Patients Mutual Assistance v. Cir

FOR PUBLICATION
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
PATIENTS MUTUAL ASSISTANCE No. 19-73078
COLLECTIVE CORPORATION, DBA
Harborside Health Center, Tax Ct. Nos.
Petitioner-Appellant, 29212-11
30851-12
v. 14776-14
COMMISSIONER OF INTERNAL
REVENUE, OPINION
Respondent-Appellee.
Appeal from a Decision of the
United States Tax Court
Argued and Submitted February 9, 2021
San Francisco, California
Filed April 22, 2021
Before: Andrew D. Hurwitz and Daniel A. Bress, Circuit
Judges, and Clifton L. Corker, * District Judge.
Opinion by Judge Bress
*
The Honorable Clifton L. Corker, United States District Judge for
the Eastern District of Tennessee, sitting by designation.
2 PATIENTS MUTUAL ASSISTANCE COLLECTIVE V. CIR
SUMMARY **
Tax
The panel affirmed the Tax Court’s decision on a petition
for redetermination of federal income tax deficiencies that
turned on whether a cannabis dispensary that purchases the
marijuana it resells and values its inventory using the cost
method of accounting must account for its inventory cost in
accordance with Treasury Regulation § 1.471-3(b).
Patients Mutual Assistance Collective Corporation, dba
Harborside Health Center (“Harborside”), is one of the
largest marijuana dispensaries in the country. For the years
at issue, Harborside was a not-for-profit corporation and
medicinal cannabis collective that operated a retail cannabis
dispensary under California state law. Harborside claimed
tens of millions of dollars in exclusions. The Commissioner
of Internal Revenue disallowed nearly all of them, then
issued notices of deficiency. On a petition for
redetermination of the deficiencies, the Tax Court ruled in
favor of the Commissioner, and this appeal followed.
Most corporations can claim deductions for “ordinary
and necessary expenses” that are “paid or incurred during the
taxable year in carrying on any trade or business.” I.R.C.
§ 162(a). However, otherwise allowed deductions are not
available to taxpayers who engage in certain activities that
Congress regards as unlawful, I.R.C. § 280E, including
trafficking in controlled substances like marijuana. The
panel first declined to consider the constitutional claim, not
**
This summary constitutes no part of the opinion of the court. It
has been prepared by court staff for the convenience of the reader.
PATIENTS MUTUAL ASSISTANCE COLLECTIVE V. CIR 3
raised in the Tax Court, that § 280E violates the Sixteenth
Amendment.
Harborside next argued that some of its expenditures,
even if they cannot be deducted under § 280E, can be
excluded from income as part of its inventory cost under
general inventory tax accounting rules. Rejecting
Harborside’s arguments that would have made more of its
costs excludible for tax purposes, the panel held that the Tax
Court did not err in concluding that Harborside’s inventory
cost is determined by Treas. Reg. § 1.471-3(b), which
applies to a purchaser and reseller of the products it sells.
The panel declined to consider Harborside’s argument,
not raised before the Tax Court, that the Tax Court should
have allowed at least some of Harborside’s claimed
exclusions as “necessary charges incurred in acquiring
possession of the goods” under Treas. Reg. § 1.471-3(b).
The panel therefore expressed no opinion on whether any of
Harborside’s claimed exclusions may have been properly
regarded as inventory costs under § 1.471-3(b), nor did it
address arguments made by amici curiae that Harborside did
not advance on appeal.
COUNSEL
James B. Mann (argued), Brooklyn, New York, for
Petitioner-Appellant.
Nathaniel S. Pollock (argued), Francesca Ugolini, and
Michael J. Haungs, Attorneys; T. Joshua Wu, Deputy
Assistant Attorney General; Richard E. Zuckerman,
Principal Deputy Assistant Attorney General; Tax Division,
United States Department of Justice, Washington, D.C.; for
Respondent-Appellee.
4 PATIENTS MUTUAL ASSISTANCE COLLECTIVE V. CIR
Charles C. Sipos and Lauren Watts Staniar, Perkins Coie
LLP, Seattle, Washington; Barak Cohen and Tre A.
Holloway, Perkins Coie LLP, Washington, D.C.; for Amicus
Curiae National Cannabis Industry Association.
Jennifer E. Benda, Hall Estill Hardwick Gable Golden &
Nelson P.C., Denver, Colorado, for Amici Curiae Marijuana
Industry Group and Cannabis Trade Federation Action.
