1 5 1 T.C. No . 1 1

UNITED STATES TAX COURT

PATIENTS M UTUAL ASSISTANCE COLLECTIVE CORPORATION d .b .a.

HARBORSIDE HEALTH CENTER, Pet it i o n er v . COM M ISSIONER OF INTERNAL REVENUE, Res po n d en t

Do ck etNo s . 2 9 2 1 2 -1 1 , 3 0 85 1 -1 2 , Fi l edNo vem b er 2 9 , 2 01 8
. 1 47 7 6 -1 4
. 1

Cal ifo rn i a m ed i cal -m ari ju an a d i s p en s ary

P d edu ct edI.R.C. s ect i o n 1 6 2 b us i n es s ex pen s es an dad ju s t ed fo r i n d i rect COGS p er t h e I.R.C. s ect i o n 2 6 3 AUNICAP ru l es fo r p ro du cers . R d et erm i nedth at P’ s s o l e t rad e o r b us i nes s was traffi ck i n g i n a co n tro ll eds ub s t an ce an d th atI.R.C. s ect i o n 2 8 0 E p rev en t edi tfro m d edu ct i n g b u s i n es s ex p en s es . R al s o d et erm i n edth atP h adt o cal cu l at e COGS u s i n g th e I.R.C. s ect i o n 4 7 1 reg u l at i o n s fo r res el l ers an dwas l iab l e fo r accu racy -rel at edp en al ti es . P arg uedth atI.R.C. s ect i o n 2 8 0 E d id n ’ t ap p l y t o i t , th ati twas a p ro ducer, an dth at a d i sm i s s ed ci v i l -fo rfei tu re act i o n p recl u d eda d efi ci en cy act i o n .

1 W e co n s o l i d at edth e cas es atd ock etn u m bers 2 9 2 1 2 -1 1 , 3 0 8 5 1-1 2 , an d 1 4 7 7 6 -1 4 fo r t ri al , b ri efi n g , an do p in i on .- 2
-

Hel d : Th e Go v ern m en t ’ s d i s m i s sal wi th p reju d i ce o f a ci v i l
fo rfei tu re act i o n ag ai n s tP d oes n o tb ar d efi ci en cy d et erm in at i o n s . Hel d , fu rt her, I.R.C. s ect i o n 2 8 0 E p rev en t s P fro m d edu ct i n g o rd i naryan d n eces s ary

b u s i nes s ex p en s es . Hel d , fu rt her, du ri n g t h e y ears at i ss u e P was en g ag edi n o nl y o n e trad e o r b u si n es s , wh i ch was traffi ck i ng i n a co n tro ll eds ubs t an ce. Hel d , fu rt her, P m

u stad ju s tfo r COGS acco rd i n g t o th e I.R.C. s ect i o n 4 7 1 reg u l at io n s fo r res el l ers .

Hen ry G. Wyk o w s k i an dM at thew A. W i l l i am s , fo r p et it i o n er. Ni ch o l as J . Si n g er an dJ u l i e An n Fi el d s , fo r res po n d en t .

HOLM ES, J u d g e: Pat ien t s M u tu al o wn s wh atm ay wel l b e t h e l arg es t
m ari ju an a d i s p en s ary

i n Am eri ca. To th e Co m m i s s i o n er t h at ju s tm ak es i ta g i an t dru g traffi ck er, u n en ti t l edt o th e u s u al d edu ct i o n s th atl eg i t i m at e b u s i nes s es can cl ai m , u n ab l e ev en t o cap i t al ize i t s i n d i rect co st s i n t o i t s i n ven t o ry , an d s ub jectt o p en al t i es fo r t ak in g co n traryp o s i t i o ns o n i ts t ax retu rn s fo r t h e t ax y ears en d i n g J u l y 3 1 , 2 0 0 7 t h ro u g h 2 0 1 2 . Pat i en t s M u tu al wan t s t o b e t reat ed l i k e an y o th er b u s i n es s b ecau s e i t fo l l o ws Cal i fo rn i a l aw, i t d o es m o re th an d i s tri b u te m ari ju an a,
an d th e fed eral g o v ern m en tal read y d eci d ed n ott o p u rs u e a ci v i l -fo rfei tu re act i o n ag ai n s ti t .- 3
- FINDINGS OF FACT I. Cal i fo rn i a M ed i cal -M ari ju an a Law Un d er fed eral l aw m ari

ju an a i s a Sch edu l e I co n tro l l ed s ub s tan ce. See Co n tro l l edSubs t an ces Act , Pub . L. No . 9 1-5 1 3 , s ec. 2 02 , 8 4 St at . at1 2 4 9 (co d i fi edas am en dedat2 1 U.S.C. s ec. 8 1 2 (2 0 1 2)). Th i s m ean s th atu n d er fed eral l aw t h e m an ufact u re, d i s tri bu t i o n , d i s p en s at i o n , o r p o s ses s i o n o f m ari ju an a--ev en
m ed i cal m ari

ju an a reco m

m en d edb y

a p h y s i ci an --i s p ro h i b i t ed . See i d . s ec. 8 4 1 (a); Cal i fo rn i an s Hel p in g t o Al l ev i at e M ed . Pro bl em s , In c. v . Co m m i s s i o n er (CHAM P), 1 2 8 T.C. 1 7 3 , 1 8 1 (2 0 0 7 ) (ci t i n g Un i t edSt at es v . Oak l an d Can n ab i s Bu y ers ’ Co o p ., 5 3 2 U.S. 4 8 3 (2 0 0 1)). Un d er Cal i fo rn i a l aw, th i n g s are s om ewh atd i fferen t . In1 9 9 6 Cal i fo rn i a
v o t ers ad o p t ed Pro po s it i o n 2 15 --t he Cal i fo rn i a Co m p as s io n at e Us e Acto f 1 9 9 6 (CCUA)--t o “ en s u re t h ats eri o u s l y i ll Cal i fo rn i an s h av e th e ri g h tt o o bt ai n an du s e
m ari ju an a fo r m ed i cal p u rp o s es .” See Cal
. Heal th & Safet y Co de s ec. 1 1 3 6 2 .5 (b )(1 )(A) (W es t2 00 7 ). Th e CCUA p ro v i des an ex em p ti o n fro m Cal i fo rn i a l aws p en al i zi n g t h e p o s s es s i on an d cu l t i v at i o n o f m ari ju an a fo r p at i en t s
an d th ei r p ri m ary

careg i vers wh en th e p o s s es s io n o r cu l t i v at i o n i s fo r t h e p at i en t ’ s p ers o n al m ed i cal p u rp o ses an dreco m m en d edo r ap pro v ed b y

a p hy s i ci an . Id . s ec. 1 1 3 6 2 .5 (d ). Cal i fo rn i a l at er l eg al izedco l l ect i v e o r co o perat i v e cu l t i v at i o n o f- 4
-

m ari ju an a fo r m ed i ci n al p u rp o ses . Id . s ec. 1 1 3 6 2 .7 75 ; s ee al s o Peo p l e v . Co l v i n , 1 3 7 Cal . Rp tr. 3 d 8 5 6, 8 6 0 (Ct . Ap p . 2 0 1 2 ). Th es e l aws l edt o the fo rm at i o n o f t h e fi rs tm ari ju an a d i sp en s ari es . 2 II. DeAn g el o an dHarb o rs i de St ev e DeAn g el o s aw t h es e earl y d is p en sari es --wh i ch h e d es cri b edas b ei n g
ru n b y ei th er wel l -m ean in g m ari ju an a act i v i s ts wi th n o b u si n es s ex peri en ce o r

“ th ug o p erat o rs ”--an d real i zed p at i en t s n eed eda b et t er o p t i on . So i n 2 0 0 5 DeAn g el o co fo u n d edPat i en t s M utu al As si st an ce Co ll ect i v e Co rp o rat i o n d .b .a. Harb o rs i d e Heal th Cen t er (Harb o rs i d e) t o b e t h e “ g o l ds t an dard ” i n m ed i cal
m ari ju an a d i s p en s ari es . Hi s g o al was t o creat e a p lace wh ere m ari ju an a co u l db e d i s tri b u t edres po n s ib l y , th atwas fo cu s edo n p at i en tcare, an d th atp ro v i d ed b en efi t s t o b o th p at i en t s an d t he co m m u n i ty . Harb o rs i d e o p en edi t s d o o rs i n Oct o b er 2 0 0 6 an dh as g ro wni nt o a b o o m i ng b u s i n es s wi th m o re th an 1 0 0 ,0 0 0 p at i en tv i s i t s p er y ear. Ital s o g en erat eda g us h er o f rev en u e du ri ng th e y ears at i s su e:

2 OnNo v em

b er 8 , 2 0 1 6 , Cal i fo rn i a v o t ers ad o p t edPro p o s i t i o n 6 4 , wh i ch m ad e recreat i o n al m ari

ju an a u s e l eg al u n d er Cal i fo rn i a l aw. See Cal . Heal th & Safet y Co d e s ec. 1 1 3 6 2
. 1 (W es t2 0 1 7 ).- 5
-

Year N o nm ari

ju an a s al es rev en u e M ari

ju an a s al es rev en u e To t al rev en u e M ari ju an a p ercen t ag e 2 00 7 $ 4 8 7 $ 5 ,4 4 8 ,6 35 $ 5 ,4 4 9,1 2 2 9 9.9 9 2 00 8 3 , 9 9 0 1 0 ,9 1 6 ,9 14 1 0 ,9 2 0,9 0 4 9 9.9 6 2 00 9 1 6 , 8 7 8 1 7 ,3 3 4 ,5 97 1 7 ,3 5 1,4 7 5 9 9.9 0 2 01 0 4 2 , 4 9 2 2 2 ,0 4 7 ,3 72 2 2 ,0 8 9,8 6 4 9 9.8 1 2 01 1 5 8 , 5 8 8 2 0 ,8 9 5 ,8 23 2 0 ,9 5 4,4 1 1 9 9.7 2 2 01 2 32 0 ,6 5 1 2 5 ,1 9 9 ,9 97 2 5 ,5 2 0,6 4 8 9 8.7 4 To t al 44 3 ,0 8 6 1 0 1 ,8 4 3 ,3 3 8 10 2 ,2 8 6,4 2 4 9 9.5 7 Atal l rel ev an tt im es Harb o rs i d e o p erat edo uto f an ap p ro x i m at el y 7 , 5 0 0 -s qu arefo o ts p ace t h ath ada recep t i on area, h eal i n g ro o m , p u rch as i n g o ffi ce, p ro ces s i n g
ro o m , cl o n e ro o m , an dm u l t i p u rp o s e ro o m . Th e faci l i ty al so h ada l arg e s al es fl oo r, o ffi ces , s t orag e areas , res tro o m s , an da b reakro o m wi th a k i t ch en . Bu to p erat i ng a d i s p en s ary i s n o s m al l t as k . DeAn gel o h ad t o m ak e s u re Harb o rs i d e co m

pl i edwi th Cal i fo rn i a an dl o cal l aws . Th i s i n cl u d edg et t i n g p ro p er p erm i t s , ru n n i n g as a n o np ro fi t, an do perat in g u nd er a “ cl o s ed -l o op ” s y s tem . Harb o rs i d e i nt erp ret edth e “ cl o s ed -l o o p ” requ irem en t t o m ean th at al l o f i t s
m ari ju an a m u s t b e p ro v i d edb y

i t s p at i en ts ; s o l d ex cl us i v el y t o i t s p at i en t s; h an dl ed o n l y

b y i t s em p l o y ees , al l o f wh o m

were i t s p at ien t s ; an dn o td i v ert edi n t o th e i l l eg al m ark et . Ho wHarb o rs i d e ach i ev edal l o f th is i s i m po rt an t , s o we wi l l
s t artwi th h o w Harb o rs i d e s o u rced an dp ro ces sedi t s i n v en t o ry .- 6
-

A. So u rci n g an d Pro ces s i n g Harb o rs id e s o l da wi d e v ari et y o f p ro du ct s, wh i ch we wi l l d i v i d e i n t o fo u r
m ai n g ro up s --cl on es , m ari ju an a fl o wers , m ari

j u an a-co n t ai n i n g p ro du ct s , an dn o n m ari ju an a-co n tai n i n g p ro du ct s . 1
. Cl o n es Cl o n es are cu t t i n g s fro m

a fem al e can n ab i s p l an tth atcan b e t ran s p l an t ed
an d u s edt o cu lt i v at e m ari ju an a. Harb o rs i d e b o u g htcl o n es fro m cl o n e n u rs eri es , cared fo r t h em

wh i l e t hey

were i n i t s s t o re, rep ack ag edth em , an d t h en s o l dth em t o i ts p at i en t s . Its t oredth e cl o n es i n a cl o n e ro o m an ds o ldthem

ata cl o n e
co u nt er--t h e p o rt i o n o f t h e fl oo r s p ace d ed i cat edt o cl o n e s al es . Duri n g the y ears ati ss u e Harb o rs i de h adatl eas t fo u r em p l o y ees wh o s pen t th ei r t i m e en t i rel y i n th e p u rch as e an ds al e o f cl o n es .

2
. M ari

j u an a Fl o w ers Th e Co u rtl earn edattri al th at i t ’ s n o tth e l eav es o f t h e m ari ju an a p l an t , b u t i t s fl o wers --o r b u d s --t hatp eo p l e can s m o k e. 3 Harb o rs i d e p urch as edal l o f i t s
m ari ju an a fl o wers fro m

i ts p at i en t -g ro wers . So m e o f t hes e g ro wers p ro m i s edt o
s el l wh atth ey

cu l t i v at edb ackt o Harb o rs i d e, an dHarb o rs i d e g av e t h em ei th er

3 Th e Co u rts u s p ect s , b u tm ak es n o fi n d in g , th atth i s m ay b e wh y rep u rp o sedb eer-m ark et i n g m at eri al --“ Th is Bu d ’ s fo r y o u ”--s eem s t o b e co m m o n wh ere m ari

ju an a i s s o l d
.- 7
-

s eed s o r cl on es t o g ets t art ed . Oth er g ro wers , h o wev er, b o u g hts eed s an dcl o n es fro m Harb o rs i d e. Ho wev er t h ey acq u i redth ei r s t art er s up p li es , g ro w ers wh o were i n t eres t edi n s el li n g t o Harb o rs i d e h adt o s i g n a cu l t i v at i o n ag reem en tan dwere
en co urag edt o t ak e o ne o f Harb o rs i d e’ s free g ro w cl as ses an dfo l l o w i t s b es t p ract i ces g u id es . On ce a g ro w er h adcu l t i v at ed , h arv es t ed , tri m m ed , fl u s h ed , dri ed , an dcu red h i s m ari ju an a b u d s, h e wo u l db ri n g them t o Harb o rs i d e t o s el l . Harb o rs i d e h ada p u rch as in g o ffi ce t o i n s p ectan dt es tth e i n co m i n g m ari ju an a. Harb o rs id e wo u l d rejectm ari

j u an a i f i t was n ’ tp ro p erl y cu red , i f i th ad n ’ tb een s uffi ci en tl y tri m m ed , i f i th ad ani n cu rab l e s afet y i s s u e s u ch as p at h o g en i c m o ld , o r i f i td i dn ’ tco n t ai n th e ri gh t“ can n ab i n o id p ro fi l e.” If, fo r ex am p l e, Harb o rs i d e was i n n eedo f a s t rai n
o f m ari ju an a t h atwas ri ch i n CBD, 4 i tm i g h t rejecta b at ch o f m ari ju an a t h atwas ri ch i n THC. 5 Th ere were t i m es Harb o rs i d e reject edth e “ vas tm ajo ri ty ” o f th e b u d th atg ro wers b ro u g h ti n , an da g ro wer wh o s e m ari ju an a was reject edg o tn o
co m p en s at i o n (t ho u g h h e was free t o s el l i tt o an ot h er co l l ect i v e i f h e co u l d ).

4 CBD i s th e ab b rev i at i o n fo r can n ab id i o l , a p o ten tan t ii n fl amm at ory co m p o u n d
. 5 THC s t an d s fo r t et rah y dro can n ab i n o l , th e co m p o un di n m ari

ju an a b el i ev ed t o b e res p o n s i b l e fo r p ro v i d i ng a eup h o ri c effect , o r “ hi g h ”, as u s ers cal l i t.- 8
-

Onth e o th er h an d , i f Harb o rs i d e ag reedt o b u y the m ari ju an a, i two u l d
n eg ot i at e a p ri ce wi th th e g ro wer--t y p i cal l y en o u g h t o co v er t h e g ro wer’ s actu al g ro wi n g ex p en s es an da reas on ab l e am o u n tfo r h i s t i m e an dl ab o r. Its t o redth e
m ari ju an a i n a v au l t--a rei n fo rcedco n cret e ro om wi th a b an k -v au l td o o r an d b i o m et ri c l o ck s --an ds en t a s am p l e o f t h e m ari

j u an a o u tfo r t es t i n g b y

a t h i rd -p art y l ab o rat o ry . If al l wen t wel l , th e m ari ju an a wo u l d g o t o a p ro ces si ng ro o m wh ere i t
was rei n s p ect ed , rem an i cu red , ret ri m m ed , an d t h en wei g h ed , p ack ag ed , an d l ab el ed . Harb o rs i d e s t aff wo u l dp u ti to n d i s p l ay o n t h e s al es fl o o r o r p u ti tb ack i n the v au l tu n t i l n eed ed . Harb o rs i d e h adatl eas tth ree em pl o y ees d ed i cat edt o acq u iri n g i n v en t o ry , atl eas tfo u r d ev o t edt o m an ag i n g i nv en to ry , an ds t i l l o th ers wh o s e s o l e jo b was t o p ro ces s th e b u l km ari ju an a an dread y

i tfo r res al e. 3
. M ari

j u an a-Co n t ai n i n g Pro du ct s Harb o rs id e’ s m ari

ju an a-co n t ai n i n g p ro du ct s i n cl ud eded i b l es , b ev erag es , ex tract s, co n cen trat es , o i l s , t op i cal s , an dt in ctu res --m ari ju an a-i n fu s edal co h o l , v i n eg ar, o r g l y ceri n . Harb o rs i d e b o u g h tth es e i t em s fro m o th er co l l ect i ves , t es t ed th em , rep ack ag ed th em

i f t h ey cam e i n b u l ko r n eed ed ch i l d -p ro o f p ack ag i n g , rel ab el edth em , an dthen s o l dth em t o i t s o wnp at i en t s . Harb o rs i d e’ s h u m an res o u rces d i rect o r cred i b l y es t i m at ed th atab o u t5 5 % t o 6 0 % o f i t s em p l o y ees ’- 9
-

t o t al t i m e was s pen to n b u y i n g an dp ro ces s i n g m ari ju an a--b o th th e b u d s an d
m ari ju an a-co n tai n i n g p ro du ct s --an dan o th er 2 5 % t o 3 0 % s el li n g i t . 4
. No n -M ari

ju an a-Co n t ai n i ng Pro du ct s Harb o rs id e al s o s o l d n o n-m ari ju an a-co nt ai n i n g p ro du ct s . Th es e i ncl u d ed b ran d ed g ear s u ch as s h i rt s , h at s , an dp i n s ; n o nb ran d edg ear s uch as s o ck s an d h em p b ag s ; an da v ari et y

o f o ther p ro du ct s i n cl u d i n g b o o k s , d ab b in g equ i p m en t , 6
ro l l i n g p ap ers , an dl i g h t ers . Harb o rs i d e b o u g h t th es e i t em s fro m o u t s i d e v en d o rs , s t oredth em , an dres o l dth em t o p at i en t s . Dep en d i n g o n th e v o l u m e o n h an d , Harb o rs i d e s t o redthe n o n -m ari ju an a-co n t ai n i ng p ro du ct s o n th e s al es fl o o r an di n
o n e o r m o re o f i t s v ari o u s s t o rag e ro o m s. A l i t t l e l es s th an 2 5% o f t h e s al es fl o o r
was u sedt o d i sp l ay

an ds el l th es e i t em s an daro u n d 5 % t o 1 0 % o f Harb o rs i d e’ s
em pl o y ees ’ t i m e was d ed i cat edt o b u y i n g an d s el l i n g th es e en t irel y l eg al p ro du ct s . B. Sal es an dPri ci n g Harb o rs id e t oo kg reat care t o av o i di t s m ari ju an a’ s l eak i n g i n to th e b l ack
m ark et . Fo r ex am

p l e, n o o n e co u l d en ter t h e s al es fl o o r wi th ou tg o i n g thro u g h a

