Justice Thomas, a Medical Marijuana Dispensary, and the Limits of the Sixteenth Amendment

Of the 6,000 to 8,000 cases appealed to the U.S. Supreme Court each year, fewer than a hundred are accepted. On June 28, 2021, the Court issued its weekly order list, including denials of 129 appeals submitted to it. In nearly all the denials, the Court simply states the appeal has been denied with no further comment. Occasionally a justice or two will note that they would have heard the case. Rarely, a justice will write a long statement taking their colleagues to task for declining to hear a case.

Justice Clarence Thomas did exactly that with one case denied on June 28, Standing Akimbo v. United States. The case had escaped the notice of most observers: no amicus curiae (friend of the court) briefs were filed urging the Court to hear it, and the Court evidently wrestled with it since it appeared on the agenda of 13 successive private conferences of the justices before the denial was announced. Justice Thomas’s five-page statement makes sure it won’t be forgotten.

Standing Akimbo involved a Colorado medical marijuana dispensary challenging section 280E of the tax code, a provision dating from 1982 that denies ordinary business deductions (such as rent, employee pay, etc.) to any business selling drugs on Schedule I or II of the Controlled Substances Act (which includes marijuana). The IRS demanded sales information from the business and the business sued to quash the IRS summons, arguing their business is legal under Colorado law. The trial judge and the Tenth Circuit Court of Appeals sided with the IRS, and Standing Akimbo only then belatedly raised a constitutional challenge to section 280E, arguing that denying their deduction for business expenses means the tax is beyond Congress’s Sixteenth Amendment power to tax “incomes.”

First, Justice Thomas notes that the owners of Standing Akimbo faced “traps for the unwary,” as Colorado law allows the operation of a medical marijuana business, the U.S. Department of Justice has adopted a policy of non-interference, Congress has prohibited federal funds to be spent on preventing state implementation of medical marijuana laws, but the IRS continues to enforce section 280E which operates to discriminate against marijuana businesses. 

Second, Thomas observes that in Gonzales v. Raich (2005), where the Court upheld federal regulation of the intrastate sale or possession of marijuana (and in which Thomas himself dissented), the justification given by the majority was that no exception could be allowed to a “watertight nationwide prohibition” of marijuana. Now, Thomas says, federal policy is a “half-in, half-out regime that simultaneously tolerates and forbids local use of marijuana,” undermining the rationale supporting the federal ban. While Thomas has been consistent for years in this position, his observation is a pointed one (and one that caught notice in the press).

Third, on Standing Akimbo’s claim that taxing their gross income is beyond the power of the Sixteenth Amendment, Thomas (in a footnote) gently states that the argument “implicates several difficult questions, including the differences between ‘direct’ and ‘indirect’ taxes and how to interpret the Sixteenth Amendment.” Thomas agrees that this case, with an incomplete record, isn’t the right one “to delve into these questions,” but that he mentions it at all is a hint that he sees something worth litigating in the future. Thomas cites two cases in his footnote: Taft v. Bowers (1929), which held that capital gains are a type of income and not a non-taxable growth in the value of the capital; and NFIB v. Sebelius (2012), which summarized the Court’s view that direct taxes include capitation taxes, income taxes, real estate taxes, and taxes on personal property. A third he might have mentioned is from the D.C. Circuit Court of Appeals, Murphy v. IRS, which in 2006-07 first held that compensation for emotional distress was not income under the Sixteenth Amendment, and then reversed themselves and held that income covers “all economic gains.”

Justice Thomas is correct that the Supreme Court has never been clear on the dividing line between direct and indirect taxes, which matters because the Constitution, as amended by the Sixteenth Amendment, bans unapportioned direct federal taxes other than the income tax. However, the precedents generally follow an economic standard that direct taxes are those in which the taxpayer bears the economic incidence of the tax; indirect taxes are those in which someone other than the taxpayer bears the economic burden of the tax. Direct taxes are on people or their property, such as income, property, or wealth taxes. Indirect taxes include customs duties, sales taxes, business taxes, or taxes on a particular event like estate or inheritance taxes. 

One case that may confront this issue is Moore v. United States, currently pending before the Ninth Circuit Court of Appeals. The case challenges the “deemed repatriation” tax passed as part of the 2017 tax bill, which imposed a one-time unapportioned tax on accumulated overseas business earnings. Prior to 2017, such earnings were taxed at the full corporate tax rate (35% plus state rates) when such income was brought back, or repatriated, to the United States. Post-2017, such earnings are generally exempt from tax, with the “deemed repatriation” tax of 8% (15.5% for cash assets) a one-time transition measure. The plaintiffs in Moore argue in part that it is a legal fiction to call these amounts “income,” as shareholders never received it, so it is really a tax on personal property accumulated in past years, and therefore an unconstitutional unapportioned direct tax. The trial court held that a tax on undistributed corporate earnings is a tax on income.

For their part, Standing Akimbo cited a part-concurring, part-dissenting opinion by three Tax Court judges in Northern California Small Business Assistants Inc., v. Commissioner of Internal Revenue, 153 T.C. No. 4 (October 23, 2019), where they wrote that section 280E’s denial of deductions operated more akin to a fine than a tax (and excessive one at that): “Because the Sixteenth Amendment gives Congress only the power to tax ‘incomes,’ Congress does not have the prerogative to disallow deductions to such an extent that the resulting tax fails to be a tax on ‘income…’ Even if deductions are indeed wholly matters of ‘legislative grace,’ I would hold that the application of section 280E results in the imposition of a ‘fine’ for purposes of the Eighth Amendment's excessive fines clause.”

In summary, while Standing Akimbo’s contention that section 280E violates both the Eighth and Sixteenth Amendments was not raised in time to allow it to be adjudicated, it does not mean that these arguments are without merit. Indeed, the potential veracity of these constitutional claims coupled with the current uncertainty as to the federal government's approach to state-level marijuana legalization makes it apparent that this is an issue that will come again before the Supreme Court. In doing so, such a case would also clarify whether federal taxing power has bounds.