Sections 199A and 280E: So Much In Common?

  • Both Code sections[1] end with a capital letter.
  • Both are in Subchapter B.
  • Both have to do with deductions.
  • Both treat certain types of businesses differently than others for no good reason.
  • Both feature separate/multiple trades or businesses tests.

 

It’s the last bullet that makes me wonder if or how §199A might influence the application of §280E in the future (assuming § 280E isn’t repealed and/or marijuana descheduled in the near term).

A Very (Very) Brief Obligatory Overview of §199A

The Tax Cuts and Jobs Act of 2017[2] reduced the corporate income tax rate from a maximum graduated rate of 35% to a flat 21%. In order to create some parity between the lower corporate rate and the rates applicable to pass-through forms of business, §199A was added. Section 199A provides an income tax benefit to investors in pass-through businesses (e.g., partnerships and S corporations). Non-corporate investors may (after navigating a minefield of thresholds and exclusions and re-inclusions and exceptions to exceptions) be eligible to claim a deduction of up to 20% of the “qualified business income” earned by such pass-through businesses (the “QBI Deduction”).

Separate Trade or Business Considerations

There are several interesting cases that opine whether a taxpayer is engaged in a “trade or business”. Often they revolve around the application of, or interplay between, §§162 and 212. However, if you’re in the legal marijuana industry (as opposed to gambling or investing your frozen bagel fortune) or you’re trying to make the most of the QBI Deduction, you may be more interested in whether you have two or more separate and distinct trades or businesses.

For the marijuana businesses it can be very helpful to ultimate profitability to have two separate trades or businesses, hopefully one of which does not consist of trafficking in a controlled substance. This is because, in one of the few taxpayer victories in testing §280, the CHAMP[3] court held that:

Section 280E and its legislative history express a congressional intent to disallow deductions attributable to a trade or business of trafficking in controlled substances. They do not express an intent to deny the deduction of all of a taxpayer’s business expenses simply because the taxpayer was involved in trafficking in a controlled substance. We hold that section 280E does not preclude petitioner from deducting expenses attributable to a trade or business other than that of illegal trafficking in controlled substances simply because petitioner also is involved in trafficking in a controlled substance.

To the extent that a marijuana business taxpayer can establish two bona fide trades or businesses, there is the possibility of deducting otherwise unallowable business expenses. So far few such marijuana business taxpayers have met the two separate trade or businesses bar.

Likewise, pass-through businesses with tainted service income will be looking to plan into a two separate trade or business scenario in order to qualify for §199A benefits. Treasury released final §199A regulations in February. The preamble makes clear that the existence of two or more separate trades or businesses is based on all of the facts and circumstances. The preamble further states that Treasury and the IRS expect that taxpayers claiming to have two or more trades or businesses will have separate or “separable” books and records—a thematic issue for taxpayer’s taking the separate trade or business position in published §280E cases.

Tying It Together

Until now, save for a couple of poultry farmers worried about accounting methods,[4] no taxpayers other than marijuana business taxpayers have flapped much about whether they have two separate trades or businesses. It seems likely that with §199A this issue will receive exponentially more attention and there will be more controversy, published cases, and administrative guidance. As a result, a more refined test will develop. The two or more trades or businesses guidance that will stem from §199A seems likely to influence two or more trades or businesses position in the §280E context—for better or worse.


[1] All references to sections herein are references to the Internal Revenue Code (the “Code”) or Treasury Regulations (the “Regs.”).

[2] An act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018, P.L. 115-97.

[3] Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner (CHAMP), 128 T.C. 173 (2007).

[4] Peterson Produce Company v. United States, 313 F.2d 609 (8th Cir. 1963); Burgess Poultry Market Inc. v. United States, 64-2 USTC 93 (1964).