“ v ery ri g o ro u s i d en t i fi cat i o n p ro ces s .” Th i s p ro ces s req u i redn ew p at i en t s t o

6 “ D ab b i n g ” m ean s h eat i n g p ro du ct s th atco nt ai n m ari ju an a s o as t o creat e an i n t o x i cat i n g v ap or. Itm ay o r m ay n oth av e a co n n ect i o n t o th e s tran g e fad am on g th e y ou n g th ats eem s t o co n s i s to f p o i n ti n g t o th e s ky wi th o n e arm

wh i l e p u t t i ng o n e’ s face i n th e cro ok o f t h e o th er arm wh i l e s eem i ng t o s neeze o r s n i ff.- 1 0 -

p res en tv al i dp h o t o IDs , h av e wri t t en reco m m en d at i o n s fro m

p h y si ci an s l i cen s ed t o p ract i ce i n Cal i fo rn i a, s i gn a co l l ect i v e cu l ti v at i o n ag reem en tg iv i n g o th er Harb o rs i d e p at i en t s th e ri g h tt o cu lt i v at e m ari ju an a o n th ei r b eh al f, an dag ree t o ab i d e b y Harb o rs id e’ s ru l es an d reg u lat i on s . Harb o rs i d e al s o s o l di t s m ari ju an a at a p rem iu m

ab o v e t h e b l ack -m ark etrat e t o d i sco u rag e i t s p at i en ts fro m res el l i n g i t . Th e ex actm eth o du s edt o d et erm i n e t h e s al e p ri ce i s u n cl ear fro m th e reco rd , b u t DeAn g el o t es t i fi edth atHarb o rs i d e l o o k ed“ at[i t s ] g en eral o v eral l p i ctu re an d d et erm i n edth e m arg i n th atwe n eed ed t o p l ace o n ev ery b i t o f can n ab i s t h atcam e i n .” C. Co m

m un i ty Ou treach W i th p rem iu m p ri ces , h o wev er, co m e s i g n i fi can tp ro fi t s . Harb o rs i d e i s a C
co rp o rat i o n fo r fed eral t ax p u rp o s es , 7 b u tt o co m pl y wi th Cal i fo rn i a’ s n o np ro fi t req u i rem en t , 8 i t s b y l aws p ro h i bi t edi tfro m p ay i n g d i v i den d s o r s el li n g equi ty , an d

7 Th e IRS h as d et erm i n edth ata m ari ju an a d i s p en s ary

g en eral l y can n o t qu al i fy as a t ax -ex em

p to rg an i zat i o n u nd er s ect i on 5 0 1 (c)(3 ) b ecau s e i t i s en g ag ed i n wh atfed eral l aw reg ard s as a cri m i n al en t erp ri s e an dth u s i s n o t o p erat ed ex cl u s i v el y

fo r ch ari t ab le p u rp o s es . Rev
. Ru l . 7 5 -3 8 4 , 1 97 5 -2 C.B. 2 0 4 ; s ee al s o Pri v . Ltr. Ru l . 2 0 1 2 2 40 3 6 (J u n e 1 5 , 2 0 1 2). (Un l es s we s ay o th erwi s e, al l s ect i o n referen ces are t o th e In t ern al Rev en u e Co d e i n effect fo r t he y ears ati s s u e.)

8 Cal i fo rn i a l aws d ecri m i n al i zi n g m ed i cal m ari ju an a s p eci fi cal l y s tat edth at th ey d i dn o t“ au th o ri ze an y

i n d i v i du al o r g ro up t o cu l t i v at e o r d i s tri b u t e can n ab i s fo r p ro fi t.” Cal . Heal th & Safet y Co d e s ec. 1 1 36 2 .7 6 5(a) (W es t 2 0 0 7 ).- 1 1 -

req u i redi tt o u s e an y

ex ces s rev en u e fo r t he b en efi to f i t s p at i en t s o r t h e
co m m u n it y . To thi s en d , Harb o rs i d e p ro v i d edi t s p at i en t s wi th a wi d e v ari et y o f
s erv i ces atn o ad d i t i o n al co s t. Itt o l dp at ien t s du ri n g t h ei r o ri en t at i o n --an dag ai n wi th s i g n s o n the p rem i ses --t h atp arto f t h e p u rch as e p ri ce o f t he m ari ju an a wo u l d b e u s edt o p ay

fo r p at i en ts erv i ces an dco m m u n i ty o u treach . Bu tp at i en t s were n o t req u i redt o b uy

m ari j u an a t o u s e t h e s erv ices
. Th e s erv i ces i ncl u d edo n e-o n -o n e t herap eu t i c s es s i o ns fo r rei k i , h y p n o therap y , n atu ro p at h y , acup un ctu re, an dch i ro p ract ic co ns u l t at i on s as wel l as g ro up s es s i o n s fo r y o g a, q i g o n g, th e Al ex an d er t ech n i qu e, an dt ai ch i
. Harb o rs i d e al s o o ffered g ro w cl as s es , s up p o rtg ro up s , ad d i ct i o n treat m en tco u n s el i n g , an da

“ s l i d i n g scal e p ro g ram ” t h atg av e d i s co u n ts t o p at i en t s wi th fi n an ci al d iffi cu l t i es . Al l o f t he s erv i ces were co o rd i n at edb y Harb o rs i d e’ s h o l i st i c-s erv ices d i rect o r an d t o o kp lace i n ei th er Harb o rs i d e’ s h eal i n g ro o m o r i t s m u l t ip u rp o s e ro o m . Harb o rs i d e fo o t edth e b i l l an dp ai d th e s erv ice p ro vi d ers --al l o f wh o m were i n d ep en den tco n tract o rs . Th e t o t al am ou n t s p ai dwere:- 1 2 - Year Am o u n t 2 0 0 7 $ 3 0,2 9 0 2 0 0 8 9 3 ,3 4 1 2 0 0 9 1 1 9,8 8 4 2 0 1 0 1 4 4,4 4 1 2 0 1 1 1 4 1,9 2 6 2 0 1 2 1 5 0,4 6 6 D. Ad m i ni st rat i v e Fu n ct i o ns Harb o rs id e h ado th er em

p l o y ees i n s up p o rtro l es . Th e s ecu ri ty d ep art m en t , fo r ex am p l e, s p en tm o sto f i t s t i m e ch eck i n g i n b o th p at i en t s an dv en d o rs an dth en
es co rt i n g v en d ors i nt o the b acko f t h e b u il d i n g t o m eetwi th a p u rch as i n g m an ag er. Harb o rs i d e’ s h u m an -res o u rces d i rect o r es t i m at edth atth e s ecu ri ty g ro up s p en t 6 0 % o f i t s t i m e ch eck i n g i n p at i en t s wh o cam e t o b u y m ari ju an a, an o th er 5 % ch eck i n g i n p eo p l e o n s i t e t o recei v e a s erv i ce, an d t h e res ti n as s i s t i n g v en d o rs . Harb o rs i d e al s o h ad anad m i n i s trat i v e g ro up , wh i ch i n cl u d edem p l o y ees i n i t s
o m bu d s , 9 fi n an ce, h u m an res o u rces , an dfaci li t ies d ep art m en t s as wel l as i t s
ex ecu t i v es .

9 Th i s i s n o t a t y

p o . It ’ s Harb o rs id e’ s p u n.- 1 3 -

III. Fo rfei tu re Act i o n Al l s eem edwel l u n t il J u ly 2 01 2 , wh en th e fed eral g o v ern m en tfi l eda ci v i l
fo rfei tu re act i o n i n th e U.S. Di s tri ctCo urtfo r t h e No rth ern Di s tri cto f Cal i fo rn i a. Th e l aws u i tal l eg edth at th e p ro p ert y wh i ch Harb o rs i de ren t s an do n wh i ch i t
o p erat es i t s b u s i n es s was s ub jectt o fo rfei ture b ecau s e i twas u s ed t o co m m i tth e d i s tri b u t i o n , cu l t i v at io n , an dp o s s es s i o n o f m ari ju an a i n v io l at i o n o f 2 1 U.S.C.
s ect i on s 8 4 1 (a) 1 0 an d8 5 6
. 1 1 Th e act i o n was d i s m i s s edwi th p reju d i ce i n M ay 2 0 1 6 b y s t i pu l at i o n o f the p art i es . IV. Tax Retu rn s an dAu d i t Th e fo rfei tu re act io n was n ’ t Harb o rs i d e’ s o n l y ru n -i n wi th th e fed eral g o v ern m en t --i t al s o cau g h tth e at t en t io n o f t h e IRS. Recal l th atHarb o rs i d e i s a C
co rp o rat i o n fo r fed eral t ax p u rp o s es wi th t ax y ears en d i ng J u ly 3 1 . Itfi l edFo rm s 1 1 2 0 , U.S. Co rp orat i o n In co m e Tax Return , fo r 2 0 0 7 t o 2 0 1 2 an dl at er am en d ed i t s 2 0 0 7 , 2 0 0 8 , an d 2 0 09 retu rn s . Th es e ret u rn s were s el ect edfo r au di ts th atl edt o

1 0 Ti tl e 2 1 U.S.C. s ect i o n 8 4 1 (a)(1 ) (2 0 1 2 ) s t at es th at“ its h al l b e u n l awfu l fo r an y p ers on kno wi n g l y o r i n t en t i o n al l y * * * t o m an u fact u re, d i s tri b u te, o r d i s p en s e, o r p o s s es s wi th i n t en tt o m an u fact u re, d i s tri b u t e, o r d is pen se, a co n tro l l eds ub st an ce.”

1 1 2 1 U.S.C. s ect i o n 8 5 6 (a)(1 ) s t at es th ati t s h al l b e u n l awfu l t o “ kn o wi n g l y o p en , l eas e, ren t , u s e, o r m ai n t ai n an y p l ace, wh et h er p erm an en t ly o r t em p o rari l y , fo r t h e p u rp o s e o f m anu fact u ri n g , d i s tri bu t i n g , o r u s i n g an y co n tro l leds ub st an ce.”- 1 4 -

th e i s s uan ce o f t h ree n ot i ces o f d efi ci en cy --o n e fo r 2 0 0 7 an d2 0 0 8 , o ne fo r 2 0 0 9
an d 2 0 1 0 , an do ne fo r 2 0 1 1 an d 2 01 2 . Th e n o t i ces d en i edm o s t o f Harb o rs i d e’ s cl ai m edd edu ct i on s an d co s t s o f g o o d s s o l d, an d as s ert edt en s o f m il l i o ns i n d efi ci en ci es an daccu racy -rel at edp en al t ies
. Th e IRS’ s p ri m ary

reas o n fo r i t s ad

ju s t m en ts was th at“ [n ] o d edu ct i o n o r cred i ts h al l b e al l owedfo r an y am o u n tp ai do r i n cu rreddu ri n g th e t ax ab l e y ear i n carry i n g o n a t rad e o r b u s i n es s th atco n si s t s o f t raffi ck i n g i n co n tro l l ed
s ub s t an ces .” Harb o rs id e fi l edt i m el y

p et i t i o n s fo r al l y ears ati ss u e. It s p ri n ci pal p l ace o f b u s i n es s was i n Cal i fo rn i a atal l rel ev an tt i m es , s o ab s en ta s ti p u l at i o n b y th e p art i es th es e cas es are ap p eal ab l e t o th e Ni n th Ci rcu i t. See s ec. 7 4 8 2 (b )(1 )(B). OPINION I. Back g ro u n d Th e CCUA d i d no td ecri m i n al i ze m ari ju an a i n Cal i fo rn i a. See, e.g ., Peo p le
v . Harri s , 5 2 Cal . Rp tr. 3 d5 7 7 , 5 8 2 (Ct . Ap p . 2 00 6 ) (m ari ju an a rem ai n eda
co n tro l l eds ub st an ce u nd er Cal i fo rn i a l aw). Iti n s teadcreat edan affi rm at i v e d efen s e t o ch arg es o f p o s s es si n g o r cu l ti v at i n g m ari ju an a fo r p ers on s wh o d i ds o fo r p ers o n al , p h y s i ci an -ap p ro v edu s e. Cal . Heal th & Safet y Co d e s ec. 1 13 6 2 .5 (d );- 1 5 -

Peo pl e v . Wri g h t, 1 46 P.3 d 5 3 1, 5 3 3 (Cal . 2 0 0 6). Pri m ary careg i v ers o f s u ch p ers o n s co u ldal so rai s e t h e d efen s e. Cal . Heal th & Safet y Co d e s ec. 1 1 3 6 2 .5 (d ). In 2 0 0 3 Cal i fo rn i a en act edth e M ed i cal M ari ju an a Pro g ram

Act(M MPA), al s o kn o wnas Sen at e Bi l l 4 2 0 an dn o w co d i fi edatCal i fo rn i a Heal th an d Safet y Co d e s ect i o n s 1 1 3 6 2 .7 -1 1 3 6 2.8 3 . Th e M MPA ex t en d edth e CCUA’ s affi rm at i v e d efen s e t o ch arg es o f t ran s p o rt i n g m ari ju an a fo r p at ien t s an dp ri m ary careg i v ers wh o “ as so ci at e wi th i n th e St at e o f Cal i fo rn i a i n o rd er co l l ect i vel y o r co o p erat i v el y t o cu l t iv at e m ari

ju an a fo r m ed i cal p u rp o s es .” 1 2 Cal . Heal th & Safet y Co d e s ec. 1 1 3 6 2 .7 7 5 ; Peo pl e v . Urzi cean u , 3 3 Cal . Rp tr. 3 d8 5 9 , 8 8 3 -8 4 (Ct . Ap p . 2 0 0 5 ). It al s o i n s tru ct edCal i fo rn i a’ s at t orn ey g en eral t o d ev el op g u i d el i n es t o “ en s ure t h e
s ecu ri ty an dn o n d i v ers i o n o f m ari ju an a g ro wn fo r m ed i cal u s e.” Cal . Heal th & Safet y Co d e s ec. 1 1 3 6 2
. 8 1 (d ). Th o se g ui d el i n es s tat edth atm ed i cal -m ari ju an a
co o perat i v es s h o u l db e fo rm al ly o rg an ized , n o to p erat e fo r p ro fi t , m ai n t ai n b u s i n es s l i cen s es an dp erm it s , p ay t ax , v eri fy

each m em

b er’ s s t atu s as a p at i en t , ex ecu t e an ag reem en t w it h each m em ber reg ard i n g t h e u s e an dd i s tri b u t io n o f

1 2 Th e M M PA al s o s et p er-p ers o n quan t i ty l im i t s fo r h arv es t edm ari ju an a an d m ari ju an a p l an t s , al th o ug h th e Cal i fo rn i a Suprem e Co u rti nv al i dat edth es e as i m p erm i s s i b le am en d m en ts t o t h e CCUA. Peo p l e v . Kel l ey , 2 2 2 P.3 d1 8 6 , 1 9 7
- 2 0 0 , 2 1 3 -1 4 (Cal . 2 0 10 ). Pat i en t s an dcareg i v ers were t h ereaft er al l o wedt o p o s s es s , cu l t i v at e, o r t ran s p o rtwh at ev er am o u n t o f m ari j u an a was “ reas on ab l y rel at ed t o the p at i en t ’ s cu rren tm ed i cal n eed s . ” Id . at1 8 8 (qu o t i n g Peo p l e v . Tri p p et , 6 6 Cal . Rp tr. 2 d5 5 9 , 5 7 0 (Ct . Ap p . 1 9 9 7 )).- 1 6 -

m ari ju an a, k eep reco rd s o f d i s tri b ut i o n , an dn ei th er b u y m ari ju an a fro m

n o r d i s tri b u t e m ari

ju an a t o n o n m em

b ers . Qu al i fi edPat ien t s As s o c. v . Ci ty o f An ah ei m , 1 1 5 Cal . Rp tr. 3 d8 9 , 9 7 -9 8 (Ct . Ap p . 2 0 1 0 ); Peo p l e v . Ho ch an ad el , 9 8 Cal . Rp tr. 3 d3 4 7, 3 5 6 -5 8 (Ct . Ap p . 2 0 0 9 ); Cal . At t ’ y Gen ., Gu i d el i n es fo r th e Secu ri ty an dNo n -Di vers i o n o f M ari ju an a Gro wnfo r M ed i cal Us e 8 -1 0 (2 0 0 8 ). Fed eral l aw d i d n o t fo l l o w. Th e co nfl i ct b et ween fed eral an ds t at e l aw wen t t o the Sup rem e Co u rti n 2 00 5 wh en two Cal i fo rn i a m ed i cal -m ari ju an a u s ers tri ed t o en jo i n th e U.S. At t o rn ey Gen eral an dth e Dru g En fo rcem en tAg en cy fro m
en fo rci n g fed eral m ari

ju an a l aw ag ai n s t th em . See Go n zal es v . Rai ch , 5 4 5 U.S. 1 , 7 (2 0 05 ). Th e Co u rtup h el d t h e fed eral p ro h i b i t i o n o n m ari ju an a s al e an d p o s s es s i o n wi th res p ectt o m ed i cal -m ari j u an a u s ers , b o th u n d er t he Co m m erce Cl au se, U.S. Co ns t . art . I, s ec. 8 , cl . 3 , an dth e Sup rem acy Cl au s e, U.S. Co n s t . art . VI, cl . 2 . Rai ch , 5 4 5 U.S. at2 2 , 2 9
. On e m i g h tth i n kth e Sup rem acy Cl au s e wo u l d h av e s t i fl edthe s p reado f
s t at e at t em

p t s atl eg al i zi n g wh atrem ai n edi l l eg al u n d er fed eral l aw. Bu to n e
wo u l db e wro n g . An dCo n g res s co m p l i cat edth e s i tu at io n b y

en act in g a s eri es o f ap p ro p ri at io n s ri d ers th at p rev en tth e Dep art m en to f J u s ti ce (DOJ ) fro m u s i n g an y fu n d s “ t o p rev en t* * * [St at es th atp erm i tm ed i cal -m ari ju an a u s e] fro m i m p l em en t i n g th ei r o wn l aws th atau th o ri ze t he u s e, d i st ri b u t i o n , p o s ses s i o n , o r- 1 7 -

cu l t i v at i o n o f m ed i cal m ari ju an a.” Co n s o l i d at edAp p ro pri at i on s Act , 2 0 17 , Pub
. L. No . 1 1 5 -3 1 , s ec. 5 3 7 , 1 3 1 St at . at2 2 8 ; s ee al s o Co n s o li dat edAp p ro p ri at i o n s Act , 2 0 16 , Pub . L. No
. 1 1 4 -1 1 3, s ec. 5 4 2 , 1 2 9 St at . at 2 3 3 2 -3 3 (2 01 5 ); Co n s o l i dat edan d Fu rt her Co n ti n u i n g Ap pro p ri at i o n s Act , 2 0 1 5, Pub
. L. No . 1 1 3- 2 3 5 , s ec. 5 38 , 1 2 8 St at . at2 2 1 7 (2 0 1 4 ). Wh en i n t erp ret i n g s uch a ri d er, t h e Ni n t h Ci rcu i ts ai dthatDOJp ro s ecu ti o n s o f i n d i v i du al s wh o co m p l i edwi th s t at e
m ed i cal -m ari

ju an a l aws i nt erfered wi th th e i m p l em en t at io n o f s u ch l aws an dwere th erefo re i m

p erm is s i b l e. Un it edSt at es v . M cIn t os h , 8 3 3 F.3 d1 1 63 , 1 17 7 -7 8 (9 t h- 1 8 -

