Congress’s recent embrace of research into medical marijuana and cannabidiol probably won’t fall prey to the restriction on deductions and credits tormenting state-legal pot businesses, according to cannabis tax specialists.
In December 2022 President Biden signed the Medical Marijuana and Cannabidiol Research Expansion Act into law. The law imposes a 60-day deadline for the U.S. attorney general to act on applications for marijuana research by approving them or demanding more information.
The act is meant to increase research involving medical and commercial uses for marijuana through agencies including the Drug Enforcement Administration, the National Institutes of Health, and the Food and Drug Administration.
Psilocybin, another Schedule I drug that states are starting to legalize, has also been making headlines for its potential as an effective mental health treatment.
But section 280E denies both tax deductions and credits — which would include the section 41 research credit — to businesses engaged in trafficking Schedule I drugs like marijuana as prohibited by federal law.
Does that mean the research universities and pharmaceutical companies that do drug and health research could face tax difficulties if they start or increase marijuana research projects?
The question highlights the importance of the definition of trafficking, and most institutional researchers will probably avoid that danger and thus section 280E, several cannabis tax specialists told Tax Notes.
Navigating Trafficking
Marc Claybon of Crowe LLP said that while section 280E certainly applies to licensed marijuana dealers, he hasn’t seen the IRS assert the provision against pure research companies investigating cannabidiol. There is some uncertainty regarding the breadth of “trafficking” under section 280E, so companies doing research should be careful to avoid the selling side of the business, he said.
If they keep their hands off sales, researchers will have strong cases against the application of section 280E, Claybon said. But one more wrinkle could emerge if a research business enters into a profit-sharing arrangement with a licensed dealer, he noted. That might cross the line into trafficking for the researcher, he said.
On the other hand, it would be unfortunate if the IRS started asserting section 280E in cases of medical research involving marijuana and psilocybin, in light of the potential uses for those substances, Claybon added.
Jennifer Benda of Holland & Hart LLP noted that courts have generally restricted trafficking under section 280E to activities like distribution and manufacturing.
The definition of trafficking might be ambiguous, but it’s a public policy question on which the tide is shifting, as demonstrated by Supreme Court Justice Clarence Thomas’s recent statement in a case challenging an IRS marijuana summons, according to Benda.
Thomas questioned the continuing validity of Gonzales v. Raich, 545 U.S. 1 (2005), in which the Court determined that the federal marijuana prohibition is compatible with the commerce clause of the Constitution.
Research authorizations granted by the DEA could provide another protection for researchers engaged in marijuana or psilocybin projects, Benda suggested. Pharmaceutical companies already perform research on Schedule I substances with DEA permission, and that permission negates the federal illegality condition in section 280E, she said, adding that she also hasn’t seen the IRS assert the prohibition against pure researchers.
Mike Goral of Armanino LLP said he expects large entities that regularly do substantial research as part of their normal operations, like universities and pharmaceutical companies, to receive some deference, and the 2022 bill contemplates that.
However, private cannabis companies with their own research divisions may have more complex questions about whether those divisions are trafficking and subject to section 280E, Goral said. The regulations and other implementation of the new law could be particularly important to them, he said.
Keep ‘Em Separated
Goral’s point alluded to one of the foundational marijuana tax precedents, Californians Helping to Alleviate Medical Problems Inc. v. Commissioner, 128 T.C. 173 (2007) (CHAMP).
In CHAMP the Tax Court determined that a taxpayer had two separate lines of business — selling marijuana and providing counseling services — for purposes of section 280E. The denial operates on a trade or business level, so the deductions from the counseling business survived.
Benda said a separate research business should be more credible if it has revenue separate from any trafficking activity. Institutional researchers like universities and big pharmaceutical companies have lots of non-trafficking revenue, so they should easily be able to silo off any marijuana research just in case the IRS takes a hard line, she said.
Any taxpayer attempting that sort of business separation should pay careful attention to the Tax Court’s discussion in CHAMP and keep separate books for separate entities with separate employees, according to Claybon. Taxpayers researching cannabidiol already have taken those lessons to heart, he said.
A taxpayer that is not growing, selling, or distributing marijuana should be able to avoid section 280E, Claybon said. He found it interesting that there haven’t been many plant-touching businesses doing material research over the years, though some research companies do handle the plants, he said.
Even taxpayers separated from marijuana plants should be careful with research that could be seen as facilitating trafficking activity, according to Goral. The research subject may matter, and the IRS will likely look more generously on research into new medical treatments than investigations into how to increase crop yields. The latter could be seen as part of the trafficking subject to section 280E, he said.
Funded Research
A private marijuana company funding research performed by an unambiguous researcher — perhaps a university — could be another way to keep the research activity and the trafficking separate, Goral said. However, a nonprofit researcher might be less interested in the section 41 credit, he noted.
Claybon agreed that the basic section 280E analysis shouldn’t change for funded research and that the research company will probably have that activity accepted by the IRS as its trade or business rather than marijuana trafficking.
Licensing revenue and entities created to hold intellectual property can add to the complications, according to Benda. However, if the researcher is able to use the section 41 credit, maybe the parties could price that into their contract, she said.