OPINION
BRESS, Circuit Judge:
On its face, this tax case presents the technical issue
whether a cannabis dispensary that purchases the marijuana
it resells and that values its inventory using the cost method
must account for its inventory cost in accordance with
section 1.471-3(b) of the Treasury Regulations. But at its
core, this dispute reflects the latest attempt by a medical
marijuana retailer to ameliorate the significant tax
consequences Congress has prescribed for businesses that
Congress regards as trafficking in controlled substances.
Under federal law, those prohibited substances include
marijuana, even though some states have more recently
legalized its sale. This disharmony between federal and state
law produces the multi-million-dollar tax controversy before
us. Ultimately, we hold that the taxpayer’s arguments either
are without merit or were not preserved for our review. We
therefore affirm the Tax Court.
I
The taxpayer is Patients Mutual Assistance Collective
Corporation, one of the largest marijuana dispensaries in the
United States. It is a C corporation under federal tax law that
PATIENTS MUTUAL ASSISTANCE COLLECTIVE V. CIR 5
does business as Harborside Health Center. We refer to it as
“Harborside.” This appeal concerns Harborside’s corporate
income tax liabilities for its tax years ending July 31, 2007
through July 31, 2012. To understand Harborside’s
arguments, it is necessary to have some understanding of its
business.
Harborside operates a retail cannabis dispensary. For the
years at issue, Harborside was a not-for-profit corporation
and medicinal cannabis collective operating under
California laws governing medical marijuana operations.
See Cal. Health & Safety Code §§ 11362.765(a), 11362.768.
Consistent with California law, Harborside sold products
only to individuals who possessed a physician’s written
recommendation for medical marijuana. See id.§ 11362.5(d). Prospective members also had to sign a
cultivation agreement permitting other Harborside members
to grow marijuana on their behalf as part of the Harborside
collective.
Harborside sold several categories of products, including
“buds,” or cannabis flowers. Harborside purchased buds
from its patients-growers and did not grow any itself.
Would-be sellers brought buds to Harborside’s purchasing
office, where a Harborside employee would inspect and test
the buds for quality. If the buds were acceptable, the
employee negotiated a purchase price. Once Harborside
purchased the buds, it stored them in a secure vault and sent
a sample for third-party laboratory testing. If the results
were satisfactory, employees would reinspect, trim, weigh,
package, and label the buds in preparation for resale.
Harborside also purchased from nurseries marijuana
“clones,” i.e., “cuttings from a female cannabis plant that can
be transplanted and used to cultivate marijuana.” After
acquiring clones, Harborside stored, cared for, and
6 PATIENTS MUTUAL ASSISTANCE COLLECTIVE V. CIR
repackaged them before sale. Additionally, Harborside
purchased and resold other marijuana-containing products,
such as extracts and oils, which it purchased from other
marijuana collectives, as well as non-marijuana products
such as branded shirts and various marijuana-related
paraphernalia.
As a C corporation, Harborside pays corporate income
tax on its “taxable income.” I.R.C. § 11(a); see also id.
§ 1361(a)(2) (defining “C corporation”). 1 Taxable income
is determined through a multi-step process. A taxpayer first
computes its “gross income.” I.R.C. § 63(a). For a
“merchandising” business such as Harborside, gross income
includes the business’s “total sales, less the cost of goods
sold.” Treas. Reg. § 1.61-3(a). That “cost” is said to be
“excluded” from the taxpayer’s income. See Max Sobel
Wholesale Liquors v. Comm’r, 630 F.2d 670, 671 (9th Cir.
1980); see also Treas. Reg. § 1.162-1(a) (providing that
“[t]he cost of goods purchased for resale” is treated as an
exclusion from gross receipts).
Once a taxpayer has calculated its gross income, it
subtracts any “deductions,” such as ordinary and necessary
business expenses, to which it is entitled. I.R.C. §§ 63(a),
161; see, e.g., id. § 162(a). The remaining amount is the
taxpayer’s “taxable income.” Id. § 63(a). The regulations
further provide that no item shall be treated as a deductible
business expense “to the extent that it is used by the taxpayer
in computing the cost of property included in its inventory,”
1
Unless otherwise specified, all statutory and regulatory references
are to the Internal Revenue Code or the Treasury Regulations,
respectively codified as Title 26 of the United States Code and Title 26
of the Code of Federal Regulations.