Ci r. 2 0 16 ). 1 3 So , m ed i cal m ari ju an a i s i l leg al u n d er fed eral l aw, b u t the s t atu t es cri m i n al i zi n g i tm ay

n o t b e en fo rced --atl eas t n otb y th e DOJ
. Bu tth e IRS i s p arto f t h e Dep art m en t o f th e Treas u ry , an d m ari ju an a s el l ers
m u sts t i l l co n t en dwi th t h e Co d e. Here t h ei r m ajo r p ro b l em i s s ect i on 2 8 0 E , wh i ch p rev en ts an y

trad e o r b u s i n es s th at“ co n s i s t s o f traffi ck i n g i n co n tro ll ed
s ub s t an ces ” fro m

d edu ct i n g an y

b u s i n es s ex p en s es . Co n gres s en act edth i s s ect i o n i n 1 9 8 2 as a res p on se t o o ur d eci s i o n i n Edm o nd s on v . Co m m i s s i o n er, T.C. M em o. 1 9 8 1 -6 2 3 , wh ere we al l o weda co cai n e d eal er t o d eductth e o rd i n ary an dn eces s ary
ex p en s es o f h is i l li ci ttrad e. See S. Rep t . No . 9 7 -4 9 4 , at3 09 (1 9 8 2 ), 1 9 82

1 3 No t e as wel l th atth es e ap p ro p ri at i o n s ri d ers l i m i tDOJp ro s ecu t i o n s o f act i vi ty thatwo u l db e l eg al u n der medi ca l -m ari ju an a l aws . Th i rt y -t h ree s tat es n o w al l o w m ed i cal m ari

j uan a u s e: Al as k a, Ari zo n a, Ark an sas , Cal ifo rn i a, Co l orad o, Co n n ect i cu t, Del aware, Fl o ri d a, Hawai i , Il l in o i s , Lo u is i an a, M ai n e, M ary l an d , M as sach u set ts , M i ch i g an , M i n nes o t a, M i s s o uri , M o nt an a, Nev ad a, New Ham

p s h i re, New J ers ey , New M ex i co , New Yo rk , No rt h Dak o t a, Oh i o , Ok l ah o m a, Oreg o n , Pen n s y l v an i a, Rh o d e Is l an d, Ut ah , Verm o nt , W as h i n gt o n , an d W es tVi rg in i a. Nat ’ l Co n feren ce o f St at e Leg i s l atu res , St at e M ed i cal M ari ju an a Laws , Tb l . 1 (l as t up d at edNo v . 8 , 2 0 1 8 ), h t tp : //www.n cs l .o rg /res earch /h eal th / s t at e-m ed i cal -m ari

j u an a-l aws .as p x . So d o th e Di s tri cto f Co l u m b i a, Gu am , an d Pu ert o Ri co . Id . Th i rt een s t at es p erm i t m ed i cal u s e o f s o m e l o w-p o t en cy m ari ju an a p ro du ct s : Al ab am a, Geo rg i a, Io wa, In d i an a, Ken tu cky , M i s s is s i p p i , No rt h Caro l i n a, So u th Caro l i n a, Ten n es s ee, Tex as , Vi rg i n i a, W i s co n s i n, an d Wy o m i n g . Id . Tb l . 2
. Al as k a, Cal i fo rn i a, Co l o rad o , M ai ne, M as s ach u s et t s , M i ch i g an , Nev ad a, Oreg o n , Verm o n t , W as hi ng t o n , th e Di s tri cto f Co l u m b i a, an dth e No rt h ern M ari an a Is l an d s h av e rep eal edb an s o n recreat i on al m ari ju an a u se. Id . Tb l . 1 . No cas el aw o n h o w th es e ap p ro p ri at i o n s ri d ers wi l l affect fed eral en fo rcem en to f fed eral l aw i n th es e s t at es h as y etem erg ed
.- 1 9 -

U.S.C.C.A.N. 7 8 1 , 1 0 5 0 . In 1 9 8 6 n ew u n i fo rm cap i t al i zat i o n (UNICAP) ru l es
u n d er s ect i o n 2 6 3 A rai s edth e p o s s ib i li ty th at traffi ck ers o f co n tro l l eds ub s t an ces
co u ldcap i t al i ze i n d i rect i n ven t o ry co s t s t h ats ect io n 2 8 0 E p rev en t edth em fro m d educt i n g as ex pen s es . See Tax Refo rm Acto f 1 9 8 6 (TRA), Pub . L. No . 9 9 -5 1 4 , s ec. 8 0 3, 1 00 St at . at2 3 5 0
. Bu ti n 1 9 8 8 Co n g res s am en deds ect i o n 2 6 3 A(a)(2 ) t o
s ay thatt ax p ay ers co u l dn ’ tcap i t al i ze co st s th atwere o th erwi se n o n d educt i b l e. See Tech n i cal an dM i s cel l an eo u s Rev en u e Acto f 1 9 88 (TAM RA), Pub . L. No
. 1 0 0 -6 4 7 , s ec. 1 0 0 8 (b )(1 ), 1 0 2 St at . at3 4 3 7 . It ’ s wi th in th i s co n fu s i n g l eg al
en v iro n m en tth atHarb o rs i d e o p erat ed
. Gi v en th i s s t at e o f t h e l aw i t’ s p erh ap s n o ts u rp ri s i n g th atHarb ors i d e i s n ’ t th e fi rs tm ari

ju an a d i s p en sary to ap p ear i n o u r Co u rt . Ino ur fi rs tm ajo r m ed i cal
m ari ju an a cas e, we fo u n d th at th e t ax p ay er o p erat edtwo s ep arat e t rad es o r b u s i n es s es --o n e t h at p ro v i d edcareg i v i n g s erv i ces an do n e t h ats o l d m ari ju an a. CHAM P, 1 2 8 T.C. at1 8 3 -8 4 . W e t h erefo re req u i redth e t ax p ay er t o al l o cat e i t s
ex p en s es b et ween i t s t wo b u s i n es s es acco rd i n g t o th e num b er o f i ts em

pl o y ees an d th e p o rt i o n o f i t s faci l i ti es d ev o t edt o each . Id . at1 8 5
. W e al lo wedi tt o d edu ctth e
ex p en s es th ati tp ro p erl y

al l o cat ed t o i t s careg i v i n g b u s i n es s, b u tn o t th o s e al l o cat edt o i ts m ari

ju an a-s al es b u s i n es s . Id . at1 7 3-7 4
.- 2 0 -

In o u r n ex tm ed i cal -m ari

ju an a cas e, Ol i v e v . Co m m i s s i o n er, 1 3 9 T.C. 1 9 , 4 2 (2 0 1 2), aff’ d , 7 9 2 F.3 d1 1 4 6 (9 th Ci r. 2 0 15 ), we h el dth ata d i s p en s ary that d eri v edal l i t s rev en u e fro m m ari ju an a s al es b utal s o p ro v i d edfree act i v it i es an d
s erv i ces t o i t s p at ro n s was b u ta s i n g l e t rad e o r b us i n es s . Becau s e t h ats i n g l e t rad e
o r b u si n es s was s el l i ng m ari ju an a, we al s o h el dth at s ect io n 2 80 E p recl u d edth e d educt i o n o f an y

o f the t ax p ay er’ s o perat in g ex p en s es , b u td i dn o tp rev en tth e t ax p ay er fro m

ad ju st i n g fo r co s t s o f g o o d s s o l d , i d
. at3 2 -3 6 , 3 8 n .1 9 . An d i n Can na Care, In c. v . Co m

m i s si o n er, T.C. M em o . 2 01 5 -2 0 6, at * 12 , aff’ d , 6 9 4 F. Ap p ’ x 5 7 0 (9 th Ci r. 2 0 1 7 ), we fo u n dth atth e t ax p ay er--wh i ch s t i p u l at edth ati t
was “ i n th e b u s i n es s o f d i st ri b u t i n g m ed i cal m ari ju an a”--was en g ag edi n o ne t rad e
o r b u si n es s b ecau s e i ts s al e o f n o n m ari ju an a i tem s s u ch as b o o ks an ds o ck s “ was
an act i v i ty

i n ci d en t t o i t s b u s i n es s o f d i s tri b u t i n g m ed i cal m ari ju an a.” W e th erefo re h el dth ats ect i on 2 8 0 E b an n edd edu ct io n s fo r an y o f i t s b u si nes s
ex p en s es . Id . at * 1 3
. Wh i l e Harb o rs i d e rai ses s o m e o f t h e s am e i s s u es we ad dres s edi n th es e
cas es , i t al s o p res en t s s o m e n ew o n es . Here we are as kedt o d eci d e

• wh et her r es j u di ca ta p recl u d es th e Co m m i s s i o ner fro m

arg u i n g Harb o rs id e was en g ag ed i n t raffi ck i n g i n a co nt ro l l eds ub s t an ce;

• wh et her Harb o rs i d e’ s b u s in es s “ co n s i s ts o f” t raffi ck i n g i n a co n tro ll eds ub st an ce u n d er s ect i o n 2 80 E;- 2 1 -

• wh et her Harb o rs i d e h as m o re t h an o ne t rad e o r b us i n es s ;

• wh at Harb o rs i d e m ay i n cl u d e i n i t s co s t o f g oo d s s o l d ; an d

• wh et her Harb o rs i d e i s l i ab le fo r accu racy -rel at edp en al t i es . W e wi l l t ak e each i n tu rn . II. Res J u d icat a Harb o rs id e fi rs targ u es th at r es j u di ca ta i s a co m p l et e d efen s e t o i t s t ax
wo es . It s p o s i t i o n i s th atth es e cas es an dthe 2 0 1 2 ci v il -fo rfei ture act i o n are al l b as edo n th e s am e cl ai m --t h atHarb o rs id e was traffi ck i n g i n a co nt ro l l ed
s ub s t an ce. Itarg u es thatth e U.S. at t o rn ey ’ s d eci s i o n t o d i sm i s s th e fo rfei tu re act i on wi th p reju d i ce m ean s th atas a m at t er o f l aw Harb o rs i d e was n o ta dru g traffi ck er an d can no tb e s ub jectt o s ect i o n 2 8 0 E. Res j u di ca ta --o r cl ai m

p recl u s io n --i s an affi rm at i v e d efen se t h atb ars s u i t s
o n th e s am e cau se o f act i o n , an di td o es ap p l y t o t ax l i t i g at i o n . See Ru s s el l v . Co m m i s s i o n er, 6 7 8 F.2 d7 8 2 , 7 8 5 -8 6 (9 th Ci r. 1 9 82 ); Ko pro ws k i v . Co m m i s s i o n er, 1 3 8 T.C. 5 4 , 5 9 -6 0 (2 0 1 2 ). Th e ru l e i s eas y t o s t at e: [W ] h en a co urto f co m

p et en tjuri s d i ct i o n h as en t ereda fi n al ju d g m en t o n th e m eri ts o f a cau s e o f act i o n , th e p art i es t o th e s u i t an dth ei r p ri v ies are t h ereaft er b o un d“ n o t o nl y as t o ev ery

m at t er wh i ch was o ffered an drecei v edt o s u s t ai n o r d efeat th e cl ai m o r d em an d, b u tas t o an y o th er ad m i s s i b l e m at t er wh i ch m i g h t h av e b een o ffered fo r t h at p u rp o s e.”- 2 2 -

Co m m i s s i o n er v . Su nn en , 3 3 3 U.S. 5 9 1 , 5 9 7 (1 9 48 ) (qu o t i n g Cro m wel l v . Co u n t y
o f Sac, 9 4 U.S. 3 5 1 , 3 5 2 (1 87 6 )). To s u cces s fu ll y as s erta r es j ud i ca ta cl ai m , Harb o rs i d e wo u ldh av e t o cl ear t h es e h u rd l es :

• an i d en t it y

o f cl ai m s b et ween th e act i o n s ;

• p ri v it y

b et ween th e p art ies i n th e act i o n s ; an d

• a fi nal ju d g m en to n th e m eri t s i n th e ci v i l -fo rfei tu re act i o n . See Tah o e-Si erra Pres . Co u n ci l , In c. v . Tah o e Reg ’ l Pl an n i ng Ag en cy , 3 2 2 F.3 d 1 0 6 4 , 1 0 7 7 (9 th Ci r. 2 0 0 3 ). W e t h i nkHarb o rs id e s m as h es ri g ht i nt o th e fi rs t . Fo r t h ere t o b e an i d en t i t y
o f cl ai m s , two cas es m

u s t“ ari se o u to f th e s am e t ran s act i o n al n u cl eu s o f fact s .” Cen t. Del t a W at er Ag en cy v. Un i t edSt at es , 3 0 6 F.3 d9 38 , 9 5 2 (9 th Ci r. 2 0 0 2 ) (qu o ti n g Fu n d fo r An i m al s v . Lu jan , 9 6 2 F.2 d1 3 9 1 , 1 3 9 8 (9 th Ci r. 1 99 2 )). 1 4 Th i s al m o s tal way s m ean s th at r es j ud i ca ta ap p l i es o nl y wh en th e s eco ndcl ai m

co u ld h av e b een as s ert edi n th e p rev i o u s act i o n . See Tah o e-Si erra Pres . Co u n ci l , 3 2 2 F.3 dat 1 07 8 ; Sawy er Tr. o f M ay 1 9 9 2 v . Co m

m i s s i o n er, 1 3 3 T.C. 6 0 , 7 7-7 8

1 4 Oth er q u es t i o n s thataffect a d eci s i o n ab o u twh et h er two cl ai m s s h are a s i ng l e i d en t i ty

are wh et h er: (1 ) “ ri g h t s o r i n t eres t s es t ab l is h ed i n th e p ri or ju d g m en two u l d b e d es tro y ed or i m p ai redb y p ro secu t i o n o f t h e s eco n dact i o n ; ” (2 ) “ sub s t an t ial l y

th e s am e ev i d en ce i s p res en tedi n th e t wo act i o n s ; ” an d(3 ) “ t h e two s ui t s i nv o l v e i n fri n g em en t o f t h e s am e ri g h t .” Cen t . Del t a W at er Ag en cy , 3 0 6 F.3 dat 9 52 n .1 1 (quo t i n g Fu n dfo r An im al s , 9 6 2 F.2 dat1 3 9 8 ).- 2 3 -

(2 0 0 9). Harb o rs i d e’ s cas es h ere are ab o u ti t s t ax d efi ci en ci es , an dth e p art i es ag ree t h atth e g o v ern m en t co u ldn o t h av e b ro ug h ts u ch act i o n s as p arto f t h e ci v il
fo rfei tu re cas e i n d is tri ctco u rt . Harb o rs id e i ns i s t s , h owev er, t h i s d o es n ’ t m at ter an d p o i n ts t o Un i t edSt at es
v . Li qu id at o rs o f Eu ro pean Fed . Cred i tBan k, 6 3 0 F.3 d1 13 9 (9 th Ci r. 2 0 1 1 ). In Li qu id at o rs , th e Ni n th Ci rcu itex p l ai n edth ati n m os tcas es th e an s w er t o th e qu es ti o n o f wh et h er t wo cas es s h are t h e “ s am e t ran s act io n al n ucl eu s o f fact s ” wi l l b e s yn o n y

m o u s wi th th e qu es t io n o f wh et h er th e co n t es t edcl ai m i n th e s eco n d
cas e co u ldh av e b een b ro u gh t i n th e fi rs t . Id . at1 1 5 1 . Bu ti tfo u n dan ex cep t i o n wh en i tl o o k edcl o s el y

atfo rfei tu re act i o ns , an d i th el dthat r es j ud i ca ta b arred a l at er cri m i nal -fo rfei tu re cl ai m ag ai n s tth e s am e p ro p ert y th ath adb een th e o b

ject
o f an earl i er ci v i l -fo rfei tu re cas e. Id . at1 1 5 1-5 2 . It reas o nedth atth e two ty p es o f fo rfei tu re act i o n s al way s s eekex act l y th e s am e res u l t , ari s e fro m ex act l y th e s am e fact s, an do ffer t h e g o vern m en ttwo p at h s t o reach th e s am e g o al
. Id . at1 1 5 2 (wh ich m i g h th av e l edo ne t o th i n kth atth e d o ct ri ne t o ap p l y was “ el ect i o n o f
rem ed y ” rat h er t han res j u di ca ta ). Bu twh et h er o n e l o o k s atth i s p u zzl e as o n e o f el ect io n o f rem ed y o r r es j u di ca ta d oes n ’ tm at t er h ere. Th e fo rfei ture act i o n i n d i s tri ctco u rts o u g h tju s t th at --t h e fo rfei tu re o f t h e p ro p ert y l eas edb y

