Cannabis businesses can potentially secure tax relief from Section 280E through two converging developments: ongoing litigation in the Ultra Health tax case and the anticipated federal rescheduling of marijuana to Schedule III. To capitalize on these shifts, businesses should file protective refund claims immediately for open tax years (like 2022) before statutes of limitations expire, preserving their right to retroactive deductions if the law changes in their favor.
Key Takeaways:
- Litigation Impact: The Ultra Health case could allow retroactive deductions for prior tax years.
- Rescheduling Effect: Moving marijuana to Schedule III would end 280E restrictions going forward.
- Protective Claims: Filing now preserves rights to refunds for years like 2022 before deadlines pass.
- Critical Timing: Statutes of limitations are expiring; immediate action is required.
Section 280E of the Internal Revenue Code refers to a federal tax provision that prohibits businesses trafficking in Schedule I or II controlled substances from deducting standard business expenses. For the cannabis industry, this has meant a crushing tax burden. However, recent legal and regulatory shifts are creating a potential pathway for significant relief, both prospectively and retroactively.
The Convergence of Litigation and Rescheduling
Two major developments are currently reshaping the tax landscape for cannabis operators. First, the U.S. Tax Court is weighing the case of New Mexico Top Organics, Inc. d/b/a Ultra Health v. Commissioner. A central question in this litigation is whether a change in marijuana's federal scheduling could be applied retroactively. If the court rules in favor of the taxpayer, it could unlock deductions that were previously disallowed under Section 280E for past years.
Second, the federal government is moving toward rescheduling marijuana from Schedule I to Schedule III. If finalized, this administrative change would automatically render Section 280E inapplicable to state-legal cannabis businesses moving forward, allowing them to deduct ordinary and necessary expenses just like any other industry.
Why Protective Refund Claims are Essential Now
While future relief looks promising, businesses must act now to safeguard potential refunds for past years. This is where protective refund claims come into play. A protective claim is a formal request filed with the IRS to preserve a taxpayer's right to a refund pending the outcome of a specific contingency—in this case, the Ultra Health ruling or a retroactive rescheduling decision.
Filing a protective claim is critical because of the strict statutes of limitations on tax refunds. Generally, a claim must be filed within three years of filing the original return or two years from the time the tax was paid. For many businesses, the window for the 2022 tax year is rapidly closing.
Steps to File a Protective Claim
To effectively file a protective claim, businesses must:
- File Before Deadlines: Ensure the claim is submitted before the statute of limitations for the specific tax year expires.
- Identify Specifics: Clearly state the tax years and estimated refund amounts involved.
- State the Legal Basis: Cite the contingent event (e.g., the Ultra Health litigation or rescheduling) that would validate the refund.
Corporations typically use Form 1120X, while pass-through entities will need to use the appropriate amended return forms depending on their structure. It is vital to sign, substantiate, and file these claims using a method that proves timely delivery.
Bottom Line for Operators
The combination of the Ultra Health case and Executive Order 14370 has opened a narrow but potentially lucrative window for tax recovery. Cannabis business owners and investors should immediately assess their open tax years and file protective claims to ensure they don't miss out on what could be substantial refunds if the legal tides turn in their favor.