PATIENTS MUTUAL ASSISTANCE COLLECTIVE V. CIR 7
because in that case the item is properly treated as an
exclusion. Treas. Reg. § 1.162-1(a).
A stylized example may be helpful to show how these
concepts work in practice. If a corporation purchased
100 domino sets for $6 each and resold them for $8 each, its
gross sales would be $800. It would then exclude cost of
goods sold of $600, resulting in gross income of $200. If the
corporation also paid wages of $50 and rent of $25, it would
seek to deduct those expenses under section 162(a), resulting
in taxable income of $125.
The tax consequences are markedly different, however,
if one is in the business of selling marijuana. Most
corporations can claim deductions for “ordinary and
necessary expenses,” such as employee salaries, rent, and
license fees, “paid or incurred during the taxable year in
carrying on any trade or business.” I.R.C. § 162(a). But
taxpayers may not take the otherwise allowed deductions
when they engage in certain activities that Congress regards
as unlawful. See, e.g., Max Sobel, 630 F.2d at 671. That
includes trafficking in controlled substances.
Section 280E is the relevant provision, and it states:
No deduction or credit shall be allowed for
any amount paid or incurred during the
taxable year in carrying on any trade or
business if such trade or business (or the
activities which comprise such trade or
business) consists of trafficking in controlled
substances (within the meaning of schedule I
and II of the Controlled Substances Act)
which is prohibited by Federal law or the law
of any State in which such trade or business
is conducted.
8 PATIENTS MUTUAL ASSISTANCE COLLECTIVE V. CIR
I.R.C. § 280E. Under federal law, marijuana is such a
controlled substance. See 21 U.S.C. § 812(c), sch. I(c)(10);
21 C.F.R. § 1308.11(d)(23); Olive v. Comm’r, 792 F.3d
1146, 1148 (9th Cir. 2015).
Harborside concedes it is subject to section 280E.
Nevertheless, on its tax returns for the years at issue,
Harborside claimed tens of millions of dollars in exclusions
for cost of goods sold and business expense deductions. The
Commissioner of Internal Revenue disallowed nearly all
those exclusions and deductions and issued Harborside
notices of deficiency showing over $29 million in tax
deficiencies for those years.
Harborside petitioned the Tax Court for redetermination
of the deficiencies. After Harborside provided additional
substantiation of its costs, the Commissioner agreed that
amounts Harborside paid its suppliers to purchase goods
were excludible. But he continued to deny Harborside’s
other claimed exclusions and all its claimed deductions.
After a three-day trial, the Tax Court ruled in favor of the
Commissioner. Patients Mut. Assistance Collective Corp. v.
Comm’r, 151 T.C. 176 (2018). That decision addressed a
range of issues, many of which Harborside does not raise on
appeal. The parties then agreed to stipulated decisions under
Tax Court Rule of Practice and Procedure 155 that identified
approximately $11 million in agreed-upon deficiencies.
According to the government, roughly $1 million of that
amount corresponds to the disallowed exclusions, with the
remainder due to the denied deductions.
This timely appeal followed. We have jurisdiction to
review the Tax Court’s decisions under I.R.C. § 7482.
PATIENTS MUTUAL ASSISTANCE COLLECTIVE V. CIR 9
II
On appeal, Harborside’s strategy is twofold: take out
section 280E as unconstitutional under the Sixteenth
Amendment and, if that fails, seek a more favorable ruling
on its exclusions, so that some of what it cannot deduct under
section 280E might instead be treated as cost of goods sold
excludible from gross receipts. We conclude that
Harborside’s various arguments must be rejected.
A
We begin with its constitutional challenge. In recent
years, cannabis businesses have tried to secure rulings
invalidating section 280E as unconstitutional. These efforts
have not been successful. The Tax Court recently rejected
the argument that section 280E violates the Eighth
Amendment’s Excessive Fines Clause. N. Cal. Small Bus.
Assistants Inc. v. Comm’r, 153 T.C. 65, 72 (2019) (reviewed
opinion). And the Tenth Circuit recently upheld section
280E against a Sixteenth Amendment challenge. Alpenglow
Botanicals, LLC v. United States, 894 F.3d 1187, 1201 (10th
Cir. 2018).
Reprising an argument similar to the one the Tenth
Circuit turned down, Harborside argues that the corporate
income tax, as modified by section 280E, is a “direct tax”
that taxes more than “incomes,” in violation of the Sixteenth
Amendment. The most immediate problem, however, is that
Harborside did not raise this constitutional challenge in the
Tax Court.