Harb o rs i d e-- wh ereas th es e cas es s eekt o i m p o s e a ci vi l t ax l i ab i l i ty . An dwh i l e t h e t wo act i o ns- 2 4 -

s h are s o m e o f t h e s am e fact s , they are n o t --u n l i k e ci v i l an d cri m in al fo rfei tu re-- d i fferen t p at hs t o th e s am e g o al . W e wi l l th erefo re d ecl i n e t o ex t en dLi qu i d at o rs b ey o n d the “ p ecu li ari t i es o f t h e fo rfei tu re co n t ex t.” See Un i t edSt at es v . W an l an d , 8 3 0 F.3 d9 4 7, 9 5 7 (9 th Ci r. 2 0 16 ). In s t ead we h o l dth at th es e d efi ci en cy cas es
co u ldn o th av e b een rai s edi n th e s am e cas e, an dd i dn o tari s e fro m the s am e tran s act io n al n ucl eu s o f fact . Id en t i ty o f cl ai m s d o es n o tex i s t h ere an d r es j u di ca ta d o es n o tb ar t he Co m m i s s i o n er’ s d efi ci en cy

act i o n s . See Sawy er Tr., 1 3 3 T.C. at7 8
. III. Sect io n 2 8 0 E Th e Co d e al l o ws a b us i nes s t o d edu ctal l o f i ts “ o rd i naryan dn eces s ary
ex p en s es p ai d o r i n cu rreddu ri n g the t ax ab l e y ear i n carry in g o n an y trad e o r b u s i n es s .” Sec. 1 6 2(a). Bu ti tal s o h as ex cep t i o n s, o ne o f wh i ch i s s ect i o n 2 8 0 E. See Ol i v e, 7 9 2 F.3 dat1 1 48 (n o t i n g th ats ect io n s 2 6 1 th ro u g h 2 8 0 H l i s t“ It em s No t Dedu ct i bl e”). Sect i o n 2 8 0 E s tat es : No d edu ct i on o r cred i ts h al l b e al lo wedfo r an y am o u ntp ai do r i n cu rreddu ri n g th e t ax ab l e y ear i n carry i n g o n an y trad e o r b u s in es s i f s u ch trad e o r b u s in es s (o r t h e act iv i t i es wh i ch co m p ri s e s uch trad e o r b u s i n es s ) co n sis t

s o f traffi ck i n g i n co nt ro l l eds ubs t an ces (wi th i n th e m ean i ng o f s ch edu l e I an dII o f t h e Co n tro l l edSubs t an ces Act ) wh i ch i s p ro h ib it edb y

Fed eral l aw o r t h e l aw o f an y St at e i n wh i ch s u ch trad e o r b u s i nes s i s co n du ct ed . [Em p h as i s ad ded .]- 2 5 -

M ed i cal m ari

ju an a i s a Sch edu l e I co n tro ll ed s ub s t an ce, an dd i sp en s in g i tp u rs u an t t o the CCUA i s “ traffi ck i ng ” wi th in th e m ean i n g o f s ect i o n 2 8 0 E. See CHAM P, 1 2 8 T.C. at1 82 -8 3 ; Beckv . Co m m i s s i o n er, T.C. M em o . 2 0 1 5 -1 4 9 , at* 1 5 . Bu t Harb o rs i d e as k s u s t o fo cu s o n th e t wo wo rd s t h atwe’ v e i tal i ci zedab ov e: Wh at d o es itm ean fo r a b u s in es s t o co n s ist o f traffi ck in g ? Harb o rs id e arg u es th at“ co n s i s t s o f” m ean s an ex hau s t iv e l i st --o r i n o th er
wo rd s th ats ect i o n 2 8 0 E ap p li es o n ly t o b us i n es s es that excl us i vel yo r so l el ytraffi c i n co n tro l l eds ub s t an ces an dn ott o th o s e t h at al s o en g ag e i n o th er act iv i ti es . Th e Co m m i s s i o n er arg u es th ata s i n g l e t rad e o r b u s i n es s can h av e s ev eral act i v i t i es an d th ats ect i o n 2 8 0 E ap pl i es t o an en t i re t rad e o r b u s i nes s i f an y o n e o f i t s act iv i t i es i s traffi ck i ng i n a co n tro l l eds ub s t an ce. Bo th p art i es s ay th ei r i n t erp ret at i o n s m at ch
o th er Co d e s ect i o n s’ u s e o f “ co n s i s t s o f” an db es tfi t s ect i o n 2 8 0 E’ s p u rp o s e. W e’ v e s een Harb o rs i d e’ s arg u m en tb efo re. In Ol i v e, 1 3 9 T.C. at 3 9 , th e t ax p ay er m ad e a n earl y

i d en t ical arg u m en t , wh i ch we cu rs o ri l y reject ed
. 1 5 An d , o n ap p eal , th e Ni n th Ci rcu i tfo cu s edo n th e t ax p ay er’ s m i s u s e o f CHAM P. See Ol i v e, 7 9 2 F.3 dat1 1 4 9 -5 0 . W e co u l ds to p th ere wi th a n o dt o s ta r e d ecis is , b u tth e p art i es arg u e t h e ques t i o n atg reat l en g th an d , g i v en th e i m p o rt an ce o f t h es e cas es

1 5 W e n o t e t h atth is p arto f Harb o rs i d e’ s b ri ef rep eat s v erb at i m p art o f t h e t ax p ay er’ s b ri ef i n Ol i v e.- 2 6 -

t o the i n du s try , we wi l l s i m i larl y ex p l ai n o ur reas o ni n g at g reat er l en g th th an we d i dwh en we fi rs tco n s i d eredi t. A. St atu t o ry

In t erp ret at i o n Harb o rs id e b eg i n s wi th an ap p eal t o th e “ o rd i n ary , ev ery d ay u s ag e” o f t h e p h ras e. An dwe d o ag ree t h atHarb o rs i d e i s ri g h tab o u t th e m ean in g o f “ co n s i s t s
o f” i n ev ery day u s e: Fo r ex am p l e, o n e s ay s “ T h e AFC Eas t co n s is t s o f th e Bi l l s , Pat ri ot s , J et s , an dDo l p h i n s ,” an dan y o n e fl u en ti n En g l i s h wo ul du nd ers t an dth at t o m ean th atth o s e are b o th al l , an d th e o nl y , t eam s i n thatd i v i s i on . Harb o rs i d e al s o h as s o m e ex cel l en ts eco n darys o u rces b eh i n d i to n th i s p o in t . See, e.g ., An t on i n Scal i a & Bry an A. Garn er, Read i n g Law: Th e In t erp ret at i o n o f Leg al Tex ts 1 3 2 (2 0 1 2 ) (co n tras t i n g “ i n cl u d es ”, wh i ch s et s o ff a n o n ex h au s t i v e l i s t , wi t h

“ co n s i s ts o f” o r “ co m

p ri ses ”, each o f wh i ch g en eral l y i nt ro duces an ex h au s t i v e l i st ); Bl ack ’ s Law Di ct i o n ary 2 7 9 (5 th ed . 1 9 7 9 ) (ex p l ai n i ng th at“ co ns i s ti ng ” “ i s
n o ts yn o nym o u s wi th ‘ i n cl ud i n g ’ ” b ecau se “ i n cl u di n g ”, wh en u s edi n co n nect i o n wi th a n u m

b er o f s p eci fi ed o b

ject s , al way s co n n o t es i n co m p l et en es s). Th i s m i g h t
s eem as th o u g h i ts h ou l db e t h e en do f o u r an al y s i s --aft er al l , “ [t ] h e o rd i n ary m ean i n g ru l e i s th e m o s t fu n d am en t al s em an t i c ru l e o f i nt erp ret at i o n.” Scal i a & Garn er, s up ra, at6 9
.- 2 7 -

An o th er fu n d am en tal can o n o f co ns tru ct i o n , h o wev er, t el l s u s t o p refer t ex tu al l y p erm i s si b le read i n g s th atd o n ’ tren d er a s t atu t e i n effect i v e. 1 6 Id . at6 3 (ci t i n g Ci t i zen s Ban ko f Bry an v . Fi rs tSt at e Ban k , 5 8 0 S.W .2 d3 4 4, 3 4 8 (Tex
. 1 9 7 9 ) (“ [I] f th e l an gu ag e i s s us cep t i b l e o f t wo co n s tru ct i o n s, o n e o f wh ich wi l l carryo u tan d t h e o th er d efeat * * * [t h e s t atu te’ s ] o b ject , i t s ho u ldrecei v e t h e fo rm er co n s tru ct i o n .”)). Fo l lo wi n g th e m o s t co m m on u s ag e o f “ co n s i st s o f,” as Harb o rs i d e s u g ges t s , wo u l di nd eedm ak e s ect io n 2 80 E i n effect iv e. If t h ats ect i o n d en ies d edu ct i o n s o n l y

t o b u si n es s es th at excl u s ivel y traffi c i n co n tro l l ed
s ub s t an ces , th en an y

s treet -l ev el dru g d eal er co u l dci rcu m v en t i tb y s el l i n g a s i n g l e i t em th at was n ’ ta co n tro ll eds ub s t an ce--l i k e a p ack o f g um , o r ev en dru g p arap h ern al i a s uch as a h y p o d erm i c n eed l e o r a g l as s p i p e. Th i s read i n g wo u l d ed g e u s cl o s e t o ab s u rd i ty , wh i ch i s an o th er res u l to u r read i n g o f a s t atu t e s h o u l d
av o idi f p o s s i b l e. See i d . at2 3 4 -3 5
. On e m i g h ti m ag i n e--as a s tri ct l y theo ret i cal m at t er--t h ata l eg i s l atu re m i g h t
en actan ab s u rd i ty , an do u r jo b as ju d g es wo u l db e t o en fo rce i t . Bu t th e Co m m i s s i o n er rem i n ds u s th at we s h o u l dn ’ td o s o i f t h ere i s an effect i v e-an d -n o t ab s u rdm ean i n g th at i s al s o p erm i ss i b l e. W e m u s tb o th av o id“ a s t eri l e l i t eral i s m

1 6 Wh en can o n s o f co n s tru ct i on co m p et e wi th o n e an o th er, we m us td eci d e wh i ch i s m o s tap p ro p ri at e u n d er t h e ci rcu m s t an ces . See An t o n i n Scal i a & Bry an A. Garn er, Read i n g Law: Th e In t erp ret at i o n o f Leg al Tex ts 5 9 (2 0 12 ).- 2 8 -

wh i ch l o s es s i g h to f t h e fo res tfo r t h e t rees ” an dm ai n t ai n “ a p ro per s crupl e ag ai n st i m p u t i n g m ean i n g s fo r wh ich th e wo rd s g i v e n o warran t .” N.Y. Tr. Co . v . Co m m i s s i o n er, 6 8 F.2 d1 9 , 2 0 (2 dCi r. 1 93 3 ) (L. Han d , J .), aff’ ds ub n o m . Hel v eri n g v . N.Y. Tr. Co ., 2 9 2 U.S. 4 5 5 (1 9 34 ); s ee al s o Scal i a & Garn er, s up ra, at3 5 6
. Bu tcan “ co n s is t s o f” ev er i n tro du ce a n o n ex h au s ti v e l is t? 1
. Di ct io nari es Harb o rs id e s ay s “ n o ”, an du rg es u s t o t ak e a h i n tfro m th e fo urt h ed i t i o n o f th e Am eri can Heri t ag e Di ct i o n ary . Harb o rs i d e quo t es a u s ag e n o te i n th e en try fo r

“ i n cl u d e”. See Am eri can Heri t ag e Di ct i on ary 8 8 7 (4 th ed . 2 0 0 6 ). Th e n o t e
ex p lai n s th at“ in cl u d e” co n no t es , b u td o es n o tn eces s ari l y m ean , thata l i s t i m m ed i at el y fo l l o wi n g i ti s i nco m

p l et e. Id . Ital so s u g g es t s th atau tho rs i n tro du ci n g ex h au s t i v e l i s t s u s e “ co m p ri s e” o r “ co n s i s to f” i ns t ead . Id . Itd o es n ’ t
s ay , h o wev er, t h at“ co n s i s t s o f” n eces s ari l y i n tro du ces an ex h au s t i v e l i s t . See i d
. An dthe d i ct i o n ary ’ s d efi n i t i on o f “ co n s i s t ” i s “ [t ] o b e m ad e up o f o r co m p o s ed ,”

“ [t ] o h av e a b as i s ; res id e o r l i e,” o r “ [t ] o b e co m p at ib l e.” Id . at3 9 2
. Harb o rs id e’ s o ther d i ct i o n ary ci t at io n i s s i m i l arl y am

b i gu o u s . An o ld ed i t i o n o f Bl ack ’ s Law Di ct i o n ary d efi n es “ co ns i s t i n g ” as “ [b ] ei n g co m p o sedo r- 2 9 -

m ad e up o f.” Bl ack ’ s Law Di ct i o n ary 2 79 (5 th ed
. 1 9 7 9). 1 7 Ital so ex p l ai ns th at

“ co n s i s ti n g ” i s n o ts yn o nym o u s wi th “ in cl u di n g ” b ecau s e “ i n cl u d i n g ” al way s
co n no t es i n co m

p l et en es s, an d“ co n s i s t i n g ” d o es n’ t . Id . Th e en try d o es n’ ts ay

th at

“ co n s i s ti n g ” an d“ i n cl u d i n g ” are an t o n ym s; th at i s , al th o u g h “ co n s i s t i n g ” d o es n ’ t
co n no t e an i n co m

p l et e l i s t , i tal s o d o es n ’ t co n n o t e an ex h au s t i v e l i s t . Id . An d
ev en if “ co n s i s t i n g ” were t h e an t o n ym o f “ i n cl u d i n g”, t h atwo u l d m ean o n ly th ati t
co n no t es co m

p l et en es s--n o t th ati tn eces s ari l y mea n s co m p let en es s. Harb o rs i d e d o es n’ tm en t io n i t, b utth e s am e d ict i o naryal s o d efi n es “ co n s i s t ” as “ [t ] o s t an d t o g et h er, t o b e co m

p os edo f o r m ad e up o f.” Id
. Harb o rs id e ev en p o i n t s u s t o an o d do p in i o n th atci tes a p recu rs o r o f t h e Ox fo rd En g l i s h Di ct io nary 1 8 thats ay s “ ‘ [c] o n s i s t i n g o f’ can h av e t h e m ean i n g o f

‘ to h av e i t s es s en t i al ch aract er i n ’ o r ‘ fo un d at io n i n .’ ” M ad i s o n Teach ers , In c. v . M ad i s o n M et ro . Sch . Di s t ., 5 4 1 N.W .2 d7 86 , 8 0 1 (W i s . Ct . Ap p . 1 9 95 ) (Su n db y , J ., co n cu rri n g i n p art an dd i s s en t i n g i n p art ) (ci t i n g IIC A New En g l i s h Di ct i o n ary

1 7 Th e s ev en th , ei g h th, an dn i n th ed i t i o n s o f Bl ack ’ s Law Di ct i o n ary d o n ’ t d efi n e “ co ns i s t i ng ” atal l
. See Bl ack ’ s Law Di ct i o n ary 3 0 3 (7 th ed . 1 9 9 9 ); Bl ack ’ s Law Di ct i o n ary

3 2 7 (8 th ed . 2 00 4 ); Bl ack ’ s Law Di ct i on ary 3 5 0 (9 th ed . 2 0 0 9 ). Th e t en th ed i t i o n d efi n es “ co n s i s t in g o f,” b uto n ly fo r t h e s p eci al i zedp u rp o s es o f p at en tl aw. Bl ack ’ s Law Di ct i o n ary 3 7 3 (1 0t h ed . 2 0 1 4).
1 8 See OED, Hi s t ory

o f t h e OED, h t tp ://p ub li c.o ed .co m /h i st ory -o f-t h e-o ed/ (l as t v is i t edNo v . 2 , 2 0 1 8 ).- 3 0 -

o n Hi st o ri cal Pri n ci p l es 8 6 1 -6 2 (1 8 9 3 )). 1 9 Th e t ak eaway h ere i s th atn o n e o f t h e d i ct i o n ary

d efi n i t i o n s t h atHarb o rs i d e p ro v i d es p recl u d e read i n g “ co n s i s t s o f” as
s et t i n g o ff a n o n ex h au s t iv e l is t .

2
. Th e Co d e Bu tth i s i s a t ax cas e, an db efo re we g o t o o far afi el di n d i ct i on ari es o r l i terat u re, we s h ou l ddraw b ackt o o th er s ect i o n s o f t he l aw we h av e t o ap p l y t o th es e cas es . See, e.g ., Un it edSt at es v . Ol ym p i c Rad i o & Tel ev i si on , In c., 3 4 9 U.S. 2 3 2 , 2 3 6 (1 9 5 5 ) (i n t erp ret i n g p h ras e co n s i s t en t l y wi th i n Co d e ch ap t er an d
s ay i ng co u rt s s h o u l d g i v e Co de “ as g reat an i n t ern al s ym m et ry an d co n s is t en cy

as i t s wo rd s p erm i t ”). Bu ts ee Ut i l . Ai r Reg u l at o ry Grp . v . EPA, 5 73 U.S. , , 1 3 4 S. Ct . 2 4 2 7 , 2 4 4 1 (2 0 1 4 ) (“ th e p res u m p t i o n o f co n s i st en tu s ag e ‘ read i l y y i el d s ’ t o co n t ex t ” (q u ot i n g En v i ro n m en tal Defen s e v . Du k e En erg y Co rp ., 5 4 9 U.S. 5 6 1 , 5 7 4 (2 0 0 7 ))). Wh at d o es th e Co de i t s el f t el l u s ab o u t h o w t o read

“ co n s i s ts o f”?

