One of the largest cannabis dispensaries in the country is arguing that the current laws barring dispensaries from most business expense deductions is unconstitutional and is preparing to advance its point before the Ninth Circuit Court of Appeals, according to Accounting Today.

Despite cannabis being legalized in many states, the federal government still considers it a Schedule 1 controlled substance. Because of this designation, the law does not allow cannabis industry firms to claim business expense deductions, unlike nearly every other business. Under Sec. 280E, a cannabis company, for example, cannot deduct advertising, insurance, marketing, rent, repairs, salaries, state taxes, utilities and many other expenses. The one exception that has been allowed is a deduction on cost of goods sold, usually through the calculations under Sec. 471.

The case, Patients Mutual Assistance Collective Corporation d.b.a. Harborside Health Center v. Commissioner, involves a dispensary that tried to deduct cost of goods sold using the more expansive Sec. 263A, as it also sold non-cannabis therapeutic products. In 2018, the tax court ruled against the company, finding that the non-cannabis components of the business were a small fraction of overall activity and so were considered incidental. The court said this meant that, despite its non-cannabis-related products and services, the dispensary was functionally a cannabis company and therefore needed to use the more narrow Sec. 471.

In its appeal, the dispensary is now saying that denying business expenses goes against the 16th Amendment. The dispensary's attorneys argue that since Sec. 471 ignores a large number of other costs that go into a dispensary business, the government is taxing it on things that aren't actually income. Because the 16th Amendment says that only income can be taxed, the dispensary argues that the calculation of the amount subject to tax is not income, because income means gain and it is being taxed on something other than gain.

If the court agrees with the plaintiffs, Accounting Today said the matter is likely to go to the Supreme Court.

This is not the first time a constitutional argument has been raised in response to the lack of business expense deductions for cannabis dispensaries. Late last year, the tax courts heard a case in which another dispensary argued that the rules against deductions violated the Eighth Amendment prohibition on excessive fines. The court, however, held that the Eighth Amendment applies to penalties, and that taxes are not penalties and therefore not within its purview. Further, the opinion added that Section 280E is part of Congress's authority, under the 16th Amendment, to levy taxes, which it said further bolstered the tax provision's constitutionality. Moreover, the opinion found that deductions, in and of themselves, are more a form of "legislative grace," and there's nothing that strictly requires the government to make them available.