Harborside Fires Back at IRS

By Willis Jacobson
Dec 9, 2020
(Photo Illustration by Scott Olson/Getty Images)

Oakland-based dispensary chain Harborside has accused the IRS of taking a “neutered” view of the U.S. Constitution, while seeking to “weaponize” federal tax law. It’s the latest salvo in a federal tax fight about 280E, the industry-hated IRS rule which limits the deductions cannabis companies can take on their taxes.

Harborside is battling the IRS in the U.S. Court of Appeals for the Ninth Circuit after a U.S. Tax Court ruled in October 2019 that the company owed $11M in taxes due to inappropriately claiming business deductions from 2007 to 2012. After Harborside appealed that ruling, the commissioner of the IRS filed a response in September, arguing the case should be dismissed since, among other issues, Harborside raised constitutional concerns that it hadn’t raised previously with the lower court.

Harborside responded to that filing with a 35-page reply (read here), submitted Nov. 30, that pushes back on the IRS’s assertions and maintains the unconstitutionality of Section 280E, which the appeal seeks to invalidate. 

The case is closely watched within the cannabis industry, as it could affect how businesses are able to deduct expenses going forward. That gravity was reflected in Harborside’s latest filing, which noted that clarity regarding Section 280E’s constitutionality “will have cascading impacts in a fledgling industry.”

Here’s what’s at stake:

  • Harborside, which operates four California dispensaries, maintains that it properly calculated its costs of goods sold for the years in dispute. Because Harborside used acceptable accounting methods as required by the IRS, the agency cannot force the company to calculate with a different method, Harborside argues.
  • At particular issue in the case is the definition of “income.” The IRS has taken the position, in this case, that the 16th Amendment applies only to income derived from property, such as collecting rent, and has nothing to do with business income. 
  • Harborside calls it a “neutered conception” of the 16th Amendment, which permits Congress to directly tax income. Because Harborside operated at a loss for some of the years in question, the company argues it had no “income” to tax, and therefore the government is seeking to illegally tax its revenue.
  • Harborside argues that the government’s narrow view of cost of goods sold, and its relation to income, artificially inflates taxable income.

The IRS argued, in its prior response, that gross income, not gain, is the baseline for the government’s power to tax income.

  • “Those arguments ignore constitutional text, contravene longstanding precedent, contort and overread non-binding authority, and defy common sense,” Harborside attorney James Mann wrote in the filing.
  • Section 280E, which prohibits cannabis businesses from claiming business deductions in the same way as traditional companies, effectively taxes cannabis companies at higher rates. The law was developed in the early 1980s to stop drug traffickers from claiming deductions. It applies to commercial cannabis since marijuana is federally illegal.
  • Two separate amicus briefs were filed with the court this summer in support of Harborside’s appeal. One was filed by the National Cannabis Industry Association and another was filed by the Colorado-based Marijuana Industry Group and Cannabis Trade Federation.

The Ninth Circuit has scheduled oral arguments in the case for Feb. 9, 2021.