1 9 See, e.g .,W i l l iam

Sh ak es peare, Th e M erch an to f Ven i ce act 3 , s c. 3 (“ Th e du k e can n o td en y th e co u rs e o f l aw: /Fo r t h e co m m o d i ty thats tran g ers h av e / W i th u s i n Ven i ce, i f i tb e d en ied , /W i l l m u ch i m p each th e ju s t i ce o f h i s s t at e; / Si n ce t h atth e t rad e an d p ro fi to f t h e ci ty /Co n s i s t et h o f al l n at i o n s ” -- Ven i ce b ei n g o p en t o fo rei g n trad e, o r d ep en d i n g o n fo rei g n trad e, b u tn o tl i t eral l y trad i n g wi th ev ery

n at i o n i n th e wo rl d .)- 3 1 -

Th ere are s o m e s i m i l ar p h ras es . Sect i on 4 0 1 (a)(2 2) s ay s th ati f m o re th an 1 0 % o f t h e as s et s i n anem p l o y ee’ s d efi n ed -co n tri b u t i o n p l an acco u ntare s t o cki n h i s cl o s el y

h el dem pl o y er, s ect i o n 4 0 9 (e)’ s v o t i n g -ri g h t s ru l es d o n ’ tap p l y s o l o n g
as “ th e t rad e o r b u s i n es s o f s u ch em p lo y er co n si s t s o f p ub l i s h in g o n a reg u l ar b as i s
a n ews p ap er fo r g en eral ci rcu l at i o n .” Sect i on 4 5 1 (i )(3 )(B) p ro v i d es an o p t i o n al
ru l e fo r d et erm i n i n g i n wh aty ear i n co m e i s real izedfo r “ an y s t ocko r p art n ers h i p i n t eres ti n a co rp o rat i o n o r p art n ers h i p * * * wh o s e p ri n ci p al trad e o r b u s i n es s
co n si s t s o f p ro v id i n g el ect ri c t ran s m i s s i o n s erv i ces .” An ds ect i o n 5 1 3 (h )(1 )(B)
ex cl u d es fro m

th e d efi n i t io n o f u nrel at edtrad e o r b u s i n es s “ an y trad e o r b u s i n es s wh i ch co n s i st s o f” ex ch an g in g o r ren t i n g d o no r an dm em b er l i s t s am o ng
n o np ro fi t s . W e h av en ’ t fo u n dan y cas es co n s tru i n g wh at“ co ns i s t s o f” m ean s i n
an y o f t h es e s ect i o n s . Harb o rs id e p o in t s o u tth ati n m an y Co d e s ect i o ns Co n g res s u s edth e p h ras e

“ co n s i s ts o f” b u tth en m od i fi edi t --as i td i d i n th e el ect ri ci ty -rel at eds ect i o n ab o v e --t o cl ari fy

th ati td o es n ’ tm ean “ i s co m p o seden t i rel y

o f.” See, e.g ., s ec. 5 8 1 (“ a
s ub s t an t i al p arto f t h e b u s i n es s o f wh i ch co n si st s o f”); s ec. 1 8 1 (e)(2 )(E) (ad d edb y th e Co n s o l i d at edAp p ro p ri at i o n s Act , 2 0 1 6 , s ec. 1 69 (c), 1 2 9 St at . at3 0 67 (“ i n cl u d es o r co n s i s t s o f”)). Harb o rs i d e s u g g es ts th atCo n g res s co u ldh av e
s i m i l arl y m o d i fi ed“ co n s i s t s o f” i n s ect i o n 2 8 0E i f i th ad i n t en d edt o s eto ff a- 3 2 -

n o n ex h au s t i v e l i s tth ere. Th e Co m m i s s i o n er, o n th e o th er h an d , p o i n t s t o s ev eral Co d e s ect i o n s wh ere Co n g res s u s edth e p h ras e “ co n s i s t s o f” b ut then m o di fi edi t t o cl ari fy th ati t m ean t“ i s co m

po s eden ti rel y

o f.” See, e.g ., s ec. 4 44 (d )(3 )(B) (“ co n s i st s o n l y

o f”); s ec. 4 1 6 (g )(4 )(H) (“ co ns i s ts s ol el y o f”). He s ug g es t s th at Co n g res s wo u ldh av e d o n e t he s am e fo r s ect i o n 2 8 0 E i f i th adm ean t t o i n d i cat e an
ex h au s t i v e l i s t th ere. Un m o d i fi edu s es o f “ co n s i s t s o f” d o s o m et i m es s eem t o i n tro du ce
ex h au s t i v e l i s t s. See, e.g ., s ec. 1 0 8 (e)(4 )(B) (“ fam i l y o f an i n d iv i du al co n s i s t s o f th e i n d i v i du al ’ s s p o u s e, the i n di v i du al ’ s ch i l dren , g ran d ch i l dren , an dp aren t s , an d
an y s p o u se o f t h e i n d i v idual ’ s ch i l dren o r g ran d ch i l dren ”). Bu ti n o th er p l aces

“ co n s i s ts o f” wo u l dl eadt o an ab s u rdres u lti f i t i n d i cat edan ex h au s t i v e l is t . Th e Co m m i s s i o n er p o i n t s u s t o a g l ari n g ex am pl e: A “ co m

p u t er” el i g i b l e fo r accel erat edd ep reci at i o n “ co n s is t s o f a cen tral p ro ces s i n g u n i t co nt ai n i n g ex t en s i v e
s t orag e, l o gi c, ari th m et i c, an dco n tro l cap ab i l i t i es .” Sec. 1 6 8 (i )(2 )(B)(i i)(II) (em p h as i s ad ded ). Here, Harb o rs i d e’ s read i n g o f “ co n s i s t s o f” wo u l dm ean th at
an yth i n g o th er t han a cen tral p ro ces s i n g u n i ti s n ’ ta co m p u t er. Su rel y

s o m et h i n g
wo u l dn ’ tfai l t o b e a co m p ut er b ecau s e i th ada m on i t o r, a k ey b o ard , a m o u s e, o r a p o wer co rd . See Du nfo rdv . Co m m i s si o n er, T.C. M em o . 2 0 1 3 -1 8 9, at* 30 -* 3 1 (referri ng t o a l ap t o p as a “ co m p u t er” wh en d et erm i n i ng d ep reci at i o n el i g i b i l i ty ).- 3 3 -

Th es e ex am

p l es s ho w, we th in k , th atth e Co de u s es “ co n s is t s o f” i n m o re th an o ne way . Its o m et i m es s et s o ff an ex h au s t i v e l i s t , b u t i tal s o s om et i m es i n tro du ces a n o n ex cl u s i v e l i s t .

3
. Cas el aw Th atl eav es u s wi th cas el aw. Each p art y h as p reced en th ere, t o o . Harb o rs i d e’ s ch ief ex am

p l e i s o n e fro m

W i s co n s i n wh i ch h el d thata s tatu t e p rev en ti n g “ a co l l ect iv e b arg ai n i n g u n itco n s i s t i n g o f s ch o o l d i s tri ctp ro fes s i o n al
em pl o y ees ” fro m

arb i trat i ng cert ai n i s s ues d i dn ’ tp recl u d e arb i trat i o n b y a u n i tth at
m ai n l y h ads u ch em

p l o y ees b u tal s o h ads o m e o th er t y p es o f em p l oy ees . M ad i s o n Teach ers , In c., 5 4 1 N.W .2 dat 7 9 0 -9 1 , 7 9 3 -9 4 . Th atco u rts ai d thata “ d ecen t
res p ectfo r l an g u ag e m ak es i ti m p o s s i b l e t o read‘ co ns i s ti n g o f’ i n th e i n cl u s i v e
s en s e.” Id . at7 9 4 . Bu t i tal s o ex p l ai n edth at n o ne o f t he 4 8 2 o ccu rren ces o f t h e p h ras e “ co n s i s t i n g of” i n W i s co n s i n ’ s s t atu t es i n tro du cedn o n ex h au s t i v e l i s t s , an d i t po i n t edo u tth atth e W i s co n s i n l eg i s l atu re was carefu l t o m o di fy th atp h ras e wh en ev er i tm ean t to u s e i ti n cl u s i v el y . Id . Ap p aren t l y W i s co n s i n’ s co d e en

jo y s a
co n si s t en cy

m i s s i n g fro m

the In t ern al Rev en u e Co d e, wh i ch as we’ v e s een u s es

“ co n s i s ts o f” m

u l t i p l e way s . It ’ s th erefo re h ardfo r u s --d es p i te wh atwe h o p e i s
o u r d ecen tres pect fo r l an gu ag e--t o d o as Harb o rs i d e as k s an d i n t erp ret the p h ras e
as m ech an ical l y

as th e W i s co n s i n Co u rto f Ap p eal s h as .- 3 4 -

Th e Co m m is s i o n er, fo r h i s p art , p o i n t s u s t o a cas e t hatd eal twi th a s ect i on
o f t h e Co d e i t s el f--a s t atu t e ex cl u d i n g fo r t ax p u rp o s es fro m a t ax -ex em

p t
o rg an i zat i o n ’ s u n rel at ed trad e o r b u s i n es s “ an y trad e o r b u s in es s wh i ch co n s i s t s o f
co n du ct in g b i n g o g am es .” J ul iu s M . Is rael Lo d g e o f B’ nai B’ ri th No . 2 1 13 v . Co m m i s s i o n er, T.C. M em o . 1 9 9 5 -4 3 9 , 1 9 95 W L 5 4 4 8 7 7, at* 3 , aff’ d , 9 8 F.3 d1 9 0 (5 th Ci r. 1 9 9 6 ); s ee al s o s ec. 5 1 3 (f). Bu tth atcas e h o ld s that“ i n s t an tb i n g o ” i s n ’ t

“ b i ng o ” fo r s ect i o n 5 1 3 (f); i t d o es n ’ t ex p l i ci t l y ad dres s wh at i tm ean s t o “ co n s i st []
o f co n du ct i n g b in g o g am es . ” See J u li u s M . Is rael Lo d g e, 1 9 9 5 W L 5 4 4 8 77 , at* 7 (al th ou g h i ti m

p l ici tl y s u gg es t s t h e s am e en ti ty

can h av e t w o b u si n es s es i n th at
s i tu at i o n , m

u ch as we d i d i n CHAM P). It ’ s therefo re o f l i m i t edu s e h ere. Cas el aw d o es n’ ts et t l e t h e m ean i n g o f “ co n s i s ts o f” an y b et t er t h anth e Co de i t s el f d o es . Di ct io n ari es , th e Co d e, an dcas el aw al l s ho w th at“ co n s i s t s o f” can i n tro du ce ei th er an ex h au s t iv e l i s to r a n o n ex h au s ti v e l i s t . 2 0 A n o n ex h au s ti v e l i s t

2 0 Th e Co d e i s i n g o o dco m p an y . Sh ak es peare ap p ears t o u s e “ co ns i s t s o f” b o th way s i n a s i n g l e ex ch an ge: Si r To b y Bel ch : * * * Do es n o to u r l i fe co ns i s to f t h e fo u r el em en t s ? Si r An drew Ag uech eek : Fai th , s o th ey s ay ; b u tI th i n k i trat h er co n s i s t s o f eat i n g an ddri n k in g . Si r To b y Bel ch : Th o u ’ rta s ch o l ar; l etu s th erefo re eat an ddri n k
. (co n ti n u ed ...)- 3 5 -

i s the o n l y

o pt io n thatd oes n’ tren der s ect io n 2 80 E i n effect i ve an dab su rd . W e th erefo re read s ect i o n 2 8 0E t o d en y b u s i n es s-ex p en s e d edu ct i o ns t o an y trad e o r b u s i n es s th ati n vo l v es traffi ck i n g i n co n tro l l eds ub s t an ces , ev en i f t h attrad e o r b u s i n es s al s o en g ag es i n o ther act i vi t i es . B. Pu rp o s e W e al s o n o t e t h atHarb o rs i d e h as a s ub tl er arg u m en tab o u tth e p l ay b et ween l i teral m ean i n g an ds t atu t o ry p u rp o s e. Itrem in d s u s th atd i s p en s ari es th atare l eg al
u n d er s t at e l aw d i dn ’ tex i sti n 1 9 8 2 an dCo n g res s ev en t o d ay wo n ’ tl etth e DOJ p ro s ecu te t h em

as i f t h ey were s t reet -co rn er d ru g d eal ers . See Co n so l i d at ed Ap p ro p ri at i o ns Act , 2 0 1 7 s ec. 5 3 7 ; Co n so l i d at ed Ap p ro p ri at i o n s Act , 2 0 1 6 s ec. 5 4 2 ; Co n s o l i d at edan dFu rt h er Co n t in u i ng Ap pro p ri at i o n s Act , 2 0 1 5 s ec. 5 3 8 ; s ee al s o M cIn t o sh , 8 3 3 F.3 dat1 1 77 . Th es e arg u m en ts aren ’ t n ew, ei th er--t h e Ni n t h Ci rcu i td i s p o s edo f t h em

i n Ol i v e, 7 9 2 F.3 dat1 1 5 0 -5 1 , s o we m o s t l y rei t erat e i t s
reas on i n g h ere t o ack n o wl ed g e th atHarb ors i de h as p res erv edi t . Al th ou g h s ect io n 2 80 E p red at es s tat es ’ l eg al i zat i o n o f m ed i cal m ari ju an a,

“ [t ] h at Co n g res s m ig h tn o th av e i m ag i n edwh ats o m e s t at es wo ul dd o i n fu tu re y ears h as n o b eari n g o n o ur an al y s i s. Iti s co m m o n fo r s t atut es t o ap p l y t o n ew

2 0 (...co n t i nu ed ) W i ll i am Sh ak es peare, Twel ft h Ni g h tact2 , s c. 3 . Th e fo u r el em en t s are an ex h au s t i v e l i s t , b u teat in g an d d ri n k in g aren ’ tal l o f l i fe, ev enfo r Si r An drew.- 3 6 -

s i tu at i o n s. An d h ere, ap p li cat i o n o f th e s t atu t e i s cl ear.” Id . at1 1 5 0 . Th e
res tri ct i o n o n h o w th e DOJ u s es fu n d s i s i rrel ev an th ere b ecau se “ th e g o v ern m en t i s en fo rci n g o n l y

a t ax , wh i ch d o es n o tp rev en tp eo p l e fro m u s i n g , d i s tri b u t i n g , p o s s es s i n g , o r cu l t i v at in g m ari ju an a i n Cal i fo rn i a. En fo rci n g th es e l aws m i g h t
m ak e i tm o re co s t l y

t o ru n a d i sp en s ary , b u ti td o es n otch an g e wh et h er t h es e act i vi t i es are a u th o ri

z ed i n t he s t at e.” Id . at1 15 0
. Fi n al l y , we n o t e t h at s ev eral m em b ers o f Co n g res s as k edth e IRS t o i s s u e g u i d an ce s ay i n g th atm ed i cal -m ari ju an a d i s p en s ari es aren ’ ts ub jectt o s ect i o n 2 8 0 E, an dth e IRS s ai di tco u l dn ’ td o th atu n l es s Co n g res s am en d edth e Co d e o r th e Co n tro l l edSub st an ces Act . See IRS In fo rm at i o n Let ter 2 01 1 -0 00 5 . M em b ers
o f Co ng res s h av e s ub s equ en t l y i n tro du ceds ev eral b i l l s th atwo u l dex em p t s t at el eg al m ari ju an a b u s i n es s es fro m

s ect i o n 2 8 0E. Sm al l Bu s i n es s Tax Equ i ty Acto f 2 0 1 1 , H.R. 1 9 8 5 , 1 12 th Co n g . (2 0 1 1 ); Sm al l Bu s i nes s Tax Equ i ty Acto f 2 0 1 3 , H.R. 2 2 40 , 1 1 3 th Co ng . (2 01 3 ); Sm al l Bu s i n es s Tax Equ i ty Acto f 2 0 1 5 , H.R. 1 8 5 5 , 1 1 4 th Co n g . (2 0 1 5); Sm al l Bu s i n es s Tax Equ it y Acto f 2 0 1 5 , S. 9 8 7, 1 1 4 th Co n g . (2 0 1 5 ); Sm al l Bu s i n es s Tax Equ i ty Acto f 2 0 1 7 , H.R. 1 81 0 , 1 1 5 th Co n g . (2 0 1 7); Sm al l Bu si n es s Tax Equ i ty Acto f 2 0 1 7 , S. 7 7 7 , 1 1 5 th Co n g . (2 01 7 ); Res po n s i b l y

Ad dres s i n g the M ari

ju an a Po l i cy

Gap Act o f 2 0 1 7, H.R. 1 8 2 4, 1 1 5 t h- 3 7 -

Co n g . (2 0 1 7 ); Res po ns i bl y Ad dres s i n g th e M ari

ju an a Po l icy

Gap Acto f 2 0 1 7 , S. 7 8 0 , 1 1 5 th Co n g . (2 0 1 7 ). No ne h as b een en act ed
. W e h o ldth ats ect i o n 2 8 0 E p rev en t s Harb o rs i d e fro m d edu ct i ng i t s b u s i n es s
ex p en s es . IV. M o re Th an On e Trad e o r Bu si n es s ? Harb o rs id e s ay s thatev en i f s ect i o n 2 8 0 E ap p l i es t o i t s m ari ju an a s al es , i t
can s t i ll d edu cti t s ex p en s es fo r an y s ep arat e, n o n traffi ck i n g trad es o r b u s i nes s es . Th at ’ s co rrect . See CHAM P, 1 2 8 T.C. at1 84 -8 5 ; s ee al s o Ol iv e, 7 9 2 F.3 dat 1 1 4 9 . W e t h erefo re n eedt o d et erm i n e wh i ch --i f an y --o f Harb o rs i d e’ s act i vi t i es
are s ep arat e t rad es o r b u s i n es s es . Anact i v i ty

i s a t rad e o r b u s i n es s i f t h e t ax pay er d oes i t co n t i n uo u sl y an d reg u l arl y wi th th e i nt en to f m ak i n g a p ro fi t . See, e.g ., Co m m i s s io n er v . Gro et zi n g er, 4 80 U.S. 2 3 , 3 5 (1 9 8 7 ); Un i t edSt at es v . Am . Bar En d o w m en t , 4 7 7 U.S. 1 0 5 , 1 1 0 n .1 (1 9 8 6 ). A s i n g l e t ax p ay er can h av e m o re t h ano n e t rad e o r b u s i n es s , CHAM P, 1 28 T.C. at1 8 3 , o r m ul ti p l e act iv i t i es th atn ev ert h el es s are
o n l y a s i n g l e t rad e o r b u s in es s , s ee, e.g ., Dav i s v . Co m m i s s i o n er, 2 9 T.C. 8 7 8 , 8 9 1 (1 9 5 8). Ev en s ep arat e en ti t i es ’ act i v i t i es can b e a s i n g l e t rad e o r b u s in es s i f th ey ’ re p arto f a “ u n i fi edb u s i n es s en t erp ri s e” wi th a s i n g l e p ro fi tm o t iv e. M o rt o n
v . Un i t edSt at es , 9 8 Fed
. Cl . 5 96 , 6 0 0 (2 0 1 1 ).- 3 8 -

Wh et h er t w o act i vi t i es are t wo trad es o r b u s i n es s es o r o n ly o ne i s a qu es t i o n
o f fact . See, e.g ., CHAM P, 1 2 8 T.C. at1 8 3 ; Owen s v . Co m m i ss i o n er, T.C. M em o . 2 0 1 7 -1 5 7 , at* 21 . To an s wer i t , we p ri m ari ly co n si d er t h e “ d eg ree o f
o rg an i zat i o n al an d eco no m i c i nt errel at i o n s h i p o f v ari o u s u n d ert ak i n g s, the b u s i n es s p u rp o s e wh i ch i s (o r m i gh tb e) s erv edb y carry i ng o n th e v ari ou s
u n d ert ak i n g s s ep arat el y

o r t o g et h er * * * , an d t h e s i m i l ari ty o f t h e v ari o u s
u n d ert ak i n g s .” Ol iv e, 1 39 T.C. at4 1 ; s ec. 1 .1 8 3 -1 (d ), In co m e Tax Reg s . W e’ v e co n si d eredth i s i s s u e wi th o th er Cal i fo rn i a m ed i cal -m ari ju an a d i s p en s ari es . InCHAM P, 1 2 8 T.C. at1 7 5 , 1 8 3 , we fo un d thatth e t ax p ay er h ad two d is t i n cttrad es o r b u s i n es s es --careg i v i n g s erv ices an dm ed i cal -m ari ju an a
s al es --ev en th o u g h i t s cu s t o m ers p ai da s i ng l e fee t h aten t it l edthem t o u n l im i t ed
acces s t o th e s erv ices an d a fi x edam o u n to f m ari ju an a. W e n o t edth ere t h ats ev en
o f t h e t ax p ay er’ s em

pl o y ees di s tri b u t edm ari

ju an a, ei g h t een em

p l o y ees p ro v i d ed careg i v i ng s erv i ces , an d n o em p l o y ees d i db o th . Id . at 1 8 5. M o reo v er, d is p en s i n g
m ari ju an a o ccu rredi n o n l y

