Case Information
*1
UNITED STATES TAX COURT PATIENTS MUTUAL ASSISTANCE COLLECTIVE CORPORATION d.b.a. HARBORSIDE HEALTH CENTER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent Docket Nos. 29212-11, 30851-12, Filed November 29, 2018. 14776-14. [1]
California medical-marijuana dispensary P deducted I.R.C. section 162 business expenses and adjusted for indirect COGS per the I.R.C. section 263A UNICAP rules for producers. R determined that P’s sole trade or business was trafficking in a controlled substance and that I.R.C. section 280E prevented it from deducting business expenses. R also determined that P had to calculate COGS using the I.R.C. section 471 regulations for resellers and was liable for accuracy-related penalties. P argued that I.R.C. section 280E didn’t apply to it, that it was a producer, and that a dismissed civil-forfeiture action precluded a deficiency action.
Held: The Government’s dismissal with prejudice of a civil- forfeiture action against P does not bar deficiency determinations. Held, further, I.R.C. section 280E prevents P from deducting ordinary and necessary business expenses.
Held, further, during the years at issue P was engaged in only one trade or business, which was trafficking in a controlled substance. Held, further, P must adjust for COGS according to the I.R.C. section 471 regulations for resellers.
Henry G. Wykowski and Christopher A. Wood, for petitioner. Nicholas J. Singer and Julie Ann Fields, for respondent.
HOLMES, Judge: Patients Mutual owns what may well be the largest marijuana dispensary in America. To the Commissioner that just makes it a giant drug trafficker, unentitled to the usual deductions that legitimate businesses can claim, unable even to capitalize its indirect costs into its inventory, and subject to penalties for taking contrary positions on its tax returns for the tax years ending July 31, 2007 through 2012. Patients Mutual wants to be treated like any other business beсause it follows California law, it does more than distribute marijuana, and the federal government already decided not to pursue a civil-forfeiture action against it.
FINDINGS OF FACT
I. California Medical-Marijuana Law
Under federal law marijuana is a Schedule I controlled substance. See
Controlled Substances Act, Pub. L. No. 91-513, sec. 202,
Under California law, things are somewhat different. In 1996 California
voters adopted Proposition 215--the California Compassionate Use Act of 1996
(CCUA)--to “ensure that seriously ill Californians have the right to obtain and use
marijuana for medical purposes.” See Cal. Health & Safety Code sec.
11362.5(b)(1)(A) (West 2007). The CCUA provides an exemption from
California laws penalizing the possession and cultivation of marijuana for patients
and their primary caregivers when the possession or cultivation is for the patient’s
personal medical purposes and recommended or approved by a physician. Id. sec.
11362.5(d). California later legalized collective or cooperative cultivation of
marijuana for medicinal purposes. Id. sec. 11362.775; see also People v. Colvin,
II. DeAngelo and Harborside
Steve DeAngelo saw these early dispensaries--which he described as being run by either well-meaning marijuana activists with no business experience or “thug operators”--and realized patients needed a better option. So in 2005 DeAngelo cofounded Patients Mutual Assistance Collective Corporation d.b.a. Harborside Health Center (Harborside) to be the “gold standard” in medical- marijuana dispensaries. His goal was to create a place where marijuana could be distributed responsibly, that was focused on patient care, and that provided benefits to both patients and the community. Harborside opened its doors in October 2006 and has grown into a booming business with more than 100,000 patient visits per year. It also generated a gusher of revenue during the years at issue:
Nonmarijuana Marijuana sales Marijuana Year sales revenue revenue Total revenue percentage 2007 $487 $5,448,635 $5,449,122 99.99 2008 3,990 10,916,914 10,920,904 99.96 2009 16,878 17,334,597 17,351,475 99.90 2010 42,492 22,047,372 22,089,864 99.81 2011 58,588 20,895,823 20,954,411 99.72 2012 320,651 25,199,997 25,520,648 98.74 Total 443,086 101,843,338 102,286,424 99.57 At all relevant times Harborside operated out of an approximately 7,500-square- foot space that had a reception area, healing room, purchasing office, processing room, clone room, and multipurpose room. The facility also had a large sales floor, offices, storage areas, restrooms, and a break room with a kitchen.
But operating a dispensary is no small task. DeAngelo had to make sure Harborside complied with California and local laws. This included getting proper permits, running as a nonprofit, and operating under a “closed-loop” system. Harborside interpreted the “closed-loop” requirement to mean that all of its marijuana must be provided by its patients; sold exclusively to its patients; handled only by its employees, all of whom were its patients; and not diverted into the illegal market. How Harborside achieved all of this is important, so we will start with how Harborside sourced and processed its inventory.
A. Sourcing and Processing
Harborside sold a wide variety of products, which we will divide into four main groups--clones, marijuana flowers, marijuana-containing products, and non- marijuana-containing products.
1. Clones
Clones are cuttings from a female cannabis plant that can be transplanted and used to cultivate marijuana. Harborside bought clones from clone nurseries, cared for them while they were in its store, repackaged them, and then sold them to its patients. It stored the clones in a clone room and sold them at a clone counter--the portion of the floor space dedicated to clone sales. During the years at issue Harborside had at least four employees who spent their time entirely in the purchase and sale of clones.
2. Marijuana Flowers
The Court learned at trial that it’s not the leaves of the marijuana plant, but its flowers--or buds--that people can smoke. [3] Harborside purchased all of its marijuana flowers from its patient-growers. Some of these growers promised to sell what they cultivated back to Harborside, and Harborside gave them either seeds or clones to get started. Other growers, however, bought seeds and clones from Harborside. However they acquired their starter supplies, growers who were interested in selling to Harborside had to sign a cultivatiоn agreement and were encouraged to take one of Harborside’s free grow classes and follow its best- practices guides.
