Can Harborside Win Its Long Fight With the Feds?

Can Harborside Win Its Long Fight With the Feds?

Harborside can’t seem to catch a break. 

The cannabis company, which first opened its dispensaries to patients in California’s Bay Area more than a decade ago, has been fighting the federal government for years, most recently over a multimillion dollar tax bill that has its roots in a tug-of-war nearly as old as the shops themselves. Today, the company’s case is sitting in the US Court of Appeals for the Ninth Circuit, where the outcome has implications for the entire cannabis industry. 

And so it’s no surprise that this week, one of the largest cannabis industry groups, the National Cannabis Industry Association, has filed an amicus brief in the case, Harborside Health Center v. Commissioner of Internal Revenue. 

At the center of the tax dispute is a remnant from former President Ronald Reagan’s drug war efforts: Internal Revenue Code 280E, which, because cannabis remains illegal under federal law, essentially does not allow state-legal cannabis businesses to make the same deductions as other businesses (i.e. rent), therefore leading to a far higher tax rate than other businesses. (Read Cannabis Wire’s resource page on 280E for more context on its history and the uncertainties it creates in the industry today.)

“280E is incredibly detrimental to the entire cannabis industry, and is particularly hard on small businesses with limited access to capital,” Morgan Fox, NCIA’s media relations director, told Cannabis Wire. “This case could help level the playing field and give cannabis businesses a better chance at recovery and long-term success.”

Some history: Medical cannabis has been legal in California since 1996. Harborside’s issues with the IRS date back to a 2010audit. Harborside’s founder, Steve DeAngelo, like many others in the industry then, didn’t know, or at least said they didn’t know, the extent to which 280E applied to them. The following year, DeAngelo was looking at a bill of more than $2 million in back taxes related to the company’s Oakland dispensary.

DeAngelo told me in 2011, “What I fear is happening is that the IRS, or persons within the IRS, have decided to use the 280E provision as a way to accomplish through the back door what the Obama administration has promised not to do through the front door—i.e., close down medical cannabis dispensaries. I don’t think that we know the direction that the IRS is going right now, but certainly, if they choose to enforce the 280E provision bluntly, without sensitivity, it has the potential of closing down the entire legal cannabis industry in this country.”

Around the same time as the interview, the US Department of Justice was engaged in the single most sweeping nationwide crackdown in the industry’s history. (Read more about the crackdown on Cannabis Wire’s resource page on law enforcement efforts.) Northern California’s US attorney, Melinda Haag, in particular, was focusing on landlords, who could face federal charges for assisting activity that is illegal under federal law by allowing cannabis shops to operate on their property. Haag pushed civil forfeiture complaints against Harborside’s landlords, in Oakland and San Jose, and when Harborside’s Oakland landlord asked Harborside to leave in 2012, Harborside took the issue to court. The city of Oakland even came to Harborside’s defense.

At the time, when explaining the efforts against Harborside, Haag said, “The larger the operation, the greater the likelihood that there will be abuse of the state’s medical marijuana laws, and marijuana in the hands of individuals who do not have a demonstrated medical need.”

There’s a lot more to the case, but in any event, Harborside has been a sort of example for the feds for some time. 

Harborside won its battle over civil forfeiture complaints with the DOJ, but weeks later the company returned its focus to the tax fight. Owing millions in back taxes, from 2007 through 2012, Harborside challenged 280E in court, suing the IRS, in 2016. When the original decision came down against Harborside, in November 2018, the company potentially owed up to $36 million. By the time the final ruling was issued by the US Tax Court in October 2019, the number had come down to $11 million. In December, the company said it would appeal, with a focus on how the Court is interpreting which “cost of goods sold” cannabis companies can legally deduct under 280E. 

“There is an increasing realization that Section 280E as applied by the IRS is tax imposed without regard to income and violates the Sixteenth Amendment to the Constitution which requires that the federal tax must be measured by income, not sales. We remain hopeful that the Ninth Circuit will understand this,” Harborside’s DeAngelo said in a statement when the company announced its appeal.

The Sixteenth Amendment is also a focus in the National Cannabis Industry Association’s brief, which argues that 280E violates the Sixteenth Amendment “because it taxes more than income,” as well as the Eighth Amendment’s “excessive fines clause.” 

No decision is expected for months.

Editors’ Note: The upcoming decision will more specifically affect Patients Mutual Assistance Collective Corporation, which is doing business as Harborside Health Center; Patients Mutual Assistance Collective Corporation is owned by Harborside Inc., now a publicly traded company. Also, the Tax Court’s final ruling was specifically related to Harborside’s Oakland location, as another ruling is expected related to its San Jose location. 

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