1 0% o f o n e o f t h e t ax p ay er’ s th ree faci l i t i es . Id . at 1 7 6 . W e fo u n dth e t ax p ay er’ s p ri m ary p u rp o s e was t o p ro v i d e careg i vi n g
s erv i ces , an dthatth o s e s erv i ces were b ot h “ s ub s t an t i al l y d i fferen t ” fro m an d

“ s t o odo n * * * [t h ei r] o wn , s ep arat e an d ap art ” fro m d i s p en s in g m ari

ju an a. Id . at 1 8 3
.- 3 9 -

In Ol i ve, h o wev er, we h el d(an dth e Ni n th Ci rcu i tag reed ) t h at a t ax p ay er wh o s o l dm ed ical m ari

ju an a an dp ro v i d edco m

p l i m en t ary s erv ices --i n cl u d i n g
m o vi es , b o ard g am es , y o ga cl as s es , m as sag es , s n ack s , p ers o n al co u n s el i n g, an d ad v ice o n h o wt o b es tco ns u m e m ari ju an a--h ad a s i n g l e t rad e o r b u s i n es s. Ol i v e, 1 3 9 T.C. at3 8-4 2 ; Ol i v e, 7 92 F.3 dat1 1 48 -5 0 . Th e t ax p ay er i n Ol i v e ch arg ed
o n l y fo r m ari ju an a, an d s eta p ri ce b as edo n th e am o u n tan dty p e o f m ari

ju an a i t s p at i en t s b o u g h t ; the co s to f t h e o th er s erv i ces was b u n d l edi n t o th atp ri ce. Ol i v e, 1 3 9 T.C. at4 2; 7 9 2 F.3 dat1 1 4 9 . Th e s am e em p l o y ees wh o s o l dm ari

ju an a al s o p ro v id edth e s erv i ces , an dthe t ax p ay er p ai dn o ad d i t io n al wag es , ren t , o r o th er
s i gn i fi can tco s t s co nn ect ed ex cl u s i v el y wi th th o s e s erv i ces . Ol i v e, 1 3 9 T.C. at4 1
. Th e t ax p ay er al s o h ad a s i n g le b o o kk eep er an dacco u nt an t . Id . at4 2. Th es e fact s l edu s t o fi n d t h atth e s erv i ces were “ i n ci d en tt o ” t he s al e o f m ari ju an a, an dwe
n o t edth atth e t wo act i v i t i es h ada “ cl o s e an di ns ep arab l e o rg an i zat i on al an d
eco n om i c rel at i o n s h i p .” Id
. at 4 1
. W e h el d t h atth ey were “ o n e an dth e s am e b u s i n es s .” Id
. Th e m o strecen tcas e wh ere we h adt o fi g u re o u t th e n u m b er o f a m ari

ju an a d i s p en s ary ’ s trad es o r b u s i n es s es i s Can n a Care, In c. Li k e Harb o rs i d e, t h e t ax p ay er t h ere s o l dm ed i cal m ari ju an a an d o th er i t em s , i ncl u d in g b o o k s , T-s h i rt s,
an d h at s . Can n a Care, In c., at* 4 , * 1 2 . Un l i k e th e t ax p ay er i n Ol iv e, t he t ax p ay er- 4 0 -

i n Can n a Care, In c. h ad atl eas t a l i t t l e b ito f i n co m e fro m n o n m ari ju an a s al es . Id
. at* 1 2
. Bu twe s t il l fo u n d o n l y a s i n g le t rad e o r b u s i n es s--s el l i n g m ari ju an a--an d

“ th e s al e o f an y

o th er i t em

was an act iv i ty

i nci d en t t o ” t ho s e s al es . Id . Bu to u r
an al y s i s t h ere was co n s trai n ed : Th e p art i es h ads t i p u l at edth atth e t ax p ay er “ was i n the b u s i n es s o f d i s tri b u t i n g m ed i cal m ari ju an a” an dthe reco rd d i dn ’ t en ab l e u s t o d et erm i n e wh atp ercen t ag e o f t h e t ax p ay er’ s i n co m e cam e fro m m ari ju an a s al es
an d wh atp ercen t ag e cam e fro m o th er s o u rces . See i d .; s ee al so Al t erm anv . Co m m i s s i o n er, T.C. M em o . 2 0 1 8 -8 3 , at* 2 7 -* 2 8 (refu s i n g t o al l o wb u s i n es s ex p en s e d educt i o ns wh ere t h e t ax pay ers fai l edt o i d en t i fy s p eci fi c p aym en ts , p ro v id e reco rdci t at i o n s , o r p ro p o s e fi n d i ng s o f facts u ffi ci en tfo r u s t o d i s t i n g u i s h
ex p en s es as s o ci at edwi th th e s al e o f m ari ju an a fro m th o s e as s o ci at ed wi th th e s al e
o f n o nm ari

ju an a m erch an d i s e). Harb o rs id e p res en t edi t s cas e i n g reat er d et ai l . Itarg u es th at i th adfo u r act i vi t i es , each o f wh i ch was a s ep arat e t rad e o r b us i n es s :

• s al es o f m ari

ju an a an d p ro du ct s co n t ai n i n g m ari j u an a;

• s al es o f p ro duct s wi th n o m ari ju an a;

• th erap eu t i c s erv i ces ; an d

• b ran d d ev el o p m en t . W e co n s i d er each
.- 4 1 -

A. Sel l i n g M ari

ju an a an dPro du ct s Co n t ai n i n g M ari ju an a Th ere’ s n o qu es t i o n th ats el l i n g m ari ju an a an dp ro du ct s co nt ai ni n g
m ari ju an a was Harb o rs i d e’ s p ri m ary p u rp os e. Si x ty

p ercen to f t h e m em

bers Harb o rs i d e’ s s ecu ri ty

ch eck edi n were t h ere t o b u y m ari ju an a i n o ne fo rm

o r
an o th er. M ari

ju an a an d m ari

ju an a p ro du ct s t o o kup aro un d7 5 % o f Harb ors i d e’ s
s al es fl o o r. Harb o rs id e’ s em p lo y ees s p en t8 0 -9 0 % o f t h ei r t i m e p u rch as i n g , p ro ces s i n g , an d s el l i n g th es e p ro duct s . An dth o s e s al es g en erat edatl eas t 9 8 .7 %
o f Harb o rs i d e’ s rev en u e du ri ng each o f t he y ears ati s s u e. Th i s was cert ai nl y a trad e o r b u si n es s --s peci fi cal l y , th e t rad e o r b u s i n es s o f t raffi ck i n g i n a co n tro l l ed
s ub s t an ce. See Ol i v e, 1 39 T.C. at3 8 ; CHAM P, 1 28 T.C. at1 8 2 -8 3
. B. Sel l i n g Pro du ct s Th atDi dn ’ tCo n t ai n M ari j u an a Harb o rs id e’ s s al e o f i t em s th atd i dn ’ tco n tai n m ari ju an a--s uch as b ran d ed cl o th i n g , h em

p b ag s, b o o ks ab o u t m ari ju an a, an dm ari

ju an a p arap h ern al i a s u ch as
ro l l i n g p ap ers , p i p es , an dl i g h t ers --g en erat edth e rem ai n in g 0 .5 % o f i t s rev en u e. Th e s am e Harb o rs i d e em p l o y ees wh o b o u gh t , p ro ces s ed , an ds o l dm ari ju an a al s o
s o l dth es e i t em s , b u t s el li n g them t o o kup o n l y

5 -1 0 % o f t h ei r t im e. Th e
n o n m ari ju an a i t em s o ccupi edo n l y 2 5 % o f t h e s al es fl o or wh ere Harb ors i d e s o l d
m ari ju an a, an dth at s al es fl o o r was acces s i b l e o n l y t o p atro ns wh o h adal read y p res en t edth ei r cred en t i al s t o s ecu ri ty --wh i ch m ean s t h at n o o ne wh o co u l dn ’ tb u y- 4 2 -

m ari ju an a co u l d b u y

th es e n o n m ari

ju an a i t em s . An d th e reco rds h o ws n o s ep arat e
en t i ty , m an ag em en t , b o o k s, o r cap i t al fo r t h e n o n m ari j u an a s al es . Th i s l ead s u s t o fi ndth atth e s al e o f n o n -m ari ju an a-co n tai n i n g p ro duct s h ad a “ cl o s e an d i n s ep arab l e o rg an izat i o n al an deco n o m i c rel at i o ns h ip ” wi th , an dwas “ in ci den tt o ,” Harb o rs i d e’ s p ri m ary

b u s in es s o f s el l i n g m ari

ju an a. See Ol i v e, 1 3 9 T.C. at4 1 ; s ee al s o To b i n v . Co m

m i s s i on er, T.C. M em o. 1 9 99 -3 2 8 , 1 9 9 9 W L 7 7 3 9 6 4 , at* 5 -* 6 (farm an dg ard en o ne act i v i ty

b ecau s e s am e em

p l oy ees , equ i p m en t , m an ag em en t , an d b o o k s ). Th ere’ s al s o an o b v i o u s b u s i nes s p u rp o s e fo r s el l i n g i t em s th at faci li t at e an den co u rag e m ari j u an a u s e al o n g s i d e act u al m ari j u an a. W e al s o fi n d th atth e s al e o f i tem s th at are ab o u tm ari ju an a, are b ran d edwi th Harb o rs i d e’ s l o g o , o r en ab l e u s e o f m ari

ju an a i s n o t“ s ub s t an t i al l y d ifferen t ” fro m th e s al e o f
m ari ju an a i t s el f. See CHAM P, 1 2 8 T.C. at 1 83
. Harb o rs id e n ev ert h el es s arg u es th ati t s s al e o f an yth i ng o ther t h an m ari ju an a i s a s ep arat e t rad e o r b us i n es s . Itci tes an an al og y th e Ni n th Ci rcu i tu s edi n Ol i ve, 7 9 2 F.3 dat1 1 5 0 , t o ex p l ai n wh y a s t o re t h atch arg edfo r m ari ju an a an dg av e away i n ci d en t al s erv ices h ado n l y a s i n g l e t rad e o r b us i n es s . In th atan al o g y , a h y p o th et i cal b oo k s t o re t h ats o l db o o k s an d g av e away co ffee t o at tract cu s t o m ers (“ Bo o k s t o re A”) h ad o n l y o n e t rad e o r b us i n es s , wh ereas a h y p o th et i cal b o o k s t ore- 4 3 -

th ats o l db o o k s an dal so s o l d co ffee (“ Bo o k s t o re B”) h adtwo trad es o r b u s i n es s es . Id
. W e t h i nkHarb o rs id e m is s es th e an al o g y ’ s p o in t : Its h o ws th ata s erv i ce a t ax p ay er d o es n ’ tch arg e fo r, b u twh ich at tract s cu s t o m ers , i s n ’ ta s ep arat e t rad e o r b u s i n es s . It d o es n ’ t m ean th at s el l i n g two th i n g s i s n eces s ari ly two s ep arat e t rad es
o r b u si n es s es . Bo o ks t ore B i s t h ere t o p ro v id e co n tras tt o Bo o k st o re A, wh i ch i s wh atth e co u rtco m

pared t o th e t ax p ay er i n Ol i v e. Id
. Fi n al l y , th e an al o g y --t h o u g h a g o o dfi tfo r Ol i v e, wh ich was s el li n g
m ari ju an a an dg i v i n g away s nack s an d s o ftdri n ks --d oes n ’ t s ui tHarb ors i d e. A b et t er an al o g y

wo ul db e t o a b oo k s t o re t h atd eri v es 0 .5 % o f i t s rev en u e fro m
s el l i n g s t at i o n ery , b o ok m ark s , an dT-s h i rt s wi th p i ctures o f b o o k s o n th em (“ Bo o k s t o re C”). To b e co m p l et el y an al o g o us t o Harb o rs i d e, Bo o k s t o re C wo u l d
s el l th es e i t em s u s i ng th e s am e em p l o y ees , s al es fl o o r, m an ag em en t , l ed g ers , an d b u s i n es s en t i ty

i t u s edt o s el l b o o k s . Th ath y p ot h et i cal b o o k st ore wo u l d , we th i n k , b e a s i n g l e t rad e o r b u s i n es s u n d er t h e Ni n th Ci rcu i t ’ s reas o n in g . An d Harb o rs i d e’ s s al e o f n o n -m ari ju an a-co n t ai n i n g i tem s i s, we fi nd , n ota s ep arat e trad e o r b u si n es s .- 4 4 -

C. Th erap eu t i c Serv i ces Reco g n izi n g thatan act iv i t y n eed s a p ro fi tm o t i v e t o b e a s ep arat e t rad e o r b u s i n es s , Harb o rs i d e arg u es th ata p o rt i o n o f each m ari ju an a s al e was actu al l y

a p u rch as e o f i t s free h o li s t ic s erv i ces . 2 1 Th i s i s wh ati tt o l di t s p at ro n s , t oo . Harb o rs id e s ay s thi s m ak es i tl i k e CHAM P. Bu ti n CHAM P, 1 2 8 T.C. at 1 7 5 -7 6 , m em

b ers p ai da s etfee fo r u n l i m i t edacces s t o ex t en si v e s erv i ces an dal s o recei v eda fi x edam o u n to f m ari ju an a--t h e s erv i ces ’ p ri ce was n ’ t“bu n d l ed ” i n t o th e am o un tp ai dfo r m ari

ju an a, t o u s e Harb ors i d e’ s t erm in o l o g y . An dwe fo u n d th atth e s erv i ces i n CHAM P were t h e t ax p ay er’ s p ri m ary p urp o s e, t o okup m o s to f i t s em p l o y ees ’ t i m e, an du s edal m o s tal l o f i ts three faci l i ti es . Id . at1 7 4 -7 6 , 1 8 3, 1 8 5
. Harb o rs id e i s m o re l i k e t h e d i s p en saryi n Ol i v e, 7 9 2 F.3 dat1 1 4 8 , wh ere p at ro n s p ai dacco rd i n g t o th e am o u n tan dty pe o f m ari

ju an a t h ey

wan t edan di n retu rn g ai n edacces s t o i n ci d en t al s erv ices . Harb o rs i d e t ri es t o d i s ti n gu i sh i t s el f b y p o i n t i n g o u tth ati to ffered m an y m o re s erv i ces th an th e m u ch s m al l er t ax p ay er i n Ol i v e d i d
. 2 2 Bu tth e s erv i ces were s t i l l i n ci d en t al ; Harb o rs i d e’ s s ecu ri ty s p en to n l y

2 1 Harb o rs i d e arg u es th at“ th e p ri ce fo r t h es e s erv i ces was ro l ledi n t o th e p ri ce o f t h e can nab i s . ”

2 2 In Ol i ve, 7 9 2 F.3 dat1 1 4 8 , th e t ax pay er’ s co m bi n edrep ort edi n co m e an d

(co n ti n u ed ...)- 4 5 -

5 % o f i ts t i m e ch eck i n g i n p eo p l e fo r t he s erv i ces , wh i l e s p en di n g 6 0 % o f i t s t i m e ch eck i n g i n p eo p l e wh o were t h ere t o b u y m ari ju an a. An di n d ep en den t
co n tract ors , rat h er t h anHarb o rs i d e’ s o wnem p l o y ees , p ro v i d edth o se s erv i ces . Du ri n g the y ears ati ss u e Harb o rs i d e p ai dth os e co n tract o rs a t o t al o f o n ly ab o u t $ 6 8 0 ,0 0 0 --l es s th an 1 % o f i t s s al es rev en u e fro m m ari j u an a. Th e rel at i on s h ip b et ween Harb o rs i de’ s m ari ju an a b u s i n es s an dh o l i s t i c
s erv i ces cl o s el y

fi t s Ol i v e’ s “ Bo o k s t o re A” an al o g y . See i d . at1 15 0 . Ju s tas a b o o k s t o re t h at g i v es away co ffee i s s t i l l o n l y

a b oo k st o re, a m ari

ju an a d i s p en s ary th atg i ves away

s erv i ces i s s t il l o n l y

a m ari ju an a d is p en sary . See i d . Th e factth at Harb o rs i d e u s eda t i n y

b i to f i ts m ari

ju an a-s al es rev en u e t o p ay fo r th o s e s erv i ces d o es n’ tch an g e an yth i n g --aft er al l , Bo o k s t ore A n eces s ari l y p ay s fo r i ts co ffee wi th b oo ks al es . An dwe al s o fi n dth at th ere were b u s i n es s reas o n s t o o ffer t h es e
s erv i ces al o n g s i d e m ari

j u an a s al es : Itju s t i fi edp rem i u m p ri ci n g an d h el p ed Harb o rs i d e m eetth e co m m u ni ty -b en efi ts t an d ard s Cal i fo rn i a l aw requ i red . W e th erefo re fi n d t h atHarb o rs i d e’ s h o l i s t i c s erv i ces were n ot a s ep arat e t rad e o r b u s i n es s .

