guards against abuses of government's punitive or criminal-law-enforcement authority", and applies to civil and criminal penalties alike. Timbs v. Indiana, ___ U.S. ___, ___, 139 S. Ct. 682, 686 (2019); see Austin v. United States, 509 U.S. 602, 610 (1993) ("'The notion of punishment, as we commonly understand it, cuts across the division between the civil and the criminal law.' * * * Thus, the question is not, as the United States would have it, whether forfeiture * * * is civil or criminal, but rather whether it is punishment." (quoting United States v. Halper, 490 U.S. 435, 447-448 (1989))). A penalty has been described as an "exaction imposed by statute as punishment for an unlawful act." United States v. La Franca, 282 U.S. 568, 572 (1931); see also Kokesh v. SEC, 581 U.S. ___, ___, 137 S. Ct. 1635, 1642 (2017) ("A 'penalty' is a 'punishment, whether corporal or pecuniary, imposed and enforced by the State, for a crime or offen[s]e against its laws.'" (quoting Huntington v. Attrill, 146 U.S. 657, 667 (1892))). Petitioner argues that the aim of section 280E is to punish, rather than tax, and therefore it is a penalty

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that must be limited by the Excessive Fines Clause of the Eighth Amendment. We disagree.

Congress has the power to lay and collect income taxes under Article I, Section 8 of the Constitution. The Sixteenth Amendment grants Congress the power to lay and collect taxes on "incomes, from whatever source derived" without requiring apportionment among the States as required by Article I.5 The Supreme Court has held that any deductions from gross income are a matter of legislative grace and can be reduced or expanded in accordance with Congress' policy objectives. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934); see Keeler v. Commissioner, 70 T.C. 279, 284-285 (1978). Under the Sixteenth Amendment, "[t]he power of Congress to tax gross income is unquestionable." Bagnall v. Commissioner, 96 F.2d 956, 957 (9th Cir. 1938), aff'g 35 B.T.A. 1 (1936).

Unlike in other contexts where the Supreme Court has found a financial burden to be a penalty, disallowing a deduction from gross income is not a punishment. Cf. Kokesh, 581 U.S. at ___, 137 S. Ct. at 1643-1644 ("SEC

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disgorgement * * * bears all the hallmarks of a penalty: It is imposed as a consequence of violating a public law and it is intended to deter, not to compensate."); United States v. Constantine, 296 U.S. 287, 295 (1935) (holding that an excise tax that sought to punish retailers who violated State law was a penalty under the Tenth Amendment). Deductions from gross income do not turn on equitable considerations; rather they are pure acts of legislative grace, the prudence of which is left to Congress. Deputy v. du Pont, 308 U.S. 488, 493 (1940); White v. United States, 305 U.S. 281, 292 (1938); Hokanson v. Commissioner...

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