Marijuana businesses--no deductions allowed

[Famspear]

I agree that as it's currently written, 280E doesn't ban a deduction for COGS, including whatever expenses are properly allocable to inventory cost. But if Congress really wanted to disallow even a COGS deduction I think it could do so by amending 280E to provide that gross income includes the gross receipts from the sale of illegal drugs....

I believe that if a taxpayer were to challenge such a provision in court, the provision would probably be thrown out as unconstitutional. The IRS Chief Counsel, in the December 10, 2014 memorandum linked above, seems to have the same concern. Under current case law, it appears (in my view) that Congress cannot disallow a cost of goods sold offset against gross receipts (at least, as the IRS memo notes, for a taxpayer properly using an inventory method to capitalize the cost of inventory).

...My point was that from a purely tax law standpoint I don't see the constitutional issue the drafters of 280E were worried about, unless they thought the only way to prohibit the deduction of COGS would be to impose a separate gross receipts tax on illegal drug sales, which would have implicated the self-incrimination protection of the 5th Amendment under the Leary rationale.

I believe the drafters were concerned about the line of Supreme Court cases where the Court either held -- or stated in very strong dicta -- that income means gross receipts less cost of goods sold from a constitutional standpoint. If such is indeed the case, Congress might not be able to change that by statute in the way you described.

The Leary case did not involve the Federal income tax or a federal income tax return, if I recall correctly. This is a key difference. The very act of filing the kind of report involved in Leary was much more likely to involve self-incrimination than the filing of a federal income tax return. The situation was similar in Marchetti as well. The holdings in those two cases cannot really be applied to federal income taxes. In the case of the federal income tax, the courts have indicated that the mere filing of the return itself does not have a material self-incriminating aspect (I'm just using my own terms, here), so (based on a reading of the U.S. Supreme Court cases like United States v. Sullivan, 274 U.S. 259 (1927) and Garner v. United States, 424 U.S. 648 (1976)) an individual cannot generally use the Fifth Amendment to refuse to report the amount of his income on a federal INCOME tax return, even if it is illegal income.

In other words, if Congress can constitutionally include something in gross interest income that by no stretch of the imagination is income (i.e., imputed interest under Section 7872)....

I'm not sure whether I agree or disagree that imputed interest is not real income, but maybe that's a discussion for another thread....

.....it should be able to constitutionally include something else in gross income that isn't income (i.e., gross receipts) but that arises from a transaction that can be subjected to an excise (i.e., the sale of drugs).

And that's why I'm not completely 100% confident about the apparent rule that the taxpayer MUST be allowed to offset cost of goods sold against the gross receipts in a sale transaction. We do have that statement from the Court of Appeals in the Penn Mutual case that I cited earlier:

[. . . ] Congress has the power to impose taxes generally, and if the particular imposition does not run afoul of any constitutional restrictions then the tax is lawful, call it what you will.

--Penn Mutual Indemnity Co. v. Commissioner, 277 F.2d 16 (3d Cir. 1960).

[Famspear]

All this sort of relates back to the old question of whether, or to what extent, Eisner v. Macomber is still "good law."

I'd have to go back and re-read that and other cases to be sure, but I wonder if the situation in those old Supreme Court cases was that the tax collector and the taxpayer were simply arguing over whether a certain thing was "income" for purposes of the federal income tax law. If the issue in those old cases was framed along the lines of "this is not taxable to me because it's not income in any real economic sense" (e.g., the non-monetary stock dividend in Eisner v. Macomber that really represented no increase in wealth to the taxpayer), the Court could agree with the taxpayer without deciding a separate issue not raised by either party: Whether Congress can indeed tax something "as income" even if that something is not really "income" in any true economic sense.

Arguably, the government in those old cases might have simply failed to recognize that this latter question is a qualitatively different one from the question of whether a stock dividend is income, or from the question of whether cost of goods sold must be subtracted from gross receipts to arrive at "gross income" (or "net gain" if you will) in the case of a sale of an asset.

There is an old saying that the court is not going to practice law for you. If you aren't sharp enough to think of the winning argument, neither the court (nor opposing counsel) is likely to help you out.

In other words, what would happen if Congress amended the Code to impose an unapportioned tax on all gross receipts, whether from a legal or illegal source, and whether from a sale of an asset or just from providing services to someone else? If the tax were denominated by the statute as an "income" tax and the taxpayer were to challenge it, would the courts throw it out?