2 2 (...co n t i nu ed ) cl ai m edex p en s es fo r each y ear we co ns i d ered were u n d er $ 5 0 0 ,0 0 0 . Inco n tras t , Harb o rs i d e h ad$ 5 m i l l i o n-$ 25 m i l l i o n i n t ot al rev en u e du ri n g each o f t h e y ears at i s su e.- 4 6 -

D. Bran di n g Harb o rs id e’ s fi n al arg u m en to n th i s s ub ject i s th ati t s b ran d -d ev el op m en t act i vi ty was a s ep arat e t rad e o r b u s i n es s . Becau s e t h is d i dn o tg en erat e an y
rev en u e u n t i l aft er t h e y ears ati s s u e, t h e Co m m i s s i o n er co m

p ares i tt o p reo p erat i o n al ex p en di tu res th ath av e t o b e cap i t al i zedi ns t ead o f d edu ct ed
. Harb o rs i d e i ns i s t s i ti s a t rad e o r b u s i n es s el i g i b l e fo r s ect i o n 1 6 2 d educt i o n s b ecau s e fro m

d ay 1 i tp erfo rm edth em

wi th an i n d ep en d en tp ro fi tm o t i ve. To
s h o w a p ro fi tm o t i v e wi th o utan y rev en u e, Harb o rs i de s ay s i t s b ran d i n g act i v i t i es were p arto f a “ u n i fi edb u s i n es s en t erp ri s e” wi th i t s act iv i t i es thatd i d m ak e m o n ey du ri n g th e y ears ati s su e. A s ep arat e en t it y

p urp os el y

o p erat i ng ata l os s i s s t i l l a t rad e o r b us i n es s el i g i b l e fo r d edu ct i on s i f i tan den t i t i es rel at edt o i tt o g et her fo rm a u n ifi ed b u s i n es s en t erp ri s e t h ati t sel f h as a p ro fi tm o t i v e. See Cam pb el l v . Co m

m i s s i o n er, 8 6 8 F.2 d8 3 3, 8 3 6 -3 7 (6 th Ci r. 1 9 8 9 ) (p art n ers h i p l eas i n g ai rp l an e t o s i s ter
co rp o rat i o n at l o s s h adp ro fi t m o t i v e b ecau se co m m o n o wn ers b en efi t ed ), aff’ g i n p art , rev ’ g i n p art T.C. M em o . 1 9 8 6 -5 6 9 ; Ku hn v . Co m m i s si on er, T.C. M em o . 1 9 9 2 -4 6 0 , 1 9 9 2 W L 1 9 36 0 4 , at* 5 (p art n ers h i p’ s b el o w -m ark etl eas e o f l an dt o
s i st er co rp o rat i o n h adp ro fi t m o t i v e b ecau s e co rp o rat i o n b en efi t ed ); M o rt o n , 9 8 Fed
. Cl
. at6 0 2 (S co rp orat i o n th ato wn edai rp l an e was p arto f un i fi ed b u s i n es s- 4 7 -

en t erp ri se wi th s h areh o l d er’ s o th er b u s i n es s es an dth erefo re h ada p ro fi tm o t i v e). In o th er wo rd s , th e u n ifi ed -b u si n es s-en terp ri s e d oct ri n e Harb o rs i d e rel i es o n s ay s th ats ep arat e b u trel at eden t i t i es can s h are a s i n g le p ro fi tm o t iv e; i t d o es n ’ t s ay th at
a s i n g l e en ti ty ’ s u np ro fi tab l e act i v it i es are a s ep arat e t rad e o r b u s i n es s . Rat h er th an s h o w th atHarb o rs i de’ s b ran d in g was s ep arat e fro m i t s m ari ju an a s al es , th e
u n i fi ed -b u s i n es s-en t erp ri s e d o ct ri ne i n s t ead s ug g es t s th ati twas p arto f a s i n g l e
o v eral l trad e o r b u si n es s . Th ere’ s al s o n o act ual ev i d en ce t o s u g g es tth atHarb ors i de’ s b ran d d ev el o p m en twas i n an y

way a s ep arat e t rad e o r b us i n es s . As far as we can t el l , Harb o rs i d e d i di t s b ran d in g u s i n g th e s am e en t i ty , m an ag em en t , cap i t al s tru ctu re,
em pl o y ees , an d faci l i t i es as i ts m ari ju an a s al es . See To b i n , 1 9 9 9 W L 7 7 3 9 6 4 , at
* 5 -* 6. An drat h er t h an b ei n g “ s ub s tan t i al l y d i fferen t ” fro m th e u n d erl y i n g s al e o f
m ari ju an a, Harb o rs id e’ s b ran d d ev el o p m en t was n eces s ari l y en twi nedwi th i t . See CHAM P, 1 2 8 T.C. at1 8 3 . Harb o rs i d e’ s b ran d i n g , th erefo re, h ada “ cl os e an d i n s ep arab l e o rg an izat i o n al an deco n o m i c rel at i o ns h ip ” wi th , an dwas “ on e an d t h e
s am e b u s i n es s ” as , i t s m ari j u an a s al es . See Ol i v e, 1 3 9 T.C. at4 1 . Itwas n o ta
s ep arat e t rad e o r b u s in es s . Harb o rs id e d ed i cat edth e l i o n ’ s s h are o f i ts res o urces t o s el l in g m ari ju an a
an d m ari ju an a p ro du ct s . Th o s e s al es acco u n t edfo r o v er 9 9 .5 % o f i t s rev en u e. It s- 4 8 -

o th er act i v i t i es were n ei th er eco n o m i cal l y s ep arat e n o r s ubs t an t i al l y d i fferen t . W e th erefo re h o ldth atHarb o rs id e h ada s i n gl e t rad e o r b u s i n es s --t h e s al e o f
m ari ju an a. Th at ’ s t raffi ck i n g i n a co n tro l l ed s ub s tan ce u n d er fed eral l aw, s o Harb o rs i d e can n o t dedu ct an y o f i t s rel at edex p en s es . See s ec. 2 8 0 E; s ee al s o Ol i v e, 1 3 9 T.C. at3 8 ; CHAM P, 1 2 8 T.C. at 1 82 -8 3
. V. Co s to f Go o d s So l d Th e fact th atHarb o rs i d e can ’ td edu ctan y o f i t s b us i n es s ex p en ses d o es n ’ t
m ean i to wes t ax on i t s g ro ss recei p t s . Al l t ax p ay ers --ev endru g traffi ck ers --p ay t ax o n ly o n g ro s s i n co m e, wh i ch i s g ro s s recei pt s m i n u s th e co s to f g oo d s s o l d (COGS). See, e.g ., New Co l o n i al Ice Co . v . Hel v eri n g , 2 9 2 U.S. 4 3 5 , 4 4 0 (1 9 3 4 ); CHAM P, 1 2 8 T.C. at1 7 8 n .4 ; s ecs . 1 .6 1 -3 (a), 1 .1 6 2 -1 (a), In co m e Tax Reg s . Co n g res s u n d ers t oo dthatwh en i ten act eds ect i o n 2 8 0 E. See S. Rep t . No . 9 7 -4 9 4 , s up ra at3 0 9 , 1 9 82 U.S.C.C.A.N. at1 0 50 . W e’ v e u n d ers to o di to u rs el v es . See Ol i v e, 1 3 9 T.C. at3 2 -3 6
. Bu twh at i s th e d i s t in ct i o n b et ween a b u s i n es s -ex p en s e d edu ct io n an dan ad ju s t m en tfo r COGS? Dedu ct i o n s are s ub tract i o n s fro m g ro ss i n co m e th at t ax p ay ers m ak e wh en th ey cal cu l at e t h ei r t ax ab l e i n co m e. Sec. 6 3 (a). Dedu ct i o n s
are s t atu to ry , an dCo n g res s can g ran to r d en y th em as i tch o o ses --t h e s t an d ard refrai n i s th atth ey ’ re a m at t er o f Co n g res s’ s “ l eg i s l at i v e g race.” INDOPCO, In c.- 4 9 -

v . Co m m i s s i o n er, 5 0 3 U.S. 7 9, 8 4 (1 9 9 2 ); New Co l o n i al Ice Co ., 2 9 2 U.S. at4 4 0 ; Ol i v e, 1 3 9 T.C. at3 2 . W e’ v e al read y s een an ex am

p le o f Co n g res s’ s wi th h o l d i n g th atg race fro m th o s e wh os e wo rk s i treject s --i tg ran t s m o stt ax p ay ers a d edu ct i o n fo r o rd i n ary

an dn eces s ary

b us i n es s ex p en s es i n s ect i o n 1 6 2 , b u tth en u s es s ect i on 2 8 0 E t o d en y

th os e d educt i o n s t o dru g traffi ck ers . See Can n a Care, In c., at* 7
. COGS i s th e co st s o f acq u i ri n g i n v en t o ry , th ro u g h ei th er p u rch as e o r p ro duct i o n . See, e.g ., Read i n g v . Co m m is s io n er, 7 0 T.C. 7 3 0 , 7 3 3 (1 9 7 8 ) (COGS i s “ ex p en d i tu res n eces s ary t o acq u i re, co n s tru cto r ex tract a p h y s i cal p ro duct wh i ch i s t o b e s o ld ”), aff’ d , 6 1 4 F.2 d1 5 9 (8 th Ci r. 1 9 80 ); s ecs . 1 .6 1 -3 (a), 1 .1 6 2- 1 (a), In co m e Tax Reg s . As we’ v e s ai d , al l t ax p ay ers , reg ard l es s o f t h e b u s i n es s th ey ’ re i n , u s e COGS t o o ffs etth ei r g ro s s recei pt s wh enth ey cal cu l at e g ro s s i n co m e. See, e.g ., Ol i v e, 1 3 9 T.C. at2 0 n . 2
. Th e b i g d i fferen ce b et ween d edu ct i o n s an dCOGS ad ju s t m en t s i s t i m i n g . See INDOPCO, 5 03 U.S. at8 3 -8 4 ; W as co Real Pro p s. I, LLC v . Co m m i s s i o n er, T.C. M em o . 2 01 6 -2 2 4 , at* 1 9 . Tax p ay ers can u s u al ly cl ai m atl eas t p arto f a d educt i b l e ex p en s e fo r t h e y ear t h ey i n cu r i t. See, e.g ., INDOPCO, 5 0 3 U.S. at8 3
- 8 4 ; W as co Real Pro p ert i es I, LLC, at* 1 9 . Bu t wh en acco u n t i n g fo r COGS th ey h av e t o cap i t al i ze an i t em ’ s co s ti n th e y ear o f acq u i s i t i o n o r p ro du ct i o n an dei t h er
am ort i ze i to r wai tu n t i l th e y ear t h e i t em ’ s s ol dt o m ak e th e co rres p on d i n g- 5 0 -

ad ju s t m en tt o g ro ss i n co m e. 2 3 See, e.g ., INDOPCO, 5 0 3 U.S. at8 3 -8 4 ; W as co Real Pro ps . I, LLC, at* 1 9. A. Ho w Sh o ul dHarb o rs i d e Acco un tfo r i t s COGS? Th e Co d e t el l s t ax p ay ers wh att o i n cl u de i n COGS. See, e.g ., s ecs . 2 6 3 , 2 6 3 A, 4 7 1
. Bu t th ere’ s m o re th an o n e s eto f ru les , an d t h e i s s u e h ere i s wh i ch s et ap p li es t o Harb o rs i d e. Th e Co m m i s s i o n er t h i n k s Harb o rs i d e n eed s t o fo l l ow t h e
ru l es u n d er s ect i o n 4 7 1 , b u t Harb o rs i d e i n s i st s i t’ s s ub j ectt o th e ru les o f s ect i o n 2 6 3 A. W e co n s i d er each
.

1
. Sect io n 4 7 1 Sect io n 4 7 1 was i n p l ace wh en Co n g res s en act eds ect io n 2 8 0 E. It
em po wers th e Co m

m i s s i o n er t o wri t e reg u lat i o n s th at g o v ern h o w t ax p ay ers
acco u n t fo r i n v en t o ri es . See s ec. 4 7 1 . Th i s th e Co m m i s s i o n er d i d --wi th s ep arat e reg u l at i o n s fo r res el l ers an dp ro du cers . See s ecs . 1 .4 7 1 -3 (b ) an d(c), 1 .4 71 -1 1 , In co m e Tax Reg s .

2 3 A s i m p le ex am p l e i l lu s trat es th e d i fferen ce. If i n y ear 1 a t ax p ay er i n cu rs a d educt ib l e ex p en se o f $ 1 0 0 , h e can redu ce h is t ax ab l e i n co m e fo r y ear 1 b y $ 1 0 0 . If i n y ear 1 h e i n s t eadb u y s 1 0 0 u n i t s o f i n v en t o ry fo r $ 10 0 an dm an ag es t o s el l 1 0 o f t h os e u n i ts p er y ear, h e h as t o t ak e a $ 1 0 COGS ad ju s tm en t i n y ear 1 , a $ 1 0 ad ju s t m en ti n y ear 2 , an d s o o n , th ro u g h y ear 1 0 , wh en h e ru n s o u to f i n v en t o ry . Ineach cas e, the t ax p ay er red u ces th e am o u nto f i n co m e h e’ s t ax edo n b y a t o t al o f $ 1 0 0
. Th e d i fferen ce i s th ath e reco v ers th e en t i re d educt i bl e ex p en s e i n y ear 1 , b u treco v ers h is i n v en t o ry co s t as h e s el l s th e i n v en to ry , wh i ch i n th i s ex am p l e m ean s h e d o es n ’ tg etth e fu l l $ 1 0 0 b ack u n t i l y ear 1 0.- 5 1 -

Th e reg u l at i o n s t el l res el l ers t o u s e as th ei r COGS t h e p ri ce th ey p ay fo r i n v en t o ry p l us an y “ tran s p ort at i o n o r o th er n eces s ary ch arg es i n cu rredi n acq u i ri n g p o s s es s i o n o f t h e g o od s .” Sec. 1 .4 7 1 -3 (b ), In co m e Tax Reg s . Th e reg u l at i o n s fo r p ro ducers are m o re co m

pl ex . Pro du cers m

u s t i n cl ud e i n COGS b o th t h e d i rect an d i n d i rect co s t s o f creat i n g th ei r i n v en t o ry . See s ecs . 1 .4 7 1 -3 (c), 1 .4 7 1-1 1 , In co m e Tax Reg s . Th e reg ul at i o n s t el l p ro ducers t o cap i t al ize t h e “ co s to f raw m at eri al s ,”

“ ex p en d i tu res fo r d i rect l ab o r,” an d“ i n d i rect p ro du ct i o n co s t s i n ci d en tt o an d
n eces s ary fo r t he p ro duct i o n o f t h e p art i cu l ar art i cl e, i ncl u d i n g * * * an ap p ro p ri at e p o rt i o n o f m an ag em en tex p en s es .” Sec. 1 .4 7 1 -3 (c), In co m e Tax Reg s. Di rect an di n d i rect p ro duct i o n co s t s are fu rt h er ex p lai n edi n s ect i o n 1 .4 7 1 -1 1 (b ), In co m e Tax Reg s . In th ei r cu rren tfo rm s , s ect i on 4 7 1 an di t s reg u l at i o ns al s o d irect t ax p ay ers t o s ect io n 2 6 3 A fo r ad di t i o n al ru l es .

2
. Sect io n 2 6 3 A Co n gres s en act ed s ect i o n 2 6 3 A i n 1 9 8 6. TRA s ec. 8 03 . Th ats ect i o n i n s tru ct s b o th p ro ducers an dres el l ers t o i n cl u d e “ i n d i rect ” i n v en t o ry co s ts i n th ei r COGS. Sec. 2 6 3 A (a)(2 )(B), (b ); s ec. 1 .2 6 3A-1 (a)(3 ), (c)(1 ), (e), In co m e Tax Reg s. Ital s o b ro ad en s th e d efi n i t i o n o f i n d i rectco s ts fo r b ot h t y p es o f t ax p ay ers . Co m p are s ec. 1 .2 6 3 A-1 (e)(3 ), In co m e Tax Reg s ., wi th s ec. 1 .4 7 1 -1 1 , In co m e Tax- 5 2 -

Reg s. Co n g res s th o ug htth is wo u l dtreat t ax p ay ers m o re fai rl y . S. Rep t . No . 9 9
- 3 1 3 , at 1 4 0 (1 9 8 6 ), 1 9 8 6 -3 C.B. (Vo l . 3 ) 1 , 1 4 0 . Ital s o th o u g htth i s wo ul dd o a b et t er jo b o f m at ch i n g COGS ad ju s t m en t s t o t h e y ears i n wh i ch t ax p ay ers real i zed th e rel at edi n co m e. Id
. ; s ee al s o Offi ce o f t h e Sec’ y , Dep ’ to f t h e Treas u ry , 1 Tax Refo rm fo r Fai rn es s , Si m

p l i ci ty , an dEco n o m i c Gro w th : Treas u ry Dep art m en t Rep ort t o the Pres i d en t1 2 6 -2 8 (1 9 8 4 ). Th es e s ect i o ns are al s o ab o u tt i m i n g . A b u s i n es s thatco u l di m m ed i at el y d educti n d i rect co s ts u n d er s ect i o n 4 7 1 n o w h as t o t reat th o s e co s t s as cap i t al
ex p en d i tu res an dwai t u n t i l i treal i zes rel at edi n co m e t o ad ju s tfo r t hem . Ina s en s e Co n g res s i s t ak i n g away

s o m e cu rren td educt i o n s b u tal l o wi n g th em i n l at er y ears , ren am edCOGS. It i s l eg is l at i v e g race d eferred , b u t n o td en ied
. M o s t b u s i n es s d o n ’ t l i k e th i s . Th ey ’ drat h er h av e a d edu ct i o n n o wth an i n creas edCOGS l at er. See, e.g ., Fro n t i er Cu s t o m Bu i l d ers , In c. v . Co m

m i s s i o n er, T.C. M em o . 2 01 3 -2 3 1 , at* 1 4 (h o m eb u i ld er arg u edi t was a s el l er, n o ta p ro du cer, i n at t em p tt o av o i d cap i tal i zat i o n ), aff’ d , 6 26 F. Ap p’ x 8 9 (5 th Ci r. 2 0 1 5 ). Bu t dru g traffi ck ers h av e a d i fferen tat t i tu d e. Al th o u g h s ect i on 2 8 0 E p rev en t s th em fro m d edu ct i n g ex p en s es , th ey are s t i l l en ti t l edt o COGS ad ju s t m en ts . Ol i v e, 1 3 9 T.C. at3 2 -3 6 . By

ren am i n g COGS wh ath adb een d edu ct i o n s , Co n g res s m ad e i t p o s s i b l e fo r t raffi ck ers t o ad ju s tfo r ex pen s es th atth ey co ul dn ’ tp rev i o u s l y cl ai m .- 5 3 -