Although Harborside did mention the Sixteenth
Amendment in its Tax Court briefing, it did so only as part
of an unrelated constitutional avoidance argument.
Specifically, Harborside argued that the Commissioner’s
10 PATIENTS MUTUAL ASSISTANCE COLLECTIVE V. CIR
denial of exclusions under the uniform capitalization, or
UNICAP, rules of section 263A could render those rules
unconstitutional given that section 280E also disallows
deductions for those amounts. Before this court, however,
Harborside explicitly abandoned its section 263A argument,
and it points to no other occasion when it raised the Sixteenth
Amendment before the Tax Court. Nor did the Tax Court in
its extensive opinion address the Sixteenth Amendment
argument that Harborside asserts here.
“Absent exceptional circumstances, this court will not
consider an argument that was not first raised in the Tax
Court.” Sparkman v. Comm’r, 509 F.3d 1149, 1158 (9th Cir.
2007). In a previous case challenging section 280E on
constitutional grounds, we declined to consider the argument
because the taxpayer had not raised its challenge in the Tax
Court. See Canna Care, Inc. v. Comm’r, 694 F. App’x 570,
571 (9th Cir. 2017). Harborside provides no basis to treat
this case any differently. We therefore decline to consider
Harborside’s constitutional claim.
B
1
But just because Harborside is unentitled to deductions
does not necessarily mean it cannot take exclusions for some
of the amounts at issue. Section 280E does not purport to
deny to those taxpayers within its scope the ability to seek
exclusions that are available to other businesses. Patients
Mutual, 151 T.C. at 204; Alterman v. Comm’r, 115 T.C.M.
(CCH) 1452, 1460 (2018); Olive v. Comm’r, 139 T.C 19, 32,
38 (2012). Harborside therefore argues that some of its
expenditures, if they cannot be deducted, are actually part of
its inventory cost under the general inventory tax accounting
rules of section 471.
PATIENTS MUTUAL ASSISTANCE COLLECTIVE V. CIR 11
We pause to note the peculiarity of Harborside’s
position, which is a function of the world that section 280E
creates. As the Tax Court explained, all else being equal,
taxpayers generally prefer deductions over exclusions.
Patients Mutual, 151 T.C. at 205 & n.23, 207. This is
because a taxpayer generally can avail itself of the benefit of
a deduction—decreased taxable income, and thus lowered
taxes—in the same tax year in which it paid or incurred the
corresponding amount. Id. at 205; see, e.g., I.R.C. § 461(a).
In contrast, a merchandising taxpayer typically receives the
tax benefit from an exclusion in the year in which it sells (or
otherwise disposes of) the product associated with that
exclusion (which may be years into the future). Patients
Mutual, 151 T.C. at 205; see, e.g., I.R.C. § 451(a). 2
But although exclusions generally are not as good as
deductions, they are better than nothing. So contrary to
taxpayers’ usual preferences, and in an evident attempt to
alleviate the effect of section 280E, Harborside takes the
otherwise sub-optimal position that various expenditures it
2
Taxpayers engaged in merchandising businesses often are subject
to the UNICAP rules under section 263A, under which they must
capitalize the costs of inventory acquired for resale, including certain
“indirect costs . . . which are allocable to” the inventory. I.R.C.
§ 263A(a)(2)(B); Treas. Reg. § 1.263A-1(c)(1). Taxpayers subject to
section 263A would recover those costs as they sell or otherwise dispose
of items in their inventories. See Mertens Law of Federal Income
Taxation § 16.41, Westlaw (Mar. 2021 Update). However, section 263A
expressly prohibits the capitalization of “[a]ny cost which (but for [the
UNICAP rules]) may not be taken into account in computing taxable
income for any taxable year.” Treas. Reg. § 1.263A-1(c)(2); see also
I.R.C. § 263A(a) (flush language). In other words, if a cost is not
deductible, it cannot be capitalized under section 263A. On that basis,
the Tax Court determined that the UNICAP rules were inapplicable to
Harborside, Patients Mutual, 151 T.C. at 209, a determination that
Harborside does not dispute on appeal.
12 PATIENTS MUTUAL ASSISTANCE COLLECTIVE V. CIR
incurred in the course of purchasing and processing the
marijuana it resold are in fact excludible costs. These
expenditures total over $7 million and include, for instance,
employee compensation relating to the negotiation of bud
purchases and the cost of laboratory testing of marijuana.
