NORTHERN CALIFORNIA SMALL BUSINESS ASSISTANTS INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 26889-16.
UNITED STATES TAX COURT
Filed October 23, 2019.
153 T.C. No. 4
P is a California corporation that operates a medical marijuana dispensary legally under California law. R argues that P is subject to the limitations of
Held:
Held, further,
Held, further, P has provided no compelling argument to overrule our precedent holding that
Robin Lesley Klomparens, Douglas L. Youmans, Christian A. Speck, and Matthew D. Carlson, for petitioner.
Patsy A. Clarke and Melissa D. Lang, for respondent.
OPINION
GOEKE, Judge: This case is before the Court on petitioner‘s motion for partial summary judgment filed pursuant to Rule 121,1 to which respondent objects. Respondent determined a
Background
The relevant facts are not in dispute. Petitioner is a California corporation solely owned by Dona Ruth Frank. Petitioner and Ms. Frank jointly own additional California entities.
On September 20, 2016, respondent issued a notice of deficiency to petitioner for its 2012 tax year determining adjustments related to income and expenses from passthrough entities.2 On December 16, 2016, petitioner timely filed a petition with this Court. Respondent‘s notice of deficiency asserts in part:
You operated a medical marijuana dispensary. Thus, it is determined that your business consists of trafficking in marijuana, a controlled substance within the meaning of schedule I or II of the controlled substance [sic] Act. Accordingly, you are subject to the limitations of IRC 280E, which disallows all deductions or credits paid or incurred during the taxable year in carrying on a trade or business that consists or [sic] trafficking in controlled substance [sic].
Petitioner does not dispute that its business consists of operating a medical marijuana dispensary; however, petitioner contends that its operations are legal under California State law. On July 12, 2018, petitioner filed its motion for partial summary judgment pending before the Court in which it alleges that
Discussion
I. Summary Judgment
Rule 121(a) provides that either party may move for summary judgment upon all or any part of the legal issues in controversy. Summary judgment may be granted only if it is demonstrated that there is no genuine dispute as to any material fact and a decision can be rendered as a matter of law. See Rule 121(b); Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff‘d, 17 F.3d 965 (7th Cir. 1994). A partial adjudication may be made which does not dispose of all issues in the case. Rule 121(b).
When considering a motion for summary judgment, we view all facts and inferences in the light most favorable to the nonmoving party. Naftel v. Commissioner, 85 T.C. 527, 529 (1985). Therefore, we will view respondent‘s allegations as true and limit our analysis to the legal dispute.
II. Section 280E
No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.
III. Petitioner‘s Eighth Amendment Argument
Petitioner urges us to hold that
The
Congress has the power to lay and collect income taxes under
Unlike in other contexts where the Supreme Court has found a financial burden to be a penalty, disallowing a deduction from gross income is not a punishment. Cf. Kokesh, 581 U.S. at ___, 137 S. Ct. at 1643-1644 (“SEC disgorgement * * * bears all the hallmarks of a penalty: It is imposed as a consequence of violating a public law and it is intended to deter, not to compensate.“); United States v. Constantine, 296 U.S. 287, 295 (1935) (holding that an excise
Petitioner contends that
In contrast,
Petitioner does not cite, and we are not aware of, any case where the disallowance of a deduction was construed a penalty. This is especially telling given that Congress enacted
IV. Petitioner‘s Other Arguments
Petitioner makes two additional arguments to attack
A. Sections 164 and 167
Petitioner would have us find that
The broader statutory scheme also supports our conclusion that
B. Trafficking
Finally, petitioner argues that
V. Conclusion
Our precedent is unambiguous. Congress, rather than this Court, is the proper body to redress petitioner‘s grievances. We are constrained by the law, and Congress has not carved out an exception in
In reaching our holding, we have considered all arguments made, and, to the extent not mentioned above, we conclude they are moot, irrelevant, or without merit.
To reflect the foregoing,
An appropriate order will be issued.
Reviewed by the Court.
THORNTON, MARVEL, PARIS, KERRIGAN, BUCH, LAUBER, NEGA, PUGH, and ASHFORD, JJ., agree with this opinion of the Court.
URDA, J., did not participate in the consideration of this opinion.