Once a grower had cultivated, harvested, trimmed, flushed, dried, and cured his marijuana buds, he would bring them to Harborside to sell. Harborside had a purchasing office to inspect and test the incoming marijuana. Harborside would reject marijuana if it wasn’t properly cured, if it hadn’t been sufficiently trimmed, if it had an incurable safety issue such as pathogenic mold, or if it didn’t contain the right “cannabinoid profile.” If, for example, Harborside was in need of a strain of marijuana that was rich in CBD, [4] it might reject a batch of marijuana that was rich in THC. [5] There were times Harborside rejected the “vast majority” of the bud that growers brought in, and a grower whose marijuana was rejected got no compensation (though he was free to sell it to another collective if he could). On the other hand, if Harborside agreed to buy the marijuana, it would negotiate a price with the grower--typically enough to cover the grower’s actual growing expenses and a reasonable amount for his time and labor. It stored the marijuana in a vault--a reinforced concrete room with a bank-vault door and biometric locks--and sent a sample of the marijuana out for testing by a third-party laboratory. If all went well, the marijuana would go to a processing room where it was reinspected, remanicured, retrimmed, and then weighed, packaged, and labeled. Harborside staff would put it on display on the sales floor or put it back in the vault until needed. Harborside had at least three emрloyees dedicated to acquiring inventory, at least four devoted to managing inventory, and still others whose sole job was to process the bulk marijuana and ready it for resale.
3. Marijuana-Containing Products
Harborside’s marijuana-containing products included edibles, beverages, extracts, concentrates, oils, topicals, and tinctures--marijuana-infused alcohol, vinegar, or glycerin. Harborside bought these items from other collectives, tested them, repackaged them if they came in bulk or needed child-proof packaging, relabeled them, and then sold them to its own patients. Harborside’s human- resources director credibly estimated that about 55% to 60% of its employees’ total time was spent on buying and processing marijuana--both the buds and marijuana-containing products--and another 25% to 30% selling it.
4. Non-Marijuana-Containing Products Harborside also sold non-marijuana-containing products. These included branded gear such as shirts, hats, and pins; nonbranded gear such as socks and hemp bags; and a variety of other products including books, dabbing equipment, [6] rolling papers, and lighters. Harborside bought these items from outside vendors, stored them, and resold them to patients. Depending on the volume on hand, Harborside stored the non-marijuana-containing products on the sales floor and in one or more of its various storage rooms. A little less than 25% of the sales floor was used to display and sell these items and around 5% to 10% of Harborside’s employees’ time was dedicated to buying and selling these entirely legal products.
B. Sales and Pricing
Harborside took great care to avoid its marijuana’s leaking into the black market. For example, no one could enter the sales floor without going through a “very rigorous identification process.” This process required new patients to present valid photo IDs, have written recommendations from physicians licensed to practice in California, sign a collective cultivation agreement giving other Harborside patients the right to cultivate marijuana on their behalf, and agree to abide by Harborside’s rules and regulations. Harborside also sold its marijuana at a premium above the black-market rate to discourage its patients from reselling it. The exact method used to determine the sale price is unclear from the record, but DeAngelo testified that Harborside looked “at [its] general overall picture and determined the margin that we needed to place on every bit of cannabis that came in.”
C. Community Outreach
With premium prices, however, come significant profits. Harborside is a C corporation for federal tax purposes, [7] but to comply with California’s nonprofit requirement, [8] its bylaws prohibited it from paying dividends or selling equity, and required it to use any excess revenue for the benefit of its patients or the community. To this end, Harborside provided its patients with a wide variety of services at no additional cost. It told patients during their orientation--and again with signs on the premises--that part of the purchase price of the marijuana would be used to pay for patient services and community outreach. But patients were not required to buy marijuana to use the services.
The services included оne-on-one therapeutic sessions for reiki, hypnotherapy, naturopathy, acupuncture, and chiropractic consultations as well as group sessions for yoga, qigong, the Alexander technique, and tai chi. Harborside also offered grow classes, support groups, addiction treatment counseling, and a “sliding scale program” that gave discounts to patients with financial difficulties. All of the services were coordinated by Harborside’s holistic-services director and took place in either Harborside’s healing room or its multipurpose room. Harborside footed the bill and paid the service providers--all of whom were independent contractors. The total amounts paid were:
Year Amount 2007 $30,290 2008 93,341 2009 119,884 2010 144,441 2011 141,926 2012 150,466 D. Administrative Functions
Harborside had other employees in support roles. The security department, for example, spent most of its time checking in both patients and vendors and then escorting vendors into the back of the building to meet with a purchasing manager. Harborside’s human-resources director estimated that the security group spent 60% of its time checking in patients who came to buy marijuana, another 5% checking in people on site to receive a service, and the rest in assisting vendors. Harborside also had an administrative group, which included employees in its ombuds, [9] finance, human resources, and facilities departments as well as its executives.
III. Forfeiture Action
All seemed well until July 2012, when the federal government filed a civil- forfeiture action in the U.S. District Court for the Northern District of California. The lawsuit alleged that the property which Harborside rents and on which it operates its business was subject to forfeiture because it was used to commit the distribution, cultivation, and possession of marijuana in violation of 21 U.S.C. sections 841(a) [10] and 856. [11] The action was dismissed with prejudice in May 2016 by stipulation of the parties.
IV. Tax Returns and Audit
The forfeiture action wasn’t Harborside’s only run-in with the federal government--it also caught the attention of the IRS. Recall that Harborside is a C corporation for federal tax purposes with tax years ending July 31. It filed Forms 1120, U.S. Corporation Income Tax Return, for 2007 to 2012 and later amended its 2007, 2008, and 2009 returns. These returns were selected for audits that led to the issuance of three notices of deficiency--one for 2007 and 2008, one for 2009 and 2010, and one for 2011 and 2012. The notices denied most of Harborside’s claimed deductions and costs of goods sold, and asserted tens of millions in deficiencies and accuracy-related penalties.
The IRS’s primary reason for its adjustments was that “[n]o deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on a trade or business that consists of trafficking in controlled substances.”
Harborside filed timely petitions for all years at issue. Its principal place of business was in California at all relevant times, so absent a stipulation by the parties these cases are appealable to the Ninth Circuit. See sec. 7482(b)(1)(B). OPINION
I. Background
The CCUA did not decriminalize marijuana in California. See, e.g., People
v. Harris,
In 2003 California enacted the Medical Marijuana Program Act (MMPA),
also known as Senate Bill 420 and now codified at California Health and Safety
Code sections 11362.7-11362.83. The MMPA extended the CCUA’s affirmative
defense to charges of transporting marijuana for patients and primary caregivers
who “associate within the State of California in order collectively or cooperatively
to cultivate marijuana for medical purposes.”
[12]
Cal. Health & Safety Code sec.