Because Harborside is a merchandising business that
must maintain an inventory, resolving this issue requires
determining which inventory tax accounting provisions
apply. In other words, we are tasked with resolving the
valuation rules Harborside must use to determine the
expenditures allocable to Harborside’s cost of goods sold.
We know those amounts include the purchase prices
Harborside paid to buy marijuana. No one disputes that. But
are any other items included as well? This question is a legal
one involving the interpretation of the Internal Revenue
Code and the Treasury Regulations, and our review therefore
is de novo. See Estate of Saunders v. Comm’r, 745 F.3d 953,
957 (9th Cir. 2014). “Although a presumption exists that the
Tax Court correctly applied the law, no special deference is
given to the Tax Court’s decisions.” Knudsen v. Comm’r,
793 F.3d 1030, 1033 (9th Cir. 2015) (quotations omitted).
To answer the question presented, we begin with the
Code’s notion of inventory. Inventory generally refers to the
goods owned by the taxpayer that are intended for sale to
purchasers or that will physically become part of the product
sold to purchasers. See Treas. Reg. § 1.471-1. A winery, for
instance, would include in its inventory not only the grapes
it purchases to make wine, but also the bottles, corks, and
labels it uses to package that wine for sale. See Internal
Revenue Serv., The Wine Industry Audit Technique Guide
21 (Mar. 2011).
Section 471 prescribes that whenever a taxpayer is
required to maintain an inventory, such inventory “shall be
PATIENTS MUTUAL ASSISTANCE COLLECTIVE V. CIR 13
taken by such taxpayer on such basis as the Secretary [of the
Treasury or his delegate] may prescribe as conforming as
nearly as may be to the best accounting practice in the trade
or business and as most clearly reflecting the income.”
I.R.C. § 471(a); see id. § 7701(a)(11)(B). In Thor Power
Tool Co. v. Commissioner, 439 U.S. 522 (1978), the
Supreme Court recognized that the second test—the clear
reflection of income requirement—is “paramount,”
emphasizing that the Treasury Regulations “state[]
categorically that ‘no method of accounting is acceptable
unless, in the opinion of the Commissioner, it clearly reflects
income.’” Id. at 540 (quoting Treas. Reg. § 1.446-1(a)(2)).
Thus, “the Code and Regulations give the Commissioner
broad discretion to set aside the taxpayer’s method if, ‘in
[his] opinion,’ it does not reflect income clearly.” Id.(alteration in original).
Under the authority of section 471(a), the Internal
Revenue Service has promulgated sections 1.471-1 through
1.471-11 of the Treasury Regulations, which contain
detailed rules governing how taxpayers must account for
their inventories, including valuation methods. See Thor
Power Tool, 439 U.S. at 532–33. Under these rules,
taxpayers generally calculate the value of inventory using
one of two methods: “cost” or “cost or market, whichever is
lower.” Treas. Reg. § 1.471-2(c). Regulations for each
method are provided in sections 1.471-3 and 1.471-4,
respectively. A taxpayer electing to use the “cost” method
therefore must apply the definition of “cost” contained in
section 1.471-3. See id. § 1.471-2(b).
Under section 1.471-3, the definition of “cost” is keyed
to whether a taxpayer “purchased” or “produced” a given
product. Id. § 1.471-3(b)–(c). For a taxpayer that
“produced” the product it sells, “cost” includes not only “the
14 PATIENTS MUTUAL ASSISTANCE COLLECTIVE V. CIR
cost of raw materials and supplies entering into or consumed
in connection with the product,” but also “expenditures for
direct labor” and “indirect production costs incident to and
necessary for the production of the particular article.” Id.
§ 1.471-3(c). In contrast, taxpayers reselling products that
they “purchased” are entitled to include as cost only “the
invoice price,” less certain discounts not relevant here, as
well as “transportation or other necessary charges incurred
in acquiring possession of the goods.” Id. § 1.471-3(b).
Harborside does not dispute that as a merchandising
business, it must maintain its inventory in accordance with
the regulatory scheme of section 471. See Treas. Reg.
§§ 1.471-1, 1.471-2(b). Nor does Harborside dispute that it
elected to use the “cost” method to account for its inventory.