NORTHERN CALIFORNIA SMALL BUSINESS ASSISTANTS INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 26889-16.
UNITED STATES TAX COURT
Filed October 23, 2019.
LAUBER, J., concurring: I join the opinion of the Court without reservation and write briefly in response to Judge Copeland‘s partial dissent. Judge Copeland dissents from the opinion of the Court‘s conclusion “that
With all due respect, the premises do not support the conclusion. While deterrence is one goal of the criminal justice system, it is also an objective that pervades the Internal Revenue Code (Code). Hundreds of Code provisions are designed to deter activity that Congress believes to be undesirable. But this does not make these provisions “in the nature of a penalty” for
I am aware of no authority for the proposition that these Code provisions run afoul of the
As the opinion of the Court correctly observes, the power of Congress to tax gross income is unquestionable, see op. Ct. p. 8 (citing Bagnall v. Commissioner, 96 F.2d 956, 957 (9th Cir. 1938), aff‘g 35 B.T.A. 1 (1936)), and deductions from gross income are a matter of legislative grace, see ibid. (citing INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992)). The denial of deductions for costs incurred in selling cannabis, like the denial of deductions for costs incurred in bribing Government officials, directly serves the revenue-raising function of the tax law. Indeed, the denial of deductions of any sort predictably raises revenue by increasing taxpayers’ net taxable income. There is no plausible authority for the proposition that
MARVEL, ASHFORD, and GOEKE, JJ., agree with this concurring opinion.
MORRISON, J., concurring: Petitioner‘s motion for partial summary judgment seeks a ruling that section 280E violates the
I do not advance a view as to whether section 280E is a fine.1 Even if section 280E were a fine, petitioner has not shown it would be excessive as applied to petitioner. Therefore, the Court is correct to deny petitioner‘s motion for partial summary judgment.
FOLEY, C.J., agrees with this concurring opinion.
Section 280E provides: “No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business * * * consists of trafficking in controlled substances“, i.e., drugs illegal under Federal law. (Emphasis added.) NCSBA, a dealer in marijuana (which is a drug illegal under Federal law), contends that this statute violates the
The opinion of the Court holds today that section 280E does not violate the
I. Because the Sixteenth Amendment gives Congress only the power to tax “incomes“, Congress does not have the prerogative to disallow deductions to such an extent that the resulting tax fails to be a tax on “income“.
Whatever prerogative Congress has to extend or deny “legislative grace” in the taxation of income is limited by the Constitution.
A. Congress has the power to tax “incomes“.
Under the Constitution, Congress has the power to tax. See
Under the income tax as Congress has enacted it, a taxpayer is entitled to deduct business expenses from his gross income, and any resulting profit is then subject to tax. In 1934 the U.S. Supreme Court first spoke of “legislative grace” to allow deductions when it stated in New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934):
The power to tax income like that of the new corporation is plain and extends to the gross income. Whether and to what extent deductions shall be allowed depends upon legislative grace; and only as there is clear provision therefor can any particular deduction be allowed.
In that case a predecessor corporation had losses that it had never been able to deduct for income tax purposes, and a successor corporation attempted to carry those losses forward to a subsequent year and deduct them in a manner that the statute did not permit; but the Supreme Court upheld the disallowance of the deduction of those losses. Since then the adage that deductions constitute “legislative grace” has become commonplace in tax opinions.1
The notion of deductions being “legislative grace“, which Congress has the discretion to extend or to deny, is easy to understand when (as in New Colonial Ice Co.) the deduction claimed is for previous tax years’ net losses, sustained by a different taxpayer. Congress could grant such a deduction or not, because the absence of a deduction for the previous year‘s net loss of the predecessor corporation was not an expense that was incurred in the successor corporation‘s production of revenues for the current year. The absence of that loss carryover deduction did not affect the character of
B. “Income” must take account of basis and cost of goods sold.
Very different would be an attempt by Congress to tax gross proceeds from the sale of a capital asset, without allowing a taxpayer to account for his “basis” in the property in calculating his taxable gain. A taxpayer who had bought Blackacre for $1,000 and then sold it for $900 would have received no gain but rather would have suffered a loss of $100. See
C. “Income” is gain.
The taxation of “income” must take account of the “basis” in a capital asset and of the COGS of inventory--not merely as an exercise of “legislative grace” but as mandatory under the
A proper regard for * * * [the] genesis [of the
Sixteenth Amendment ], as well as its very clear language, requires also that this amendment shall not be extended by loose construction * * *.[I]t becomes essential to distinguish between what is and is not “income,” as the term is there used, and to apply the distinction, as cases arise, according to truth and substance, without regard to form. * * *
For the present purpose we require only a clear definition of the term “income,” as used in common speech, in order to determine its meaning in the amendment * * *.