11362.775; People v. Urziceanu,
Federal law did not follow. The conflict between federal and state law went
to the Supremе Court in 2005 when two California medical-marijuana users tried
to enjoin the U.S. Attorney General and the Drug Enforcement Agency from
enforcing federal marijuana law against them. See Gonzales v. Raich,
One might think the Supremacy Clause would have stifled the spread of
state attempts at legalizing what remained illegal under federal law. But one
would be wrong. And Congress complicated the situation by enacting a series of
appropriations riders that prevent the Department of Justice (DOJ) from using any
funds “to prevent * * * [States that permit medical-marijuana use] from
implementing their own laws that authorize the use, distribution, possession, or
cultivation of medical marijuana.” Consolidated Appropriations Act, 2017, Pub.
L. No. 115-31, sec. 537,
But the IRS is part of the Department of the Treasury, and marijuana sellers
must still contend with the Code. Here their major problem is section 280E, which
prеvents any trade or business that “consists of trafficking in controlled
substances” from deducting any business expenses. Congress enacted this section
in 1982 as a response to our decision in Edmondson v. Commissioner, T.C. Memo.
1981-623, where we allowed a cocaine dealer to deduct the ordinary and necessary
expenses of his illicit trade. See S. Rept. No. 97-494, at 309 (1982), 1982
U.S.C.C.A.N. 781, 1050. In 1986 new uniform capitalization (UNICAP) rules
under section 263A raised the possibility that traffickers of controlled substances
could capitalize indirect inventory costs that section 280E prevented them from
deducting as expenses. See Tax Reform Act of 1986 (TRA), Pub. L. No. 99-514,
sec. 803,
Given this state of the law it’s perhaps not surprising that Harborside isn’t
the first marijuana dispensary to appear in our Court. In our first major medical-
marijuana case, we found that the taxpayer operated two separate trades or
businesses--one that provided caregiving services and one that sold marijuana.
CHAMP,
In our next medical-marijuana case, Olive v. Commissioner,
While Harborside raises some of the same issues we addressed in these cases, it also presents some new ones. Here we are asked to decide
• whether res judicata precludes the Commissioner from arguing Harborside was engaged in trafficking in a controlled substance; • whether Harborside’s business “consists of” trafficking in a controlled substance under section 280E; • whether Harborside has more than one trade or business; • what Harborside may include in its cost of goods sold; and • whether Harborside is liable for accuracy-related penalties.
We will take each in turn.
II. Res Judicata
Harborside first argues that res judicata is a complete defense to its tax woes. Its position is that these cases and the 2012 civil-forfeiture action are all based on the same claim--that Harborside was trafficking in a controlled substance. It argues that the U.S. attorney’s decision to dismiss the forfeiture action with prejudice means that as a matter of law Harborside was not a drug trafficker and cannot be subject to section 280E.
Res judicata
--or claim preclusion--is an affirmative defense that bars suits
on the same cause of action, and it does apply to tax litigation. See Russell v.
Commissioner,
Commissioner v. Sunnen,
• an identity of claims between the actions; • privity between the parties in the actions; and • a final judgment on the merits in the civil-forfeiture action.
See Tahoe-Sierra Pres. Council, Inc. v. Tahoe Reg’l Planning Agency, 322 F.3d 1064, 1077 (9th Cir. 2003).
We think Harborside smashes right into the first. For there to be an identity
of claims, two cases must “arise out of the same transactional nucleus of facts.”
Cent. Delta Water Agency v. United States,
Harborside insists, hоwever, this doesn’t matter and points to United States
v. Liquidators of European Fed. Credit Bank,
III. Section 280E
The Code allows a business to deduct all of its “ordinary and necessary
expenses paid or incurred during the taxable year in carrying on any trade or
business.” Sec. 162(a). But it also has exceptions, one of which is section 280E.
See Olive,
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. [Emphasis added.]
Medical marijuana is a Schedule I controlled substance, and dispensing it pursuant
to the CCUA is “trafficking” within the meaning of section 280E. See CHAMP,
Harborside argues that “consists of” means an exhaustive list--or in other words that section 280E applies only to businesses that exclusively or solely traffic in controlled substances and not to those that also engage in other activities. The Commissioner argues that a single trade or business can have several activities and that section 280E applies to an entire trade or business if any one of its activities is trafficking in а controlled substance. Both parties say their interpretations match other Code sections’ use of “consists of” and best fit section 280E’s purpose.
We’ve seen Harborside’s argument before. In Olive,
A. Statutory Interpretation
Harborside begins with an appeal to the “ordinary, everyday usage” of the phrase. And we do agree that Harborside is right about the meaning of “consists of” in everyday use: For example, one says “The AFC East consists of the Bills, Patriots, Jets, and Dolphins,” and anyone fluent in English would understand that to mean that those are both all, and the only, teams in that division. Harborside also has some excellent secondary sources behind it on this point. See, e.g., Antonin Scalia & Bryan A. Garner, Reading Law: The Interpretation of Legal Texts 132 (2012) (contrasting “includes”, which sets off a nonexhaustive list, with “consists of” or “comprises”, each of which generally introduces an exhaustive list); Black’s Law Dictionary 279 (5th ed. 1979) (explaining that “consisting” “is not synonymous with ‘including’” because “including”, when used in connection with a number of specified objects, always connotes incompleteness). This might seem as though it should be the end of our analysis--after all, “[t]he ordinary- meaning rule is the most fundamental semantic rule of interpretation.” Scalia & Garner, supra, at 69.
Another fundamental canon of construction, however, tells us to рrefer
textually permissible readings that don’t render a statute ineffective.
[16]
Id. at 63
(citing Citizens Bank of Bryan v. First State Bank,
One might imagine--as a strictly theoretical matter--that a legislature might
enact an absurdity, and our job as judges would be to enforce it. But the
Commissioner reminds us that we shouldn’t do so if there is an effective-and-not-
absurd meaning that is also permissible. We must both avoid “a sterile literalism
which loses sight of the forest for the trees” and maintain “a proper scruple against
imputing meanings for which the words give no warrant.” N.Y. Tr. Co. v.
Commissioner,
But can “consists of” ever introduce a nonexhaustive list?
1. Dictionaries
Harborside says “no”, and urges us to take a hint from the fourth edition of the American Heritage Dictionary. Harborside quotes a usage note in the entry for “include”. See American Heritage Dictionary 887 (4th ed. 2006). The note explains that “include” connotes, but does not necessarily mean, that a list immediately following it is incomplete. Id. It also suggests that authors
introducing exhaustive lists use “comprise” or “consist of” instead. Id. It doesn’t say, however, that “consists of” necessarily introduces an exhaustive list. See id. And the dictionary’s definition of “consist” is “[t]o be made up of or composed,” “[t]o have a basis; reside or lie,” or “[t]o be compatible.” Id. at 392.