Id. §§ 1.471-2(c), 1.471-3. Harborside does dispute,
however, which cost-method rules it is subject to for the
years at issue. Before the Tax Court, Harborside argued that
it had “produced” the products it sold and therefore should
calculate the corresponding costs under section 1.471-3(c).
The Tax Court rejected this argument and found that
Harborside had “purchased,” not “produced,” the products it
resold. Patients Mutual, 151 T.C. at 210–13. Harborside
does not contest that determination on appeal. It therefore
follows that Harborside’s excludible cost relating to those
products must be determined under section 1.471-3(b),
applicable to purchasers, i.e., resellers. See 151 T.C. at 213.
2
Resisting this straightforward conclusion, Harborside
proffers various arguments as to why section 1.471-3(b)
supposedly does not apply to it. In essence, section 1.471-
3(b) defines (and thereby limits) the types of outlays
associated with purchased merchandise that a taxpayer can
treat as inventory costs. Harborside wants to dump more
PATIENTS MUTUAL ASSISTANCE COLLECTIVE V. CIR 15
such expenditures into its excludible costs than section
1.471-3(b) would otherwise allow, largely because section
280E does not allow corresponding deductions (and because
section 263A’s UNICAP rules are therefore inapplicable).
Hence Harborside argues it is outside section 1.471-3(b)
altogether. But Harborside’s arguments are not persuasive.
First, Harborside asserts that it satisfied the general
requirements of section 471—the “best accounting practice”
and “clear reflection of income” rules—when it included the
disputed exclusions within its inventory cost. See I.R.C.
§ 471(a); Treas. Reg. § 1.471-2(a). Harborside argues that
because the Commissioner does not directly assert that
Harborside’s inventory methods fail either of these general
requirements, he could not force the company to comply
with the specific rules of section 1.471-3. But this argument
misapprehends the statute and its implementing regulations.
As discussed, section 471(a) mandates that “inventories
shall be taken by [a] taxpayer on such basis as the Secretary
may prescribe as conforming as nearly as may be to the best
accounting practice in the trade or business and as most
clearly reflecting the income.” I.R.C. § 471(a) (emphasis
added). Under this authority, the Service has promulgated
detailed regulations, the validity of which Harborside does
not question, governing how taxpayers are to compute their
inventories. See Treas. Reg. §§ 1.471-1 to -11. The
Treasury Regulations echo the section 471(a) requirement,
providing that “the inventory practice of a taxpayer should
be consistent from year to year, and greater weight is to be
given to consistency than to any particular method of
inventorying or basis of valuation so long as the method or
basis used is in accord with §§1.471-1 through 1.471.11.”
Id. § 1.471-2(b) (emphasis added).
16 PATIENTS MUTUAL ASSISTANCE COLLECTIVE V. CIR
Harborside wants us to treat section 471(a) as though it
does not reference the implementing regulations, but it
plainly does. Contrary to Harborside, compliance with
section 471(a) cannot be assessed without consideration of
its implementing regulations, here section 1.471-3(b). See
Thor Power Tool, 439 U.S. at 533–35, 538–40 (holding that
where a taxpayer using the “cost or market, whichever is
lower” method did not comply with section 1.471-4, its
inventory failed to clearly reflect income). Harborside cites
no authority suggesting otherwise.
Second, Harborside argues that because the
Commissioner did not frame his challenge to Harborside’s
inventory method in terms of a failure to clearly reflect
income, he was without authority to compel Harborside to
change its accounting methods—i.e., the way Harborside
computed its inventory. This argument, too, is erroneous.
Harborside is correct that the Commissioner may not force a
taxpayer to use a particular accounting method where the
taxpayer’s chosen method conforms to law. See, e.g., Jim
Turin & Sons, Inc. v. Comm’r, 219 F.3d 1103, 1109 (9th Cir.
2000). But the Commissioner does have the power to assert
deficiencies where a taxpayer’s method of accounting does
not conform with the applicable regulations. See, e.g., Thor
Power Tool, 439 U.S. at 533 (sustaining the Commissioner’s
disallowance of an inventory method of accounting that
“was plainly inconsistent with the governing [Treasury]
Regulations”). That is all the Commissioner sought to do
here.
