July 25, 2022

What the Lord Case Means to the Cannabis Industry

By Kariann McDougall, CPA, MSA, Supervisor, Tax & Business Services

Cannabis

“The cannabis industry has the most straightforward application of the federal tax code” is not a phrase that crosses anyone’s mind in this fast-paced, ever-changing industry. But as of March 2022, there is a bit more clarity in one gray area of the tax law relative to cannabis–accelerated bonus depreciation under Section 168K.

In July 2018, the Internal Revenue Service (IRS) first brought the accelerated depreciation deductions of John and Belinda Lord into question in the form of an assessed tax deficiency on their joint 2012 individual tax return. The Lords owned interest in two cannabis-related businesses–Beyond Broadway, LLC (an LLC taxed as a partnership) and Artistant Dispensary Center, Inc. (an S-Corporation). Both were licensed in 2012 by the State of Colorado to cultivate, process, and distribute medical marijuana and medical marijuana products.

Internal Revenue Code (IRC) Section 280E precludes companies conducting business in controlled substances from claiming deductions for business expenses (ordinary and necessary under section 162(a)), with the exception of expenses relative to their cost of goods sold. As of this writing, marijuana/cannabis is still listed as a Schedule I substance under the Controlled Substance Act. The definition of cost of goods sold is the cost of acquiring inventory, through either production or purchase, including indirect costs, which typically includes depreciation of production assets (Section 263A).

The Lords argued that they are entitled to the bonus depreciation deduction (168K) in calculating their indirect costs under 263A, and it would be unconstitutional not to allow them to do so. They further argued that disallowance of this deduction would result in a tax on gross receipts, rather than gross income, which is impermissible. The Lords went a step further to argue that 280E is entirely unconstitutional.

It will come as no surprise that the tax court disagreed with Mr. & Mrs. Lord’s arguments. Judge Kerrigan noted in T.C. Memo 2022-14 that IRC Section 168 provides a depreciation method for Section 167 depreciation deductions, and additionally, that depreciation deductions under Section 167 are not permitted for businesses that are subject to limitations under 280E. Subsequently, Judge Kerrigan and the tax court determined that 280E is not unconstitutional and, thus, the Lords have no entitlement to claim bonus depreciation.

While this case was not a win for Mr. and Mrs. Lord, accounting and tax professionals can rejoice in some clarity on at least one matter affecting taxation on cannabis-related businesses. To quote the Grateful Dead, “What a long, strange trip it’s been,” with no end in sight for the tax struggles of the cannabis industry.