Harborside’s other dictionary citation is similarly ambiguous. An old edition of Black’s Law Dictionary defines “consisting” as “[b]eing composed or made up of.” Black’s Law Dictionary 279 (5th ed. 1979). [17] It also explains that “consisting” is not synonymous with “including” because “including” always connotes incompleteness, and “consisting” doesn’t. Id. The entry doesn’t say that “consisting” and “including” are antonyms; that is, although “consisting” doesn’t connote an incomplete list, it also doesn’t connote an exhaustive list. Id. And even if “consisting” were the antonym of “including”, that would mean only that it connotes completeness--not that it necessarily means completeness. Harborside doesn’t mention it, but the same dictionary also defines “consist” as “[t]o stand together, to be composed of or made up of.” Id.
Harborside even points us to an odd opinion that cites a precursor of the
Oxford English Dictionary
[18]
that says “‘[c]onsisting of’ can have the meaning of
‘to have its essential character in’ or ‘foundation in.’” Madison Teachers, Inc. v.
Madison Metro. Sch. Dist.,
2. The Code
But this is a tax case, and before we go too far afield in dictionaries or literature, we should draw back to other sections of the law we have to apply to these cases. See, e.g., United States v. Olympic Radio & Television, Inc., 349
U.S. 232, 236 (1955) (interpreting phrase consistently within Code chapter and
saying courts should give Code “as great an internal symmetry and consistency as
its words permit”). But see Util. Air Regulatory Grp. v. EPA, 573 U.S. , ,
There are some similar phrases. Section 401(a)(22) says that if more than 10% of the assets in an employee’s defined-contribution plan account are stock in his closely held employer, section 409(e)’s voting-rights rules don’t apply so long as “the trade or business of such employer consists of publishing on a regular basis a newspaper for general circulation.” Section 451(i)(3)(B) provides an optional rule for determining in what year income is realized for “any stock or partnership interest in a corporation or partnership * * * whose principal trade or business consists of providing electric transmission services.” And section 513(h)(1)(B) excludes from the definition of unrelated trade or business “any trade or business which consists of” exchanging or renting donor and member lists among nonprofits. We haven’t found any cases construing what “consists of” means in any of these sections.
Harborside points out that in many Code sections Congress used the phrase
“consists of” but then modified it--as it did in the electricity-related section above
--to clarify that it doesn’t mean “is composed entirely of.” See, e.g., sec. 581 (“a
substantial part of the business of which consists of”); sec. 181(e)(2)(E) (added by
the Consolidated Appropriations Act, 2016, sec. 169(c),
Unmodified uses of “consists of” do sometimes seem to introduce
exhaustive lists. See, e.g., sec. 108(e)(4)(B) (“family of an individual consists of
the individual’s spouse, the individual’s children, grandchildren, and parents, and
any spouse of the individual’s children or grandchildren”). But in other places
“consists of” would lead to an absurd result if it indicated an exhaustive list. The
Commissioner points us to a glaring example: A “computer” eligible for
accelerated depreciation “
consists of
a central processing unit containing extensive
storage, logic, arithmetic, and control capabilities.” Sec. 168(i)(2)(B)(ii)(II)
(emphasis added). Here, Harborside’s reading of “consists of” would mean that
anything other than a central processing unit isn’t a computer. Surely something
wouldn’t fail to be a computer because it had a monitor, a keyboard, a mouse, or a
power cord. See Dunford v. Cоmmissioner,
These examples show, we think, that the Code uses “consists of” in more than one way. It sometimes sets off an exhaustive list, but it also sometimes introduces a nonexclusive list.
3. Caselaw
That leaves us with caselaw. Each party has precedent here, too.
Harborside’s chief example is one from Wisconsin which held that a statute
preventing “a collective bargaining unit consisting of school district professional
employees” from arbitrating certain issues didn’t preclude arbitration by a unit that
mainly had such employees but also had some other types of employees. Madison
Teachers, Inc.,
consistency missing from the Internal Revenue Code, which as we’ve seen uses “consists of” multiple ways. It’s therefore hard for us--despite what we hope is our decent respect for language--to do as Harborside asks and interpret the phrase as mechanically as the Wisconsin Court of Appeals has.
The Commissioner, for his part, points us to a case that dealt with a section
of the Code itself--a statute excluding for tаx purposes from a tax-exempt
organization’s unrelated trade or business “any trade or business which consists of
conducting bingo games.” Julius M. Israel Lodge of B’nai B’rith No. 2113 v.
Commissioner,
Dictionaries, the Code, and caselaw all show that “consists of” can introduce either an exhaustive list or a nonexhaustive list. [20] A nonexhaustive list is the only option that doesn’t render section 280E ineffective and absurd. We therefore read section 280E to deny business-expense deductions to any trade or business that involves trafficking in controlled substances, even if that trade or business also engages in other activities.
B. Purpose
We also note that Harborside has a subtler argument about the play between
literal meaning and statutory purpose. It reminds us that dispensaries that are legal
under state law didn’t exist in 1982 and Congress even today won’t let the DOJ
prosecute them as if they were street-corner drug dealers. See Consolidated
Appropriations Act, 2017 sec. 537; Consolidated Appropriations Act, 2016 sec.
542; Consolidated and Further Continuing Appropriations Act, 2015 sec. 538; see
also McIntosh,
Although section 280E predates states’ legalization of medical marijuana, “[t]hat Congress might not have imagined what some states would do in future years has no bearing on our analysis. It is common for statutes to apply to new situations. And here, application of the statute is clear.” Id. at 1150. The restriction on how the DOJ uses funds is irrelevant here because “the government is enforcing only a tax, which does not prevent people from using, distributing, possessing, or cultivating marijuana in California. Enforcing these laws might make it more costly to run a dispensary, but it does not change whether these activities are authorized in the state.” Id. at 1150.