After examining dictionaries in common use * * *, we find little to add to the succinct definition * * *, “Income may be defined as the gain derived from capital, from labor, or from both combined” * * *.
Eisner v. Macomber, 252 U.S. 189, 206-207 (1920) (emphasis added) (quoting Doyle v. Mitchell Bros. Co., 247 U.S. 179, 185 (1918)).
Thus, these “mandatory exclusion[s]” of basis and COGS, which the Court of Appeals acknowledged in Alpenglow, arise not from any express constitutional rule about COGS or basis but rather from the very meaning of the “incomes” that the
The Court of Appeals explicitly so held in Davis v. United States, 87 F.2d 323, 324-325 (2d Cir. 1937):
It will be well to note at the start that our scheme of income taxation provides for a method of computation whereby all receipts during the taxable period which are defined as gross income are gathered together and from the total are taken certain necessary items like cost of property sold; ordinary and necessary expenses incurred in getting the so-called gross income; depreciation, depletion, and the like in order to reduce the amount computed as gross income to what is in fact income under the rule of Eisner v. Macomber, 252 U.S. 189, 40 S. Ct. 189, 64 L. Ed. 521, 9 A.L.R. 1570, and so lawfully taxable as such. In this way true income is ascertained by taking from gross income as defined that which is necessary as a matter of actual fact in order to determine what as a matter of law may be taxed as income. While such subtractions are called deductions, as indeed they are, they are not to be confused with deductions of another sort like personal exemptions; deductions for taxes paid; losses sustained in unrelated transactions and other like privileges which Congress has seen fit to accord to income taxpayers under classifications it has established. While the first kind of deductions are inherently necessary as a matter of computation to arrive at income, the second may be allowed or not in the sound discretion of Congress * * *. Such deductions as distinguished from the first kind are allowed by Congress wholly as a matter of grace. New Colonial Ice Co. v. Helvering, 292 U.S. 435, 54 S. Ct. 788, 78 L. Ed. 1348; Van Vleck v. Commissioner, 80 F. (2d) 217 (C.C.A. 2); Gillette v. Commissioner, 76 F.(2d) 6 (C.C.A. 2). * * * [Emphasis added.]
The District Court in Alpenglow Botanicals, 2016 WL 7856477, at *5, set Davis aside by stating:
[T]he Second Circuit‘s explanation of taxable income is dicta, * * * and the Supreme Court itself has placed its decision in Eisner into context. Notably, in C.I.R. v. Glenshaw Glass Co., 348 U.S. 426, 430-431, 75 S. Ct. 473 (1955), the Supreme Court explained that the characterization of income in Eisner served a useful purpose for distinguishing gain from capital, “[b]ut it was not meant to provide a touchstone to all future gross income questions.” * * *
The issue in Eisner v. Macomber was the taxability of a stock dividend (raising questions admittedly different from those in this case and in Alpenglow), and the Supreme Court did indeed observe in Glenshaw Glass, 348 U.S. at 431, that the definition in Eisner v. Macomber “was not meant to provide a touchstone to all future gross income questions.”
