It is a new year, but why not reside in the previous just lengthy sufficient to speak briefly about that final couple of Section 280E instances that trickled in at the finish of 2018? Right now, I’m reviewing the two Harborside instances.
Weighing in at 60-plus pages, and paraphrasing Shakespeare, it is a wonder that we didn’t find out significantly extra from the initially Harborside opinion. Harborside is a healthcare marijuana dispensary positioned in California whose 2007 via 2012 tax years have been audited, with the IRS issuing deficiency notices covering all six years. The deficiency notices disallowed the company’s Section 162 expense deductions pursuant to Section 280E, and produced adjustments to charges of goods sold. Of significance to 1 of Harborside’s arguments in the case, the business enterprise had also been the topic of a civil-forfeiture action filed in 2012, stemming from what the federal law continues to view as its illegal drug-trafficking activities. That action was subsequently dismissed with prejudice in 2016.
In its petition, Harborside asked the Tax Court to choose no matter whether:
- res judicata precludes the Commissioner from applying Section 280E exactly where the prior civil-forfeiture action was dismissed with prejudice
- Harborside’s business enterprise “consists of” trafficking in a controlled substance beneath Section 280E, exactly where promoting marijuana is not the sole and exclusive activity of Harborside
- Harborside has extra than 1 trade or business enterprise
- Harborside should really have capitalized indirect inventory charges beneath Section 263A, efficiently converting them to COGS and
- Harborside is liable for accuracy connected penalties.
The res judicata concern seemed to be the only somewhat novel 1 in this case. The court held that, mainly because the tax deficiency claim could not have been raised as aspect of the prior civil-forfeiture action, res judicata was not applicable with respect to it in the present action. The crux of the application of Section 280E is no matter whether the taxpayer is “trafficking in controlled substances.” It felt like Harborside may perhaps have been going for collateral estoppel, but possibly couldn’t get there primarily based on the kind or nature of the underlying civil-forfeiture dismissal, and had to settle for an unsuccessful claim preclusion argument. Bottom line: res judicata is unlikely to perform in the Section 280E context.
You may believe the “consists of” query is also novel, but it appears (at least to me) to basically be an inverted “more than 1 trade or business” argument. The court spent an inordinate quantity of time reaching the conclusion that the phrase “consists of” could signal an exhaustive list, but does not with respect to Section 280E mainly because that would be “absurd” (in the court’s words). I believe they could have saved a handful of paragraphs and simplified the conclusion. If the business’s activities consist of extra than trafficking in marijuana, it is extra than 1 trade or business enterprise. If the business’s activities do not give rise to extra than 1 trade or business enterprise, it is basically trafficking in marijuana. This distinction and the relevant things have been nicely created via the prior Section 280E case law. (By the way, court located that, though Harborside’s separate trade or business enterprise argument was extra compelling than Olive’s [if you recall, the taxpayer in Olive sold marijuana and offered comfortable couches, video games and paraphernalia—its second trade or business], it nevertheless failed to reside up to the CHAMP typical.)
Harborside also covers COGS and the application (or non-application) of Section 263A to marijuana organizations. If you have reviewed IRS Chief Counsel Memorandum 201504011, there is not significantly extra to glean from Harborside’s Section 263A discussion. Section 263A’s flush language clearly prohibits capitalization of expenditures that wouldn’t otherwise be taken into account when figuring out taxable revenue for the year (e.g., business enterprise expenditures disallowed beneath Section 280E).
Harborside’s reseller vs. producer discussion probably presents the most sensible worth for taxpayers. Producers can involve indirect inventory charges in COGS. For marijuana organizations, this may perhaps salvage some expenditures that would otherwise be lost to Section 280E. Harborside claimed to be a producer, primarily based on its giving marijuana plant clippings and supplying individuals/collective members instruction on how to cultivate marijuana making use of these clippings. Even though the court adopted a pretty broad definition for “producer,” it located that Harborside’s activities weren’t adequate. The court’s discussion gives some beneficial bookends for taxpayers to perform inside if they want to qualify as a producer for purposes of Section 471.
The accuracy-connected penalty query was decided in the subsequently issued opinion. Harborside was thriving in asserting its affordable lead to and great faith defense. Harborside’s good results with respect to the penalties is largely primarily based on (1) the lack of offered guidance connected to applying Section 280E throughout the years at concern, and (two) the reality that Harborside kept quite great books and records. Notably, the court concluded that Harborside’s “consists of” argument was affordable and practically persuasive (harkening back to the opinion on the substantive challenges, it was absurd). Even though this is a terrific outcome for Harborside, I believe it will be tricky to for taxpayers dealing with extra current tax years to leverage, thinking about the published case law and IRS Chief Counsel Memorandum 201504011.
I’ll close by highlighting some of the court’s cheeky additions:
- “The Court discovered at trial that it is not the leaves of the marijuana plant, but its flowers—or buds—that folks can smoke.” See the accompanying footnote, “The Court suspects, but tends to make no getting, that this may perhaps be why repurposed beer-promoting material—‘This Bud’s for you’—seems to be prevalent exactly where marijuana is sold.” They know so tiny, but so significantly . . .
- “’Dabbing’ indicates heating items that include marijuana so as to produce an intoxicating vapor. It may perhaps or may perhaps not have a connection to the strange fad amongst the young that appears to consist of pointing to the sky with 1 arm though placing one’s face in the crook of the other arm though seeming to sneeze or sniff.”
- Rather than the perfunctory “unless otherwise indicates, all section references are to the Internal Income Code,” the court opts for, “Unless we say otherwise, all section references are to the Internal Income Code.”
- In reference to Harborside’s “ombuds” division, the court adds a footnote especially to clarify that this is Harborside’s pun and not a typo.
- Substantial recitation of Shakespeare at notes 19 and 20 (Merchant of Venice and Twelfth Evening, respectively) in relation to no matter whether “consists of” introduces an exhaustive or non-exhaustive list.
 Sufferers Mutual Help Collective Corporation d.b.a. Harborside Wellness Center v. Comm’r., 151 T.C. 11 (2018) T.C. Memo 2018-208.
 Determined in a companion opinion at T.C. Memo 2018-208.