Finally, we note that several members of Congress asked the IRS to issue guidance saying that medical-marijuana dispensaries aren’t subject to section 280E, and the IRS said it couldn’t do that unless Congress amended the Code or the Controlled Substances Act. See IRS Information Letter 2011-0005. Members of Congress have subsequently introduced several bills that would exempt state- legal marijuana businesses from section 280E. Small Business Tax Equity Act of 2011, H.R. 1985, 112th Cong. (2011); Small Business Tax Equity Act of 2013, H.R. 2240, 113th Cong. (2013); Small Business Tax Equity Act of 2015, H.R. 1855, 114th Cong. (2015); Small Business Tax Equity Act of 2015, S. 987, 114th Cong. (2015); Small Business Tax Equity Act of 2017, H.R. 1810, 115th Cong. (2017); Small Business Tax Equity Act of 2017, S. 777, 115th Cong. (2017); Responsibly Addressing the Marijuana Policy Gap Act of 2017, H.R. 1824, 115th Cong. (2017); Responsibly Addressing the Marijuana Policy Gap Act of 2017, S. 780, 115th Cong. (2017). None has been enacted.
We hold that section 280E prevents Harborside from deducting its business expenses.
IV. More Than One Trade or Business?
Harborside says that even if section 280E applies to its marijuana sales, it
can still deduct its expenses for any separate, nontrafficking trades or businеsses.
That’s correct. See CHAMP,
An activity is a trade or business if the taxpayer does it continuously and
regularly with the intent of making a profit. See, e.g., Commissioner v.
Groetzinger,
Whether two activities are two trades or businesses or only one is a question
of fact. See, e.g., CHAMP,
In Olive, however, we held (and the Ninth Circuit agreed) that a taxpayer
who sold medical marijuana and provided complimentary services--including
movies, board games, yoga classes, massages, snacks, personal counseling, and
advice on how to best consume marijuana--had a single trade or business. Olive,
The most recent case where we had to figure out the number of a marijuana
dispensary’s trades or businеsses is Canna Care, Inc. Like Harborside, the
taxpayer there sold medical marijuana and other items, including books, T-shirts,
and hats. Canna Care, Inc., at *4, *12. Unlike the taxpayer in Olive, the taxpayer
in Canna Care, Inc. had at least a little bit of income from nonmarijuana sales. Id.
at *12. But we still found only a single trade or business--selling marijuana--and
“the sale of any other item was an activity incident to” those sales. Id. But our
analysis there was constrained: The parties had stipulated that the taxpayer “was
in the business of distributing medical marijuana” and the record didn’t enable us
to determine what percentage of the taxpayer’s income came from marijuana sales
and what percentage came from other sources. See id.; see also Alterman v.
Commissioner,
Harborside presented its case in greater detail. It argues that it had four activities, each of which was a separate trade or business:
• sales of marijuana and products containing marijuana; • sales of products with no marijuana;
• therapeutic services; and
• brand development.
We consider each.
A.
Selling Marijuana and Products Containing Marijuana
There’s no question that selling marijuana and products containing
marijuana was Harborside’s primary purpose. Sixty percent of the members
Harborside’s security chеcked in were there to buy marijuana in one form or
another. Marijuana and marijuana products took up around 75% of Harborside’s
sales floor. Harborside’s employees spent 80-90% of their time purchasing,
processing, and selling these products. And those sales generated at least 98.7%
of Harborside’s revenue during each of the years at issue. This was certainly a
trade or business--specifically, the trade or business of trafficking in a controlled
substance. See Olive,
B.
Selling Products That Didn’t Contain Marijuana
Harborside’s sale of items that didn’t contain marijuana--such as branded
clothing, hemp bags, books about marijuana, and marijuana paraphernalia such as
rolling papers, pipes, and lighters--generated the remaining 0.5% of its revenue.
The same Harborside employees who bought, processed, and sold marijuana also
sold these items, but selling them took up only 5-10% of their time. The
nonmarijuana items occupied only 25% of the sales floor where Harborside sold
marijuana, and that sales floor was accessible only to patrons who had already
presented their credentials to security--which means that no one who couldn’t buy
marijuana could buy these nonmarijuana items. And the record shows no separate
entity, management, books, or capital for the nonmarijuana sales. This leads us to
find that the sale of non-marijuana-containing products had a “close and
inseparable organizational and economic relationship” with, and was “incident to,”
Harborside’s primary business of selling marijuana. See Olive,
Harborside nevertheless argues that its sale of anything other than marijuana
is a separate trade or business. It cites an analogy the Ninth Circuit used in Olive,
We think Harborside misses the analogy’s point: It shows that a service a taxpayer doesn’t charge for, but which attracts customers, isn’t a separate trade or business. It doesn’t mean that selling two things is necessarily two separate trades or businesses. Bookstore B is there to provide contrast to Bookstore A, which is what the court compared to the taxpayer in Olive. Id.
Finally, the analogy--though a good fit for Olive, which was selling marijuana and giving away snacks and soft drinks--doesn’t suit Harborside. A better analogy would be to a bookstore that derives 0.5% of its revenue from selling stationery, bookmarks, and T-shirts with pictures of books on them (“Bookstore C”). To be completely analogous to Harborside, Bookstore C would sell these items using the same employees, sales floor, management, ledgers, and business entity it used to sell books. That hypothetical bookstore would, we think, be a single trade or business under the Ninth Circuit’s reasoning. And Harborside’s sale of non-marijuana-containing items is, we find, not a separate trade or business.
C. Therapeutic Services
Recognizing that an activity needs a profit motive to be a separate trade or business, Harborside argues that a portion of each marijuana sale was actually a purchase of its free holistic services. [21] This is what it told its patrons, too.
Harborside says this makes it like CHAMP. But in CHAMP,
Harborside is more like the dispensary in Olive,
The relationship between Harborside’s marijuana business and holistic services closely fits Olive’s “Bookstore A” analogy. See id. at 1150. Just as a bookstore that gives away coffee is still only a bookstore, a marijuana dispensary that gives away services is still only a marijuana dispensary. See id. The fact that Harborside used a tiny bit of its marijuana-sales revenue to pay for those services doesn’t change anything--after all, Bookstore A necessarily pays for its coffee with book sales. And we also find that there were business reasons to offer these services alongside marijuana sales: It justified premium pricing and helped Harborside meet the community-benefit standards California law required. We therefore find that Harborside’s holistic services were not a separate trade or business.
D. Branding
Harborside’s final argument on this subject is that its brand-development activity was a separate trade or business. Because this did not generate any revenue until after the years at issue, the Commissioner compares it to preoperational expenditures that have to be capitalized instead of deducted. Harborside insists it is a trade or business eligible for section 162 deductions because from day 1 it performed them with an independent profit motive. To show a profit motive without any revenue, Harborside says its branding activities were part of a “unified business enterprise” with its activities that did make money during the years at issue.