However, even after Glenshaw Glass, one can still say: “Implicit in this construction [in Eisner v. Macomber of ‘income’ as it is used in the
D. Section 280E results in a tax on something other than “income“.
To state the generality that business deductions are mandatory under the
But section 280E does not prompt a question as to the constitutionality of “disallowing a deduction“. See op. Ct. p. 8 (emphasis added). Congress does not by that statute simply deny “a deduction“, as it does, for example, in
This point is illustrated by expanding upon the example of the widget seller. Suppose he purchased 100 widgets at a cost of $6 per widget (instead of $10, as above), yielding COGS of $600, and suppose that for his business he leased a retail space for $200 and paid wages of $200 to employees, yielding additional expenses of $400, so that his out-of-pockets expenditures for COGS ($600) and additional expenses ($400) totaled $1,000. If he then sold the 100 widgets at a price of $9 each, he would have gross receipts of $900, which would, after being reduced by his total costs of $1,000 (the sum of COGS and total expenses), yield a loss of $100. No one would propose that this seller had any gain. And if his product had been not widgets costing $600 but illegal drugs costing the same amount, he would have the same negative outcome--a loss of $100. But despite this obvious loss, section 280E would disallow any deduction for his rent and wage expenses totaling $400, leaving him with gross receipts of $900, less COGS of $600, yielding a supposed taxable “income” of $300--despite his having incurred not gain but loss. Section
I would hold that this wholesale disallowance of all deductions transforms the ostensible income tax into something that is not an income tax at all, but rather a tax on an amount greater than a taxpayer‘s “income” within the meaning of the
II. Even if Congress has an otherwise unrestricted power to withhold its “legislative grace” and disallow deductions, it cannot do so in a manner that violates other constitutional limitations, such as the Eighth Amendment .
A. A broad reading of Congress‘s income-taxing power under the Sixteenth Amendment does not avoid the Eighth Amendment issue.
Assuming, however, that deductions are indeed purely matters of “legislative grace” to the full extent that the opinion of the Court concludes, that proposition does not end the constitutional analysis as the opinion seems to suggest. “We must not forget that the right to select the measure and objects of taxation devolves upon the Congress * * *, and such selections are valid unless constitutional limitations are overstepped.” Flint v. Stone Tracy Co., 220 U.S. 107, 167 (1911) (emphasis added).
Even if no taxpayer has a constitutional right to deductions for “ordinary and necessary” business expenses, and even if Congress can therefore broadly disallow deductions without exceeding its authority under the
In the same way, Congress is not free, in implementing the
Eighth Amendment‘s prohibition of “excessive fines” is a fundamental constitutional protection of liberty.
The
the protection [of the Eight Amendment] against excessive fines guards against abuses of government‘s punitive or criminal law-enforcement authority. This safeguard, we hold, is “fundamental to our scheme of ordered liberty,” with “dee[p] root[s] in [our] history and tradition.”
Id. at ___, 139 S. Ct. at 686-687 (first alteration added) (quoting McDonald v. Chicago, 561 U.S. 742, 767 (2010)). In a concurring opinion, Justice Thomas elaborated:
[D]uring Virginia‘s ratifying convention, Patrick Henry pointed to Virginia‘s own prohibition on excessive fines and said that it would “depart from the genius of your country” for the Federal Constitution to omit a similar prohibition. Debate on Virginia Convention (June 14, 1788), in 3 Debates on the Federal Constitution 447 (J. Elliot 2d ed. 1854). Henry continued: “[W]hen we come to punishments, no latitude ought to be left, nor dependence put on the virtue of representatives” to “define punishments without this control.” Ibid.
* * * * * * *
Justice Story * * * explained that the
Eighth Amendment was “adopted, as an admonition to all departments of the national government, to warn them against such violent proceedings, as had taken place in England in the arbitrary reigns of some of the Stuarts,” when “[e]normous fines and amercements were . . . sometimes imposed.” 3 J. Story, Commentaries on the Constitution of the United States § 1896, pp. 750-751 (1833). Story included the prohibition on excessive fines as a right, along with the “right to bear arms” and others protected by the Bill of Rights, that “operates, as a qualification upon powers, actually granted by the people to the government“; without such a “restrict[ion],” the government‘s “exercise or abuse” of its power could be “dangerous to the people.” Id., § 1858, at 718-719.* * * * * * *
The right against excessive fines traces its lineage back in English law nearly a millennium, and from the founding of our country, it has been consistently recognized as a core right worthy of constitutional protection. * * *
Id. at ___, 139 S. Ct. at 696, 698 (Thomas, J. concurring in the judgment). Wherever excessive fines are implicated, this protection should be vindicated.