Third, Harborside argues that under our decision in Max
Sobel Wholesale Liquors v. Commissioner, 630 F.2d 670(9th Cir. 1980), section 1.471-3(b) cannot be grounds for
disallowing Harborside’s cost computation because it was
(in Harborside’s view) a “permissible” determination of cost
PATIENTS MUTUAL ASSISTANCE COLLECTIVE V. CIR 17
of goods sold. But Harborside misreads Max Sobel, which
held that a statute limiting deductions did not give the
Commissioner the authority to deny exclusions for cost of
goods sold. See id. at 671–72. The Commissioner is not
purporting to invoke section 280E as a basis to deny
Harborside exclusions for cost of goods sold. Max Sobel
does not address the issue here, namely, which expenditures
are includible in cost of goods sold in the first place.
Finally, Harborside argues that subsection (d) of section
1.471-3 exempts it from the requirements of subsection (b)
and permits it to include its purchasing and processing costs
in its inventory cost. But section 1.471-3(d) does not apply
to Harborside. That provision applies only to industries “in
which the usual rules for computation of cost of production
are inapplicable.” Treas. Reg. § 1.471-3(d). In such
industries, “costs may be approximated upon such basis as
may be reasonable and in conformity with established trade
practice in the particular industry.” Id. The regulation
provides three examples of such industries: “[f]armers and
raisers of livestock,” certain “[m]iners and manufacturers,”
and “[r]etail merchants” that use the “retail method” to
approximate costs. Id. Rules for each such industry are
further detailed in respective sections of the Treasury
Regulations. See id. §§ 1.471-6 to -8.
Section 1.471-3(d) is inapplicable because Harborside
has failed to show that marijuana retail is an industry “in
which the usual rules for computation of cost of production
are inapplicable.” Id. § 1.471-3(d). Each of the types of
taxpayers to which subsection (d) applies faces some
difficulty in using the standard methods. For example,
farmers require special inventory costing rules “[b]ecause of
the difficulty of ascertaining actual cost of livestock and
other farm products.” Id. § 1.471-6(c). Farmers therefore
18 PATIENTS MUTUAL ASSISTANCE COLLECTIVE V. CIR
are permitted to approximate their costs under special
regulations. Id. (permitting farmers to use the “farm-price
method” or “unit-livestock-price method” for approximating
cost).
Harborside presents no cogent argument for why a
marijuana dispensary cannot compute its “cost of
production” under the usual rules that apply to a retailer.
And it does not claim that it is a “retail merchant” that uses
the “retail method” in its cost accounting. Id. § 1.471-
3(d)(3). Harborside’s only argument appears to be that
because its expenditures would be disallowed as deductions
under section 280E, it instead should be allowed to exclude
those amounts as costs by electing to proceed under section
1.471-3(d) rather than section 1.471-3(b). But Harborside
does not ground this entitlement to different treatment in any
statutory or regulatory authority. That the normal inventory
accounting rules may be unfavorable to Harborside does not
make them inapplicable to it. Section 1.471-3(d) therefore
bears no relevance to Harborside’s tax liabilities for the
years at issue.
We thus hold that the Tax Court did not err in concluding
that Harborside’s inventory cost for each of the years at issue
is determined by section 1.471-3(b). Although Harborside
is subject to serious tax consequences because of the nature
of its business, see I.R.C. § 280E, the primary argument it
has preserved for our review fails based on generally
applicable provisions of federal tax law. Marijuana
dispensaries, like all taxpayers, must abide by the intricacies
of the Internal Revenue Code and the Treasury Regulations.
This leaves Harborside arguing that the Tax Court erred
in its application of section 1.471-3(b) by failing to allow at
least some of Harborside’s claimed exclusions (such as
employee salaries relating to negotiating marijuana
PATIENTS MUTUAL ASSISTANCE COLLECTIVE V. CIR 19
purchases) as “necessary charges incurred in acquiring
possession of the goods.” Treas. Reg. § 1.471-3(b).
However, as with its Sixteenth Amendment claim,
Harborside failed to raise this argument before the Tax
Court. The issue is therefore forfeited for our review. See
Sparkman, 509 F.3d at 1158–59; Merkel v. Comm’r,
192 F.3d 844, 852 n.10 (9th Cir. 1999).
We therefore express no opinion on whether any of
Harborside’s claimed exclusions may have been properly
regarded as inventory cost under section 1.471-3(b). Nor do
we address arguments made by amici that Harborside does
not advance here. See United States v. Gementera, 379 F.3d
596, 607 (9th Cir. 2004) (“Generally, we do not consider on
appeal an issue raised only by an amicus.” (quotations
omitted)).
AFFIRMED.