A separate entity purposely operating at a loss is still a trade or business
eligible for deductions if it and entities related to it together form a unified
business enterprise that itself has a profit motive. See Campbell v. Commissioner,
There’s also no actual evidence to suggest that Harborside’s brand
development was in any way a separate trade or business. As far as we can tell,
Harborside did its branding using the same entity, management, capital structure,
employees, and facilities as its marijuana sales. See Tobin,
Harborside dedicated the lion’s share of its resources to selling marijuana
and marijuana products. Those sales accounted for over 99.5% of its revenue. Its
other activities were neither economically separate nor substantially different. We
therefore hold that Harborside had a single trade or business--the sale of
marijuana. That’s trafficking in a controlled substance under federal law, so
Harborside cannot deduct any of its related expenses. See sec. 280E; see also
Olive,
V. Cost of Goods Sold
The fact that Harborside can’t deduct any of its business expenses doesn’t
mean it owes tax on its gross receipts. All taxpayers--even drug traffickers--pay
tax only on gross income, which is gross receipts minus the cost of goods sold
(COGS). See, e.g., New Colonial Ice Co. v. Helvering,
But what is the distinction between a business-expense deduction and an
adjustment for COGS? Deductions are subtractions from gross income that
taxpayers make when they calculate their taxable income. Sec. 63(a). Deductions
are statutory, and Congress can grant or deny them as it chooses--the standard
refrain is that they’re a matter of Congress’s “legislative grace.” INDOPCO, Inc.
v. Commissioner,
The big difference between deductions and COGS adjustments is timing.
See INDOPCO,
A. How Should Harborside Account for its COGS?
The Code tells taxpayers what to include in COGS. See, e.g., secs. 263, 263A, 471. But there’s more than one set of rules, and the issue here is which set applies to Harborside. The Commissioner thinks Harborside needs to follow the rules under section 471, but Harborside insists it’s subject to the rules of section 263A. We consider eaсh.
1. Section 471
Section 471 was in place when Congress enacted section 280E. It empowers the Commissioner to write regulations that govern how taxpayers account for inventories. See sec. 471. This the Commissioner did--with separate regulations for resellers and producers. See secs. 1.471-3(b) and (c), 1.471-11,
Income Tax Regs.
The regulations tell resellers to use as their COGS the price they pay for inventory plus any “transportation or other necessary charges incurred in acquiring possession of the goods.” Sec. 1.471-3(b), Income Tax Regs. The regulations for producers are more complex. Producers must include in COGS both the direct and indirect costs of creating their inventory. See secs. 1.471-3(c), 1.471-11, Income Tax Regs. The regulations tell producers to capitalize the “cost of raw materials,” “expenditures for direct labor,” and “indirect production costs incident to and necessary for the production of the particular article, including * * * an appropriate portion of management expenses.” Sec. 1.471-3(c), Income Tax Regs. Direct and indirect production costs are further explained in section 1.471-11(b), Income Tax Regs.
In their current forms, section 471 and its regulations also direct taxpayers to section 263A for additional rules.
2. Section 263A
Congress enacted section 263A in 1986. TRA sec. 803. That section instructs both producers and resellers to include “indirect” inventory costs in their COGS. Sec. 263A(a)(2)(B), (b); sec. 1.263A-1(a)(3), (c)(1), (e), Income Tax Regs. It also broadens the definition of indirect costs for both types of taxpayers. Compare sec. 1.263A-1(e)(3), Income Tax Regs., with sec. 1.471-11, Income Tax Regs. Congress thought this would treat taxpayers more fairly. S. Rept. No. 99- 313, at 140 (1986), 1986-3 C.B. (Vol. 3) 1, 140. It also thought this would do a better job of matching COGS adjustments to the years in which taxpayers realized the related income. Id.; see also Office of the Sec’y, Dep’t of the Treasury, 1 Tax Reform for Fairness, Simplicity, and Economic Growth: Treasury Department Report to the President 126-28 (1984).
These sections are also about timing. A business that could immediately deduct indirect costs under section 471 now has to treat those costs as capital expenditures and wait until it realizes related income to adjust for them. In a sense Congress is taking away some current deductions but allowing them in later years, renamed COGS. It is legislative grace deferred, but not denied.
Most business don’t like this. They’d rather have a deduction now than
increased COGS later. See, e.g., Frontier Custom Builders, Inc. v. Commissioner,
Except that maybe it’s still never. In 1988 Congress amended section 263A(a)(2), adding flush language that says: “Any cost which (but for this subsection) could not be taken into account in computing taxable income for any taxable year shall not be treatеd as a cost described in this paragraph.” TAMRA sec. 1008(b)(1). The regulations show that “cost” here means expenses that would otherwise be deductible. See sec. 1.263A-1(c)(2), Income Tax Regs. In their explanation of how section 263A(a)(2)’s flush language works, the regulations point out that if a business meal is entirely attributable to the acquisition or production of inventory, the taxpayer capitalizes only 80% of it because section 274(n), at that time, limited business meal deductions to 80% of their “cost” (which the section itself calls an “expense”, see sec. 274(n)); the taxpayer doesn’t get to capitalize the whole meal and escape the 80% limitation on the deduction, sec. 1.263A-1(c)(2)(i), Income Tax Regs. So if something wasn’t deductible before Congress enacted section 263A, taxpayers cannot use that section to capitalize it. Section 263A makes taxpayers defer the benefit of what used to be deductions--it doesn’t shower that as grace on those previously damned.
3. Harborside’s Argument
Can Congress get away with this? Harborside argues that limiting its COGS to “only the actual cost used to purchase inventory” violates the Sixteenth Amendment. Its theory is that section 263A represents the most accurate tax- accounting method for calculating COGS and that not letting marijuana dispensaries use it forces them to pay tax on more than their gross income. In other words, Harborside thinks section 263A somehow defines COGS for constitutional purposes.
That’s wrong. The Sixteenth Amendment’s meaning didn’t change when
Congress enacted section 263A. See U.S. Const. art. V (providing only method
for changing constitution). Section 471 wasn’t found unconstitutional during the
many decades when it was the only means of calculating COGS, and it wouldn’t
be unconstitutional now if Congress repealed section 263A. The Constitution
does limit Congress to taxing only gross income, and courts have consistently
held--including in cases Harborside cites--that gross income is gross receipts
minus
direct
costs. See Reading,
Harborside compares itself to the taxpayer in Anderson Oldsmobile, but that case doesn’t help it. There the taxpayer paid more for its inventory than since- repealed federal price controls allowed, and the Commissioner tried to limit the taxpayer’s COGS to the highest legal price. Id. at 903. The court held that because Congress can tax only gross income, the taxpayer was entitled to a COGS adjustment for the actual amount it paid for its inventory even though that amount was illegally high. Id. at 903, 905, 909.
