In Harborside vs. IRS, the Tax Court discusses in great depth whether a medical marijuana dispensary that also engages in other activities “consists of” trafficking in a controlled substance for purposes of Section 280E.
This post summarizes a lengthy discussion in the recent Harborside vs. IRS case – a discussion that focused on just two words!
When cannabis isn’t your entire business
Marijuana enterprises cannot deduct their ordinary and necessary business expenses like other businesses because of 26 U.S. Code § 280E, which states that tax deductions and credits are not available to any trade or business which “consists of” trafficking in controlled substances that are prohibited under federal or state law. This has been the bane of state-legal marijuana businesses, which we all know deal in a substance prohibited under federal law.
Many cannabis businesses like Harborside engage in side activities such selling shirts, hats, hemp bags, and books. Does engaging in these other activities mean that Section 280E doesn’t apply? Harborside tried to convince the court of this, not surprisingly without success.
Harborside claimed that the words “consists of” in Section 280E indicates that the items following those words is an exhaustive list – meaning that if a marijuana business does not “exclusively and solely” traffic in controlled substances prohibited by federal or state law (it does something other than cultivate and sell marijuana), Section 280E should not apply. The IRS, on the other hand, argued that Section 280E applies to an entire business if any one of its activities involves trafficking in a controlled substance.
The tax court proceeded with an in-depth analysis of the phrase “consists of” as defined and utilized in legal texts, dictionaries, the tax code, and Shakespeare.
Legal and standard dictionary definitions
The court agreed with Harborside that the ordinary, everyday usage of the phrase “consists of” is usually followed by a complete and all-inclusive list. Black’s Law Dictionary and Antonin Scalia & Bryan A. Garner’s book Reading Law: The Interpretation of Legal Texts both state that “including always connotes incompleteness,” while “consists of” or “comprises” generally introduces an exhaustive list.
However, the court also pointed out that “including” and “consisting” are not antonyms, and that none of the standard dictionary definitions presented by Harborside indicates that the word “consists” must precede a complete or exhaustive list. Well, so much for using a dictionary in your legal argument.
Rules of statutory interpretation
The court also noted that a fundamental rule in interpreting statutes is that if there are two interpretations of a particular statute, one of which would carry out the statute’s objective and the another which would defeat it, the former should be utilized. Harborside’s “exhaustive list” interpretation, the court states, would make Section 280E not only ineffective but also absurd.
By way of example, the court pointed out that by having Section 280E apply only to businesses that engage exclusively in controlled substances, “any street-level drug dealer could circumvent [the statute] by selling a single item that wasn’t a controlled substance–like a pack of gum, or even drug paraphernalia such as a hypodermic needle or a glass pipe.”
Shakespeare and the tax code
Harborside pointed out that if Congress wanted the phrase “consists of” to precede a non-exhaustive list, it would have modified the statute to clarify that it does not mean ““is composed entirely of.” On the other hand, the IRS pointed several code sections where a statute included the phrase “consists of” and Congress explicitly modified it to “is composed entirely of” to indicate that it intended for the list to be exhaustive. Congress did not make that modification with Section 280E.
The court concluded that the tax code tends to use the phrase “consists of” in more than one way – and so does Shakespeare. Here is an entertaining footnote to the court’s “consists of” discussion, in which it references a scene from Shakespeare’s Twelfth Night:
“The Code is in good company. Shakespeare appears to use “consists of” both ways in a single exchange:
Sir Toby Belch: Does not our life consist of the four elements?
Sir Andrew Aguecheek: Faith, so they say; but I think it rather consists of
eating and drinking.
Sir Toby Belch: Thou’rt a scholar; let us therefore eat and drink.”
The court then resumed its analysis by looking at whose interpretation makes more sense, that of Harborside or the IRS. After pointing out a statute where interpreting “consists of” as preceding an exhaustive list would lead to an absurd result, the tax court again sided with the IRS.
Harborside argued that state-legal marijuana dispensaries didn’t exist when Section 280E was enacted in 1982, and that Congress currently has no intent to have the Department of Justice prosecute them “as if they were street-corner drug dealers.”
So what did Congress intend when it enacted Section 280E? The court refused to speculate, responding that since Section 280E predates state legalization of marijuana, Congress’ intent has no bearing on its determination. The court also noted that although several members of Congress have introduced bills that would exempt state-legal medical marijuana dispensaries from the Section 280E deduction ban, none has been enacted.
Don’t expect the court to change what we already know by arguing semantics
The 12-page discussion of two words ended with the court concluding what we knew already – since it sells a drug listed on Schedule I of the Controlled Substances Act, 26 U.S. Code § 280E prevents the Harborside medical marijuana dispensary from deducting its business expenses.
In our next blog post, we move on to Harborside’s next argument, that even if Section 280E applies to its marijuana sales, it should still be permitted to deduct expenses for its non-marijuana-related activities.