Oregon Tax Court Rules on Marijuana Grow COGS

For several years one of the biggest problems the cannabis industry has faced is I.R.C. Section 280E. It suffocates the regulated marijuana industry. A recent decision by the Oregon Tax Court addresses Section 280E and what may properly fall under Cost of Goods Sold (“COGS”) in the context of a marijuana grow operation. (See herehereherehere and here for some of our prior coverage on COGS and Section 280E).

The case for today’s discussion is Lessey v. Dep’t of Revenue, No. TC-MD 210265G, 2022 WL 17336203 (Or. T.C. Nov. 29, 2022) (Feel free to email me for a copy). In Lessey, the plaintiff challenged the Oregon Department of Revenue’s (“ODR”) adjustment to COGS and expense deduction claimed on their 2016 return for a marijuana-grow business.

On that return, plaintiffs reported about $20,000 in gross receipts, no beginning or ending inventory, and $57,654 in COGS, of which the ODR allowed $31,187. Most of the expenses now in dispute were originally claimed by Plaintiffs within COGS. These included expenses for air conditioning units, cellular telephone service, internet service, office rental, and meals and entertainment. Let’s take a look at the Tax Court’s decision as it relates to Section 280E and COGS.

Lessey on IRC 280E and COGS

The Tax Court began by stating that expenses within the COGS are excluded from gross income rather than deducted from it, citing a Ninth Circuit case. That happens, said the court, because:

gross receipts from sale of inventory are not income to the taxpayer until the cost of the inventory sold is recovered: The ‘cost of goods sold’ concept embraces expenditures necessary to acquire, construct or extract a physical product which is to be sold; the seller can have no gain until he recovers the economic investment that he has made directly in the actual item sold. (quotations omitted.)

For marijuana businesses, the the distinction between excluding and deducting expenses is important. Marijuana business are barred from claiming deductions by Section 280E. But Section 280E does not prevent marijuana businesses from excluding the inventory costs of controlled substances from gross income.

The court then explained the different between “direct” and “indirect” production costs. The former include “components of the cost of either direct material or direct labor”: i.e., material either consumed or made an integral part of the product and labor associated with producing particular batches of product.” (citing Treas. Reg. § 1.471-11(b)(2). Examples include expenses for repair, maintenance, utilities, and rent and in some circumstances administrative costs. Indirect production costs are all other production costs besides direct production costs.

In Oregon, ORS 316.680(1)(i) allows authorized marijuana businesses to reduce their Oregon taxable income by the amount of any federal deductions to which they would have been entitled but for IRC section 280E. In 2016, Oregon’s subtraction was allowed under House Bill 4014 for:

Any federal deduction that the taxpayer would have been allowed for the production, processing or sale of marijuana items authorized under ORS 475B.010 to 475B.395 or 475B.400 to 475B.525 but for section 280E of the Internal Revenue Code.

Although Section 280E prohibited plaintiffs from claiming business expense deductions under IRC section 162(a), as growers registered with the Oregon Health Authority, plaintiffs could subtract amounts equivalent to such deductions from their federal taxable income.

Thus, the question is whether Plaintiffs would qualify for federal deductions if their business were not “trafficking in controlled substances.” See IRC § 280E.

Lessey on claimed COGS

1.  Air conditioning units

Plaintiffs installed two air conditioning units at their marijuana grow operation to remove excess heat. The cost, including duct work, was $12,000.

In general, said the Tax Court, amounts paid for such improvements or betterments are capital expenditures that may not be deducted. The cost of such improvements is instead charged to a capital account as basis. And a depreciation deduction is available. Purchasers of certain kinds of property, however, may treat the cost as fully deductible expense in the year the property is placed into service under IRC Section 179(a).

But in 2016, ruled the Tax Court, air conditioners were not eligible for an expense deduction. And, even if they were, only if plaintiffs had elected as such on their federal return, which they did not do.

So the expense deduction claimed by plaintiffs was not allowed and plaintiffs accepted only a $479 depreciation deduction.

2.  Cell phones

Plaintiffs claimed their cell phones were needed in case of an emergency and satisfied a licensing requirement. The Tax Court determined that no subtraction was allowed because “the few 2016 [cellular phone] statements provided show a regular pattern of voice calls and text messaging that does not fit with a business purpose of emergency use.”

3.  Internet service

Plaintiffs sought a subtraction of $1,175.28 for internet service expenses. But the Tax Court found the documents provided by plaintiffs in support of this subtraction did not establish whey the internet service was at plaintiff’s home, rather than the marijuana grow operation or rented office.

4.  Office rental

Plaintiffs sought a deduction for renting an office and testified they rented the office to keep their home address and the address of the marijuana grow operation off the Secretary of State’s website. They also testified that a marijuana-growing business is at a high risk of being targeted by thieves and that the Secretary of State recommends not using a home address in a marijuana business registration. Plaintiffs also provided evidence of a commercial lease.

On these facts, the Tax Court found it more likely than not the office was rented for the marijuana grow and allowed a deduction $1,400 of the claimed $1,600. (The remaining $200 appeared a damage deposit rather than an expense.)

5.  Meals with mentors

Plaintiffs presented receipts of about $700 for food and drink and testimony these were expenses “associated with mentoring on growing marijuana, made necessary by the lack of formal educational options in marijuana growing.” For the meals for which plaintiffs had receipts and corroborating evidence (e.g. notes), the Tax Court allowed a deduction.

6. Vehicle mileage

Plaintiffs reported 17,771 business miles on their 2016 return and submitted two log books. After reviewing the log books and related evidence, the court found the logs substantiated 7,742 miles that qualified for deduction.


In summary, the Tax Court reduced Plaintiff’s taxable income by $476 for air conditioner depreciation, $1,400 for office rent, and $27.49 for meals; and allowed Plaintiffs a subtraction for car and truck expenses for 7,742 business miles.

Until some federal reform related to Section 280E happens, Lessey shows that marijuana businesses must keep careful records and work closely with their bookkeepers and tax professionals on all matters COGS related. Especially since these taxing authorities may look back several years. Given all of the challenges currently faced by industry, this is no time to have a tax bill spring into existence.