As Harborside correctly points out, Anderson Oldsmobile says that statutes can’t let the Commissioner tax more than gross income. Id. at 905. But that’s not what’s happening here. Unlike Anderson Oldsmobile, where the Commissioner
wanted to use a statute to deny the taxpayer a COGS adjustment for part of its direct cost of purchasing inventory, these cases find the Commissioner saying only that Harborside can’t use section 263A to capitalize indirect costs that it wouldn’t otherwise be able to deduct. Harborside still gets to do exactly what the taxpayer in Anderson Oldsmobile did: calculate its gross income by subtracting the direct cost of its inventory from its gross receipts. See id. at 905.
What Anderson Oldsmobile really holds is that taxpayers can adjust for
COGS whether or not their direct costs are legal. See id. at 903; see also
Pittsburgh Milk Co.,
The section 263A capitalization rules don’t apply to drug traffickers. Unlike most businesses, drug traffickers can’t capitalize indirect expenses beyond what’s listed in the section 471 regulations. Section 263A expressly prohibits capitalizing expenses that wouldn’t otherwise be deductible, and drug traffickers don’t get deductions. Because federal law labels Harborside a drug trafficker, it must calculate its COGS according to section 471.
B. Is Harborside a Producer or a Reseller?
Because the section 471 regulations have different rules for resellers and producers, how Harborside calculates its COGS depends on which type of taxpayer it is. Harborside was without question a reseller of the marijuana еdibles and non-marijuana-containing products it bought from third parties and sold at its facility. But the situation is more complex for the marijuana bud it sold. Harborside insists it produced this marijuana and can include in its COGS the indirect inventory costs that section 1.471-3(c), Income Tax Regs., describes. The Commissioner says Harborside is a reseller and, under section 1.471-3(b), Income Tax Regs., it can include only its inventory price and transportation costs.
1. What Does “Produce” Mean?
To sort this out we first need to know what “produce” means. The
Commissioner, citing a Court of Claims case, says that under section 471
“production” means “manufacturing”. See Heaven Hill Distilleries, Inc. v. United
States,
Harborside at least points us to something more recent, the Ninth Circuit
case, Suzy’s Zoo v. Commissioner,
Although Suzy’s Zoo is about section 263A, it’s useful for construing
section 471’s regulations which, like section 263A’s regulations, provide different
methods оf accounting for inventory that’s “purchased” or “produced” but don’t
define those terms. See sec. 1.471-3(b) and (c), Income Tax Regs. We think
“produce” should mean the same thing in section 471 as it does in section 263A.
We also think we should follow the Ninth Circuit’s reasoning in a case appealable
to that court. See Golsen,
In Suzy’s Zoo, the taxpayer, a greeting-card company, designed images and
sent them to a contract printer who did color separations, made proofs, and printed
them using its own materials. A trucking company then picked up the prints and
took them to a finisher. The finisher cut and folded the prints into greeting cards
and returned them to the taxpayer. The printer and the finisher each bore the risk
of loss while they had the materials. Suzy’s Zoo,
We held--and the Ninth Circuit affirmed--that the taxpayer was a “producer”
because it retained title to the items throughout the contract-production process.
Id. at 877, 880. Citing regulations under section 263A, the court said: “The only
requirement for being a ‘producer’ * * * is that the taxpayer be ‘considered an
owner of the property produced,’” that “ownership is ‘based on all of the facts and
circumstances,’” and that “[a] taxpayer may be considered an owner of property
produced, even though the taxpayer does not have legal title to the property.” Id.
at 880 (citing section 1.263A-2(a)(1)(ii)(A), Income Tax Regs.). A taxpayer can
be a “producer”, moreover, even if it uses contract manufacturers to do the actual
production. Id. at 878 (citing section 263A(g)(2)). The Ninth Circuit explained
that achieving section 263A’s purpose of treating all taxpayers fairly required a
broad construction of “produce”. Id. at 879; see also Von-Lusk v. Commissioner,
“Produce” is therefore broader than “manufacture”. That’s also evident from the Code and regulations. We saw that already in section 263A(g)(1) and section 1.263A-2(a)(1)(i), Income Tax Regs. See supra pp. 58-59. The section 471 regulations also show that “production” and “manufacturing” are distinct, if related, concepts. Section 1.471-11, Income Tax Regs., discusses “production” costs, but refers in several places to costs “incident to and necessary for production or manufacturing,” a construction implying that the two terms are not identical, even if they are closely related and receive identical tax treatment. [24] For purposes of section 471, production turns on ownership--ownership as determined by facts and circumstances, not formal title.
2. Did Harborside Own What Its Growers Grew?
In finding that Suzy’s Zoo was a producer, the Ninth Circuit emphasized the
“degree of control * * * [the taxpayer] exercise[d] over the manufacturing
process.” Suzy’s Zoo,
But there was more to Suzy’s Zoo. There the taxpayer acquired ownership
when it first designed the characters because that was the most important step and
the one that required the most skill and expertise. Suzy’s Zoo,
Harborside, unlike Suzy’s Zoo, see id.; Suzy’s Zoo,
This was not the type of contract-manufacturing arrangement we saw in
Suzy’s Zoo,
This leaves only the issue of whether Harborside owes accuracy-related penalties under section 6662(a). We will address this issue in a separate opinion.
Notes
[1] We consolidated the cases at docket numbers 29212-11, 30851-12, and 14776-14 for trial, briefing, and opinion.
[2] On November 8, 2016, California voters adopted Proposition 64, which made recreational marijuana use legal under California law. See Cal. Health & Safety Code sec. 11362.1 (West 2017).
[3] The Court suspects, but makes no finding, that this may be why repurposed beer-marketing material--“This Bud’s for you”--seems to be common where marijuana is sold.
[4] CBD is the abbreviation for cannabidiol, a potent antiinflammatory compound.
[5] THC stands for tetrahydrocannabinol, the compound in marijuana believed to be responsible for providing a euphoric effect, or “high”, as users call it.