III. Section 280E imposes a “fine” under the Eighth Amendment .
Even if deductions are indeed wholly matters of “legislative grace“, I would hold that the application of section 280E results in the imposition of a “fine” for purposes of the
A. A penalty is an exaction imposed as punishment for an unlawful act.
“In distinguishing penalties from taxes, this Court has explained that ‘if the concept of penalty means anything, it means punishment for an unlawful act or omission.‘” Nat‘l Fed‘n of Indep. Bus. v. Sebelius (“NFIB“), 567 U.S. 519, 567 (2012) (quoting United States v. Reorganized CF & I Fabricators of Utah, Inc., 518 U.S. 213, 224 (1996)) (citing United States v. La Franca, 282 U.S. 568, 572 (1931) (“a penalty, as the word is here used, is an exaction imposed by statute as punishment for an unlawful act“)). An
Section 280E is plainly directed toward the unlawful act of “trafficking in controlled substances“; it fundamentally alters the normal income tax liability by disallowing all deductions;9 the increased “income tax” liability that results from that disallowance is imposed and collected by the Government; and that liability is plainly intended, at least in
Nonetheless, both the opinion of the Court and the Commissioner‘s brief essentially begin and end with the contention that, because the resulting liability is within Congress‘s
B. An exaction labeled as an “income tax” may still be a fine.
An exaction by the Government may be a “fine” or “penalty” even if it is not labeled as such.12 The “excessive fines” prohibition of the
C. The analysis in Alpenglow Botanicals was inadequate.
The opinion of the Court observes that its proposed holding “is consistent with the only U.S. Court of Appeals to have considered this issue“--i.e., Alpenglow Botanicals, 894 F.3d at 1202. See op. Ct. note 8. But I submit that Alpenglow Botanicals is not persuasive because the Court of Appeals for the Tenth Circuit never performed an
As the Supreme Court explained in NFIB, 567 U.S. at 564: “It is up to Congress whether to apply the Anti-Injunction Act to any particular statute, so it makes sense to be guided by Congress‘s choice of label on that question“; and the Court held that “that label [of penalty] is fatal to the application of the Anti-Injunction Act“. “That choice does not, however, control whether an exaction is within Congress‘s constitutional power to tax.” Id. (emphasis added). That is to say, an analysis more deferential to Congress is prescribed by the Supreme Court for the statutory construction issue of determining whether the AIA applies (i.e., the question present in Green Solution Retail, Inc.); but a functional analysis less deferential to Congress is appropriate for determining the constitutional question of whether an exaction is within Congress‘s power to tax--i.e., the question presented in NFIB, in Constantine, in Alpenglow, and in this case. See NFIB, 567 U.S. at 561-566 (disregarding the “penalty” designation in the Affordable Care Act and examining the penalty‘s substance and effect using a functional approach).
IV. Conclusion
I would hold that the
GALE, J., agrees with parts II and III of this concurring in part and dissenting in part opinion.
COPELAND, J., agrees with this concurring in part and dissenting in part opinion.
COPELAND, J., concurring in part and dissenting in part: I join in Judge Gustafson‘s concurrence and dissent but expand upon his parts II and III and highlight the unique aspects of section 280E for further constitutional inquiry. Even if section 280E is characterized as a penalty provision, petitioner in its partial summary judgment motion has not set forth evidence of excessiveness. Thus, I concur in the result of the opinion of the Court; I would deny the partial summary judgment motion on that ground. However, I dissent from the opinion of the Court‘s conclusion that section 280E is not a penalty provision.
The
Consequently, courts determine whether a law is unconstitutional under the
Courts have repeatedly held that the substance of the exaction, rather than the label given to an item, is controlling. For example, this Court has found exactions are penalties if they have the “intention or effect of punishing the taxpayer“. Ianniello v. Commissioner, 98 T.C. 165, 177 (1992) (emphasis added) (reasoning deficiencies and additions to tax are not punitive (thus not fines) for
Section 280E is punitive and requires further analysis under the
GALE and GUSTAFSON, JJ., agree with this concurring in part and dissenting in part opinion.
Notes
United States v. Bajakajian, 524 U.S. 321, 329 (1998) (explaining that “[d]eterrence, however, has traditionally been viewed as a goal of punishment” in the context of a criminal forfeiture law). Notably, the forfeiture law at issue in Bajakajian and the