Would the answer be different if the statute expressly called it a "gross receipts" tax, not an "income" tax?

What if Congress were to impose an unapportioned "income" tax on the receipt of loan proceeds?

What if Congress were to impose an unapportioned tax on the receipt of loan proceeds, but avoided the term "income tax" and instead called it the "loan proceeds tax"? What exactly would be the constitutional impediment to such a tax? If such a tax is not a capitation and it's not a "tax on property by reason of its ownership", how could it be unconstitutional?

[Famspear]

To continue this line of questioning:

What did the courts really do in those old cases in (apparently) establishing the "rule" that gross income, in a sale of property, is limited to the "net gain" (i.e., allowing the taxpayer to subtract cost of goods sold from gross receipts to arrive at the net gain that is "gross income").

The two main limitations on the power of Congress to impose taxes are that direct taxes (other than income taxes) must be apportioned among the states by population, and that all other taxes (duties, imposts and excises, otherwise lumped into a category called "indirect taxes" or "excises") must be geographically uniform. (We can set aside, for this discussion, various other constitutional limitations, such as the prohibition on taxes on exports from a state, the prohibition on certain poll taxes, the rule that revenue bills, etc., be initiated in the House of Representatives, etc.).

In requiring that the taxpayer be allowed to subtract cost of goods sold from gross receipts in computing the "gross income" from the disposition of an asset (that is, the net gain from dealings in property), did the courts engraft a constitutional requirement not found in, and not logically supported by, the text of Article I and the Sixteenth Amendment?

[Arthur Rubin]

The fact that California does not allow the cost of goods sold for an illegal (under California law) marijuana business, for the purpose of the state income tax, suggests it is not a constitutional requirement. Of course, the California constitution does little to restrict any taxes except for (some) 2/3 vote requirements, and there are some (state) gross receipts taxes (or fees).

[Cpt Banjo]

What did the courts really do in those old cases in (apparently) establishing the "rule" that gross income, in a sale of property, is limited to the "net gain" (i.e., allowing the taxpayer to subtract cost of goods sold from gross receipts to arrive at the net gain that is "gross income").

Yet in Stanton v. Baltic Mining Co., 240 U.S. 103 (1915), the Supreme Court upheld the tax on the mining company's income that under the statute had to be calculated by using a 5% depletion deduction in lieu of COGS. The company had argued that the 5% figure was arbitrary and that the actual cost of the product sold during the year in question was much larger.

Professors Bittker's and Lokken's take on Stanton:

Some of the early cases concerned with the meaning of income implied (or were understood to imply) that the taxpayer has a constitutional right to deduct the cost of property from the sales price in computing taxable gain, but the Supreme Court has never met the issue head on.

The Court came close to grappling with the issue in Stanton v. Baltic Mining Co., where it seemed to hold that an allowance for the cost of property sold was a matter of legislative grace rather than constitutional right, at least for mining corporations and perhaps for any sales in the ordinary course of business. Under the 1913 Act, the income of the taxpayer, a mining company, was computed by reducing its gross receipts by its business expenses and an arbitrary depletion allowance. Alleging that the depletion allowed by the statute (5 percent of gross receipts) was less than the actual cost of the minerals sold during the taxable year, the taxpayer argued that the tax was pro tanto a direct tax subject to the constitutional requirement of apportionment among the states according to population and that because the amount taxed was not income, the tax was not relieved of the apportionment requirement by the Sixteenth Amendment. In a murky opinion, the Court upheld the tax as an excise that did not need the support of the Sixteenth Amendment, but it is not clear whether the decision was intended to be confined to mining corporations (which encounter particular difficulty in allocating the cost of mineral deposits to the output of particular years) or to embrace all businesses.

The courts have not been called upon to choose between these competing interpretations because Congress has permitted tax-free recovery of capital in the overwhelming bulk of situations in which the issue arises. On selling property, for example, a taxpayer can offset its cost (or other basis) either under § 1001(a) or, if inventory property is involved, as part of the cost of goods sold. Business expenses and such other costs as depreciation, interest, and taxes are also deductible, except in unusual circumstances.

Bittker and Lokken, Federal Taxation of Income, Estates, and Gifts ¶ 5.4. (footnotes omitted)

[Dr. Caligari]

The Ninth Circuit has upheld the application of IRC 280E to a marijuana dispensary that was operating legally under California state law:

http://cdn.ca9.uscourts.gov/datastore/o ... -70510.pdf