[6] “Dabbing” means heating products that contain marijuana so as to create an intoxicating vapor. It may or may not have a connection to the strange fad among the young that seems to consist of pointing to the sky with one arm while putting one’s face in the crook of the other arm while seeming to sneeze or sniff.
[7] The IRS has determined that a marijuana dispensary generally cannot
qualify as a tax-exempt organization under section 501(c)(3) because it is engaged
in what federal law regards as a criminal enterprise and thus is not operated
exclusively for charitable purposes. Rev. Rul. 75-384, 1975-
[8] California laws decriminalizing medical marijuana specifically stated that they did not “authorize any individual or group to cultivate or distribute cannabis for profit.” Cal. Health & Safety Code sec. 11362.765(a) (West 2007).
[9] This is not a typo. It’s Harborside’s pun.
[10] Title 21 U.S.C. section 841(a)(1) (2012) states that “it shall be unlawful for any person knowingly or intentionally * * * to manufacture, distribute, or dispense, or possess with intent to manufacture, distribute, or dispense, a controlled substance.”
[11] 21 U.S.C. section 856(a)(1) states that it shall be unlawful to “knowingly open, lease, rent, use, or maintain any place, whether permanently or temporarily, for the purpose of manufacturing, distributing, or using any controlled substance.”
[12] The MMPA also set per-person quantity limits for harvested marijuana
and marijuana plants, although the California Supreme Court invalidated these as
impermissible amendments to the CCUA. People v. Kelley,
[13] Note as well that these appropriations riders limit DOJ prosecutions of activity that would be legal under medical -marijuana laws. Thirty-three states now allow medical marijuana use: Alaska, Arizona, Arkansas, California, Colorado, Cоnnecticut, Delaware, Florida, Hawaii, Illinois, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, Missouri, Montana, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, Utah, Vermont, Washington, and West Virginia. Nat’l Conference of State Legislatures, State Medical Marijuana Laws, Tbl. 1 (last updated Nov. 8, 2018), http://www.ncsl.org/research/health/ state-medical-marijuana-laws.aspx. So do the District of Columbia, Guam, and Puerto Rico. Id. Thirteen states permit medical use of some low-potency marijuana products: Alabama, Georgia, Iowa, Indiana, Kentucky, Mississippi, North Carolina, South Carolina, Tennessee, Texas, Virginia, Wisconsin, and Wyoming. Id. Tbl. 2. Alaska, California, Colorado, Maine, Massachusetts, Michigan, Nevada, Oregon, Vermont, Washington, the District of Columbia, and the Northern Mariana Islands have repealed bans on recreational marijuana use. Id. Tbl. 1. No caselaw on how these appropriations riders will affect federal enforcement of federal law in these states has yet emerged.
[14] Other questions that affect a decision about whether two claims share a
single identity are whether: (1) “rights or interests established in the prior
judgment would be destroyed or impaired by prosecution of the second action;”
(2) “substantially the same evidence is presented in the two actions;” and (3) “the
two suits involve infringement of the same right.” Cent. Delta Water Agency, 306
F.3d at 952 n.11 (quoting Fund for Animals,
[15] We note that this part of Harborside’s brief repeats verbatim part of the taxpayer’s brief in Olive.
[16] When cаnons of construction compete with one another, we must decide which is most appropriate under the circumstances. See Antonin Scalia & Bryan A. Garner, Reading Law: The Interpretation of Legal Texts 59 (2012).
[17] The seventh, eighth, and ninth editions of Black’s Law Dictionary don’t define “consisting” at all. See Black’s Law Dictionary 303 (7th ed. 1999); Black’s Law Dictionary 327 (8th ed. 2004); Black’s Law Dictionary 350 (9th ed. 2009). The tenth edition defines “consisting of,” but only for the specialized purposes of patent law. Black’s Law Dictionary 373 (10th ed. 2014).
[18] See OED, History of the OED, http://public.oed.com/history-of-the-oed/ (last visited Nov. 2, 2018).
[19] See, e.g.,William Shakespeare, The Merchant of Venice act 3, sc. 3 (“The duke cannot deny the course of law: / For the commodity that strangers have / With us in Venice, if it be denied, / Will much impeach the justice of his state; / Since that the trade and profit of the city / Consisteth of all nations” -- Venice being open to foreign trade, or depending on foreign trade, but not literally trading with every nation in the world.)
[20] The Code is in good company. Shakespeare appears to use “consists of” both ways in a single exchange: Sir Toby Belch: * * * Does not our life consist of the four elements? Sir Andrew Aguecheek: Faith, so they say; but I think it rather consists of eating and drinking. Sir Toby Belch: Thou’rt a scholar; let us therefore eat and drink. (continued...)
[20] (...continued) William Shakespeare, Twelfth Night act 2, sc. 3. The four elements are an exhaustive list, but eating and drinking aren’t all of life, even for Sir Andrew.
[21] Harborside argues that “the price for these services was rolled into the price of the cannabis.”
[22] In Olive,
[22] (...continued) claimed expenses for each year we considered were under $500,000. In contrast, Harborside had $5 million-$25 million in total revenue during each of the years at issue.
[23] A simple example illustrates the difference. If in year 1 a taxpayer incurs a deductible expense of $100, he can reduce his taxable income for year 1 by $100. If in year 1 he instead buys 100 units of inventory for $100 and manages to sell 10 of those units per year, he has to take a $10 COGS adjustment in year 1, a $10 adjustment in year 2, and so on, through year 10, when he runs out of inventory. In each case, the taxpayer reduces the amount of income he’s taxed on by a total of $100. The difference is that he recovers the entire deductible expense in year 1, but recovers his inventory cost as he sells the inventory, which in this example means he doesn’t get the full $100 back until year 10.
[24] The heading of section 1.471-11, Income Tax Regs., is “Inventories of
Manufacturers,” but this doesn’t change our analysis of its text. Statutory titles
and headings are useful when interpreting ambiguous words or phrases, but “they
cannot undo or limit that which the text makes plain.” Bhd. of R.R. Trainmen v.
Baltimore & Ohio R.R. Co.,
[25] DeAngelo said he never sued anyone for breach of contract because “the possibility o[f] prevailing on contract disputes in something that involves a controlled substance is slim and would be expensive.”
[26] Harborside did have a “processing room.” See supra p. 8. But the “processing” that went on there--reinspection, packaging, and labeling--fall within the category of “purchasing, handling, and storage” that resellers do without losing their character as resellers. See sec. 1.263A-3(c), Income Tax Regs.