Will the cannabis tax revolt succeed?

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There are about 38,000 active licensed cannabis businesses in the United States. As of this summer, eleven of the biggest owed more than $2.3 billion in federal income tax combined.

Based on my personal experience as a tax expert, most of the smaller companies are in no better shape. The burden imposed by Section 280E of the tax code is crushing everyone in the sector.

However, a revolt is brewing.

Big and little, an increasing number of cannabis companies are filing tax returns claiming they are not obligated to pay all the federal tax that the IRS thinks they owe.

With an unknown but almost certainly large number of companies refusing to pay and significant sums involved, it’s fair to call this a “cannabis tax revolt.”

But will this resistance succeed? The outcomes of past tax uprisings in America provide some clues.

Tax resistance throughout U.S. history

The first tax revolt in the United States came early in our nation’s history. In 1791, western Pennsylvania farmers refused to pay an excise tax on distilled spirits, intended to raise cash to pay off the young country’s Revolutionary War debt. President George Washington in 1794 personally led federal troops into Pennsylvania to suppress the Whiskey Rebellion, which quickly collapsed.

It is interesting to note that only two ringleaders were convicted of crimes and both received pardons. It’s also interesting to note that the public supported the government’s suppression. Meanwhile, the western farmers continued to refuse to pay the tax until its 1802 repeal.

Two hundred years later, the owner of an insurance agency inspired another tax revolt.

In a series of best-selling books, Irwin Schiff argued the federal income tax, introduced by the 16^th Amendment in 1909, was unconstitutional. This was clearly a populist revolt: Schiff was a libertarian and so were many of his thousands of followers.

He repeatedly lost in court and died in a hospital prison, but it took the IRS a long time to stamp this one out. In 2003, the Internal Revenue Service identified 5,000 returns filed by Schiff’s followers in which they claimed not to owe a combined $56 million.

In the 1990s, thousands of taxpayers filed returns claiming they were owed a “Black Inheritance Tax Refund” based on the estimated value of 40 acres and a mule – believed to have been authorized by the government to be given to former slaves after the Civil War.

The IRS admitted to mistakenly paying out more than $30 million in refunds in 2002 and subsequently went to great lengths to publicize the refund as fraudulent.

There have been other large-scale efforts at tax avoidance, but they have all ended the same way: the taxpayers in revolt lost.

And probably so it will be with the cannabis tax revolt.

What would victory look like in a cannabis tax revolt?

Unlike past tax rebels, many of the cannabis taxpayers have an endgame in mind where they do pay up, but by settling with the IRS for less than the full amount owed.

They point to the 2022 Harborside settlement in which the IRS agreed to accept much less than the $22 million it claimed a California cannabis company owed – and to accept payments over a period of 10 years.

However, Harborside had a strong case that it could not afford to pay the full amount and would have to close its doors and throw a number of people out of work if a lenient payment plan was not accepted.

Furthermore, most observers overlook a crucial element of the Harborside settlement: the schedule for repayment and amount to be repaid was adjusted every two years, so if Harborside ever made any money  it would have to pay much of the profit to the IRS. (Spoiler: it didn’t; StateHouse Holdings, Harborside’s later iteration, went broke and entered receivership.)

Another illusory hope is for a retroactive change in the tax law, meaning that Section 280E would not apply for past years and the tax liability from 280E would be erased – relief possibly brought about by elusive marijuana rescheduling, or the challenge to federal marijuana prohibition recently appealed to the Supreme Court.

But the Treasury Department has always strongly resisted retroactive changes in the tax law, and there have been very few significant retroactive changes.

Taxpayers rely on the law in effect at the time of filing, and that reliance interest is one of the fundamentals of our “voluntary compliance” income tax system.

Cannabis companies will have to pay the taxman

Another possibility that some have raised is a settlement program.

In past settlement programs, taxpayers who voluntarily came forward could repay the tax owed – or sometimes less than the full tax owed – and not be subject to penalties or interest.

The most recent example is the employee retention credit settlement program. Under this program, taxpayers that voluntarily disclosed improper employee retention credit claims were allowed to repay 85% of the credit they received and were shielded from penalties and interest.

But an 85% repayment offer wouldn’t help the cannabis industry. Too many cannabis businesses cannot possibly repay those amounts. This is especially true for almost all of the largest cannabis companies.

The truth of the matter is that there is no fully relevant example of this type of tax revolt – that is, where full payment of the tax owed would eviscerate an industry.

The cannabis tax revolt is one of a kind, and the outcome is unknown.

James B. Mann served as a deputy assistant attorney general at the U.S. Department of Justice’s Tax Division before becoming the senior general corporate partner at Greenspoon Marder. Responding to the lack of sophisticated tax advice for cannabis operators, his practice now centers on planning and audit work for the cannabis industry.