Th ey h av e t o m ak e th o s e ad

ju s t m en t s i n the l at er y ear wh enth e i n v en t o ry i s s o l d , b u tl at er i s b et t er t h ann ev er. Ex cep tth atm ay

b e i t ’ s s t i l l n ev er. In 1 9 8 8 Co n g res s am en d eds ect i o n 2 6 3 A(a)(2 ), ad d i n g fl u s h l an g u ag e t h ats ay s : “ An y co s t wh i ch (b u tfo r t h i s
s ub s ect i o n ) co u l d n o tb e t ak en i n t o acco u n ti n co m p u t i n g t ax ab l e i n co m e fo r an y t ax ab l e y ear s h al l n o tb e t reat edas a co s td es cri b edi n thi s p arag rap h
. ” TAM RA
s ec. 1 0 08 (b )(1 ). Th e reg u l at i o n s s h o w th at“ co s t ” h ere m ean s ex p en s es thatwo u l d
o th erwi s e b e d edu ct ib le. See s ec. 1 .2 6 3A-1 (c)(2 ), In co m e Tax Reg s . Inth ei r
ex p lan at i o n o f h ow s ect i o n 2 6 3 A(a)(2 )’ s fl us h l an g u ag e wo rk s , th e reg u l at i o n s p o i n to u tth ati f a b u s i n es s m eal i s en t i rel y at tri b u tab l e t o the acq u i s it i o n o r p ro duct i o n o f i n v en t o ry , the t ax p ay er cap i t al i zes o n l y 8 0 % o f i tb ecau s e s ect i o n 2 7 4 (n ), atth att i m e, l im i t edb u s i n es s m eal d edu ct i o n s t o 8 0 % o f t hei r “ co s t ” (wh ich th e s ect i on i t sel f cal l s an “ ex p en s e”, s ee s ec. 2 7 4 (n )); th e t ax p ay er d o es n ’ t g ett o cap i tal ize t he wh ol e m eal an des cap e t he 8 0 % l i m it at i o n o n the d educt i o n , s ec. 1 .2 6 3A-1 (c)(2 )(i ), In co m e Tax Reg s . So i f s om et h i n g was n ’ td edu ct i b l e b efo re Co n g res s en act eds ect i o n 2 63 A, t ax p ay ers can n otu s e t h ats ect i o n t o cap i t al i ze i t . Sect i o n 2 6 3A m ak es t ax p ay ers d efer t h e b en efi t o f wh at u s edt o b e d educt i o n s --i td o es n ’ ts h o wer t h at as g race o n t h o se p rev i o u sl y d am ned
.- 5 4 - 3
. Harb o rs id e’ s Arg u m en t Can Co n g res s g etaway

wi th th i s ? Harb o rs id e arg u es th at l i m i t i n g i ts COGS t o “ o n l y th e act u al co s tu s edt o p u rch as e i nv en t ory ” v i o l at es th e Si x teen th Am en d m en t . It s th eo ry i s th ats ect i o n 2 6 3 A rep res en t s th e m o s t accu rat e t ax acco u n t in g m et h o dfo r cal cu l at i n g COGS an dth at n o tl et t i n g m ari ju an a d i s p en s ari es u se i tfo rces th em t o p ay t ax o n m ore t h an th ei r g ro s s i n co m e. In
o th er wo rd s , Harb o rs i de t h in ks s ect i o n 2 6 3A s o m eh ow d efi n es COGS fo r
co n st i tu t io n al p u rp o s es . Th at ’ s wro n g . Th e Si x t een th Am en d m en t ’ s m ean in g d id n ’ tch an ge wh en Co n g res s en act ed s ect i o n 2 6 3 A. See U.S. Co n s t. art . V (p ro v i d i n g o n l y m et h o d fo r ch an g i n g co n s t i tu t io n). Sect i o n 4 7 1 was n ’ tfo u n du nco n s t i tu t i o n al du ri n g th e
m an y d ecad es wh en i twas th e o n l y m ean s o f cal cu lat i n g COGS, an d i two u l dn ’ t b e u n co n s t i tu t i o n al n o w i f Co n g res s rep eal eds ect i o n 2 6 3 A. Th e Co n s t itu t i o n d o es li m i tCo n g res s t o t ax i n g o n l y g ro s s i nco m e, an dco u rt s h av e co n s i s t en t l y h el d --i n cl u d i n g i n cas es Harb o rs i d e ci t es --t h atg ro s s i n co m e i s g ro s s recei p t s
m i n u s di rect

co s t s. See Read i ng , 7 0 T.C. at7 3 3 (COGS are d irect i n v es t m en ti n i t em s o l d ); Pi t t s bu rg h M i l kCo . v . Co m m i ss i o n er, 2 6 T.C. 7 0 7 , 7 1 5 (1 9 56 ) (g ro s s i n co m e o n s al es i s i n co m e fo r Si x t een th Am en d m en t ); An d ers o n Ol ds m o b i l e, In c.
v . Ho fferb ert , 1 0 2 F. Sup p. 9 02 , 9 0 5 (D. M d . 1 9 5 2 ) (IRS can t ax o n ly am o u n t- 5 5 -

real ized on s al e m i nu s b as i s ), aff’ d , 1 9 7 F.2 d5 0 4 (4 th Ci r. 1 9 5 2 ). Harb o rs i d e, l i k e al l t ax pay ers , can s t i l l ad

ju s t fo r i t s d i rect co st s --o r, t o u se i ts t erm i n o l o g y , “ th e actu al co s tu s edt o p u rch as e i n v en to ry .” It th erefo re p ay s t ax o n l y o n th e am o u n t i t real i zes o n s al es , wh i ch i s wh atth e Co n s ti tu t io n req u ires
. Harb o rs id e co m

pares i t s el f t o th e t ax pay er i n An d ers o n Ol ds m o b i l e, b u tth at
cas e d o es n ’ t h el p i t . Th ere t h e t ax p ay er p ai dm o re fo r i t s i n v en t o ry than s i n cerep eal edfed eral p ri ce co n tro l s al l o wed , an d th e Co m m i s s i on er t ri edt o l im itth e t ax p ay er’ s COGS t o t h e h i g h es tl eg al p ri ce. Id . at 9 03 . Th e co u rth el dthat b ecau s e Co n g res s can t ax o n ly g ro s s i n co m e, t h e t ax pay er was en ti t l edt o a COGS ad ju s t m en tfo r t h e act u al am o u n t i tp ai dfo r i t s i n v en t o ry ev en th o u g h th atam o u n t
was i l l eg al l y

h i g h . Id . at9 0 3 , 9 0 5 , 9 0 9
. As Harb o rs i d e co rrect l y p o i nt s o u t, An d ers o n Ol d s m o bi le s ay s th ats t atu t es
can ’ tl etth e Co m

m i s s i o n er t ax m o re t han g ro s s i n co m e. Id . at 9 05 . Bu t that ’ s n o t wh at ’ s h ap p en i n g h ere. Un l i k e An d ers o n Ol ds m o bi l e, wh ere t h e Co m m i s s i o n er
wan ted t o u s e a s tatu t e t o d en y th e t ax p ay er a COGS ad

ju s t m en tfo r p arto f i t s d i rect co s to f p u rch as i n g i n v en t o ry , thes e cas es fi ndth e Co m m i s s io n er s ay i n g o n l y th atHarb o rs id e can ’ tu s e s ect i o n 2 6 3 A t o cap it al i ze i n di rect co s ts th ati t wo u l dn’ t
o th erwi s e b e ab l e t o d edu ct . Harb o rs i d e s t il l g et s t o d o ex act ly wh at th e t ax p ay er- 5 6 -

i n An ders o n Ol d s m o b i l e d i d : cal cu l at e i ts g ro s s i n co m e b y s ub tract i n g th e d i rect
co s to f i ts i n v en t o ry

fro m i t s g ro s s recei p t s . See i d . at9 0 5
. Wh atAn d ers o n Ol d s m o b i l e real l y h o l d s i s th att ax p ay ers can ad ju s t fo r COGS wh et h er o r n o tth ei r d irect co s t s are l eg al . See i d. at9 0 3 ; s ee al s o Pi t t s b u rg h M i l kCo ., 2 6 T.C. at7 1 7 (t ax p ay er wh o s o l dm il kb el o w l eg al p ri ce
u s ed actu al p ri ce wh en cal cu l at i n g i nco m e). Th i s t el l s u s wh atwe al read y kn o w: Harb o rs i d e wo u ldg etCOGS ad ju s t m en t s fo r i t s d i rect i nv en to ry co s t s n o m at t er wh at --ev en i f i twas traffi ck i n g co cai n e o r an y o th er co n tro l l eds ub s t an ce n o tl eg al
u n d er Cal i fo rn i a l aw. Th e o n l y th i n g s Harb o rs i d e d o es n ’ tg etare i n d i rect i n v en t o ry co s t s g ran t edas d edu ct i o n s an d t h en d eferred u n d er s ect i o n 2 63 A. Th e s ect i on 2 6 3 Acap it al i zat i on ru l es d o n’ tap p l y t o dru g t raffi ck ers . Un l ik e m o s tb us i nes ses , dru g traffi ck ers can ’ tcap i t al i ze i n di rect ex p en s es b ey o n d wh at ’ s l i st edi n t h e s ect i o n 4 7 1 reg u l at io n s . Sect i o n 2 6 3 A ex p res s l y p ro h i bi t s cap i t al i zi n g ex pen s es th atwo u l dn ’ to th erwi s e b e d edu ct i b l e, an d d ru g traffi ck ers d o n ’ tg etd edu ct i o n s. Becau s e fed eral l aw l ab el s Harb o rs i d e a d ru g t raffi ck er, i t
m u stcal cu l at e i t s COGS acco rd i n g t o s ect i o n 4 7 1. B. Is Harb o rs i d e a Pro ducer o r a Res el l er? Becau s e t he s ect i on 4 71 reg u l at i o ns h av e d i fferen tru l es fo r res el l ers an d p ro ducers , h o wHarb o rs i d e cal cu l at es i ts COGS d ep en d s o n wh i ch ty p e o f- 5 7 -

t ax p ay er i ti s . Harb o rs i d e was wi th o u tqu es t i o n a res el l er o f t he m ari ju an a ed i b l es
an d n o n -m ari

ju an a-co nt ai n i n g p ro du ct s i tb o u g htfro m th i rdp art i es an ds o ldati t s faci li ty . Bu tth e s i tuat i o n i s m o re co m p l ex fo r t h e m ari

ju an a b u d i t s ol d
. Harb o rs i d e i ns i s t s i tp ro du ced th i s m ari ju an a an dcan i n cl ud e i n i t s COGS t h e i n d i rect i n v en t o ry

co s t s t h ats ect i o n 1 .4 7 1 -3 (c), In co m e Tax Reg s ., d es cri b es . Th e Co m m i s s i o n er s ay s Harb o rs i d e i s a res el l er an d, u n der s ect i o n 1 .4 71 -3 (b ), In co m e Tax Reg s ., i tcan i n cl u d e o n l y i t s i n v en t o ry

p ri ce an dtran s p ort at i on co s t s . 1
. Wh atDo es “ Pro du ce” M ean ? To s o rtth i s o u t we fi rs tn eedt o kn o w wh at“p ro du ce” m ean s . Th e Co m m i s s i o n er, ci t i n g a Co u rto f Cl ai m s cas e, s ay s th atu n d er s ect i o n 4 7 1

“p ro du ct i o n” m ean s “ m an u factu ri n g ”. See Heav en Hi l l Di s t i l l eri es , In c. v . Un i t ed St at es , 4 7 6 F.2 d1 3 2 7 , 1 3 3 5 (Ct . Cl . 1 9 7 3 ). He th enci tes a l i n e o f cas es s ay i n g th at“ m anu fact u ri n g ” requ i res a ch an g e t o t h e es s en t i al ch aract er o f t h e
m erch an d i s e. M arco r, In c. v . Co m m i s s i on er, 8 9 T.C. 1 81 , 1 9 3 (1 9 87 ); s ee al s o An h eu s er-Bu s ch Brewi n g As s ’ n v . Un i t edSt at es , 2 0 7 U.S. 5 5 6 , 5 6 2 (1 9 0 8 ); In re I. Rh ei n s tro m

& So n s Co ., 2 07 F. 1 1 9 (E.D. Ky . 1 9 1 3), aff’ d s ub n o m . Cen t . Tr. Co . v . Geo rg e Lu ed ers & Co ., 2 2 1 F. 8 2 9 (6 th Ci r. 1 9 1 5 ); Peo p l e ex rel . New En g lan dDres s edM eat& W oo l Co . v . Ro bert s, 1 5 5 N.Y. 4 08 , 4 1 2 (1 8 98 ); Peo p l e
v . Kn i ck erb o ck er Ice Co ., 1 N.E. 6 6 9 (N.Y. 1 88 5 ). Hi s arg u m en t , th en , i s t h at- 5 8 -

“p ro du ct i o n” m ean s “ ch an g e”. Lo o kat th e d at es o f m os to f t h es e cas es , th o u g h
-- th ey p red at e t h e Si x t een th Am en d m en t . Harb o rs id e atl eas tp oi n t s u s t o s om et h i n g m o re recen t , th e Ni n th Ci rcu i t
cas e, Su zy ’ s Zo o v . Co m

m i s s i on er, 2 7 3 F.3 d8 7 5 (9 th Ci r. 2 0 01 ), aff’ g 1 1 4 T.C. 1 (2 0 0 0). Th atcas e, h owev er, i s n ’ t ab o u t s ect i o n 4 7 1 . It ’ s ab o u ts ect i o n 2 6 3 A(g )(1 )’ s d efi n i t i o n o f “ p ro du ce”--wh i ch s ay s t h att erm “ in cl ud es co n s tru ct , b u i l d , i n s t al l , m an u fact u re, d ev el o p , o r i m p ro v e”--an d s ect i o n 1 .2 6 3 A-2 (a)(1 )(i ), In co m e Tax Reg s ., wh i ch s ay s th at“p ro du ce i n cl u d es th e fo l l o wi n g : co ns tru ct , b u i l d , i n s t al l , m an u fact u re, d ev el o p , i m p ro v e, creat e, rai s e, o r gr o w .” Su zy ’ s Zo o , 2 7 3 F.3 dat8 7 8 (em

p h as i s ad d ed ). Al th ou g h Su zy ’ s Zo o i s ab o u ts ect i o n 2 6 3A, i t ’ s u s efu l fo r co n s tru in g
s ect i on 4 7 1 ’ s reg u l at i o n s wh i ch , l i k e s ect i o n 2 6 3A’ s reg u l at i o ns , p ro v id e d i fferen t
m et h o ds o f acco u n t i ng fo r i n v en t o ry th at ’ s “p urch as ed ” o r “ p ro du ced ” b u t d o n ’ t d efi n e t h o s e t erm s. See s ec. 1 .4 7 1 -3 (b ) an d (c), In co m e Tax Reg s . W e t hi n k

“p ro du ce” s h ou l dm ean th e s am e t h i n g i n s ect i o n 4 7 1 as i td o es i n s ect i o n 2 6 3 A. W e al s o th i n k we s h o u l d fo l l o w th e Ni nt h Ci rcu i t ’ s reas o n in g i n a cas e ap p eal ab l e t o that co u rt . See Go l s en , 5 4 T.C. at7 5 7
. In Su zy ’ s Zo o, the t ax p ay er, a g reet i ng -card co m p an y , d es i g n edi m ag es an d
s en tth em t o a co n tract p ri n t er wh o d i d co lo r s ep arat i o n s , m ad e p ro ofs , an d p ri n ted- 5 9 -

th em u s in g i t s o wnm at eri al s . A tru ck i n g co m p an y th enp i ck edup th e p ri nt s an d t o o kth em

t o a fi n i s h er. Th e fi ni s h er cu tan dfo l d edth e p ri n t s i n t o g reet i ng card s
an d retu rn edth em

t o t h e t ax p ay er. Th e p ri n t er an d t h e fi ni s h er each b o re th e ri s k
o f l o s s wh i l e t h ey

h adth e m at eri al s . Su zy ’ s Zo o , 2 7 3 F.3 dat8 7 7
. W e h el d --an d t h e Ni n th Ci rcu i taffi rm ed --t h at th e t ax p ay er was a “ p ro du cer” b ecau s e i tret ai n edt i t l e t o the i t em s t h ro u gh o u tth e co n tract -p ro du ct i o n p ro ces s . Id . at8 7 7 , 8 8 0 . Ci t i n g reg u l at i o n s u n d er s ect i o n 2 6 3 A, th e co u rts ai d : “ Th e o n l y req u i rem en tfo r b ei n g a ‘ p ro du cer’ * * * i s th at th e t ax p ay er b e ‘ co ns i d eredan
o wn er o f t h e p ro p ert y

p ro duced ,’ ” t hat“ o wn ers h i p i s ‘ bas edo n al l o f t he fact s an d ci rcu m s t an ces , ’ ” an dthat“ [a] t ax p ay er m ay b e co n s i d eredan o wn er o f p ro p ert y p ro duced , ev en th o u gh th e t ax pay er d oes n ot h av e l eg al t i t l e t o t h e p ro p ert y .” Id
. at8 8 0 (ci t i n g s ect io n 1 .2 6 3 A-2 (a)(1 )(i i)(A), In co m e Tax Reg s .). A t ax p ay er can b e a “ p ro du cer”, m o reo v er, ev en i f i tu s es co n tract m anu fact u rers t o d o th e act u al p ro duct i o n . Id . at8 7 8 (ci t i ng s ect i o n 2 6 3 A(g )(2 )). Th e Ni nt h Ci rcu i tex p l ai n ed th atach i ev i n g s ect i o n 2 6 3 A’ s p u rp o s e o f treat i n g al l t ax p ay ers fai rl y req ui reda b ro adco n s tru ct i o n o f “ p ro du ce”. Id . at8 7 9 ; s ee al s o Vo n-Lu s kv . Co m m i s s i o n er, 1 0 4 T.C. 2 0 7 , 2 1 5 (1 9 9 5 ); S. Rep t . No
. 9 9 -3 1 3 , s up ra at1 4 0 , 1 9 86 -3 C.B. (Vo l
. 3 ) at1 4 0
. W e’ ve s ai dthi s b efo re o u rs el v es , n otco i n ci d en t al l y i n a cas e h o l d i n g th at- 6 0 -

“p ro du ct i o n” fo r s ect i o n 2 6 3 A d o es n ’ treq u i re a p h y s i cal ch an g e. See Vo n -Lu s k , 1 0 4 T.C. at2 17
.

“ Pro du ce” i s therefo re b ro ad er t h an “ m an u fact u re”. Th at ’ s al s o ev i d en t fro m th e Co de an dreg u l at i on s . W e s aw t h atal read y i n s ect i o n 2 6 3 A (g )(1 ) an d
s ect i on 1 .2 6 3 A-2 (a)(1 )(i ), In co m e Tax Reg s . See s up ra p p . 5 8 -5 9
. Th e s ect i o n 4 7 1 reg u l at i o n s al s o s h o w th at“p ro du ct i on ” an d “ m an ufact u ri n g ” are d i st i nct , i f rel at ed , co n cep t s. Sect i o n 1 .4 7 1 -1 1 , In co m e Tax Reg s., d i scu s s es “p ro du ct i o n ”
co s t s , b u trefers i n s ev eral p l aces t o co s t s “ i n ci d en t t o an dn eces saryfo r p ro duct i o n o r m an u fact uri n g , ” a co n s tru ct i o n i m p l y i n g th atth e two t erm s are n o t i d en t i cal , ev en i f t h ey

are cl o s el y

rel at edan drecei ve i den t i cal t ax treat m en t . 2 4 Fo r p u rp os es o f s ect io n 4 7 1 , p ro du ct i o n tu rn s o n o wn ers h i p--o wn ers h ip as d et erm i n ed b y fact s an dci rcu m s t an ces , n o tfo rm al t i t l e.

2
. Di dHarb ors i d e OwnWh atIt s Gro wers Grew? In fi n d i n g th atSu zy ’ s Zo o was a p ro du cer, t he Ni n th Ci rcu i tem ph as i zedth e

“ d eg ree o f co n tro l * * * [t h e t ax p ay er] ex erci s e[d ] o v er t h e m an u fact u ri n g

2 4 Th e h ead i ng o f s ect i o n 1 .4 7 1 -1 1 , In co m e Tax Reg s ., i s “ In v en t ori es o f M an u fact u rers ,” b u tth i s d o es n ’ tch an g e o u r an al y s i s o f i t s t ex t. St atu t o ry t i t l es an d h ead i n g s are u s efu l wh en in t erp ret i n g am bi g u o u s wo rd s o r p h ras es , b ut“ th ey can n otu n d o o r l i m i tth atwh ich th e t ex tm ak es p l ai n .” Bh d . o f R.R. Trai n m en v . Bal t i m o re & Oh i o R.R. Co ., 3 31 U.S. 5 1 9 , 5 2 8-2 9 (1 9 4 7 ); s ee al s o Di x o n v . Co m m i s s i o n er, 1 3 2 T.C. 5 5 , 8 1 (2 0 0 9 ).- 6 1 -

p ro ces s .” Su zy ’ s Zo o , 2 7 3 F.3 dat8 8 0 . Harb o rs i d e s ay s i tal s o ex erci seda h i g h d eg ree o f co n tro l o v er t h e g ro wers i tp u rch as edm ari ju an a fro m . Itp o i n t s o u tth at i t bo u g h tm ari

ju an a o n l y

fro m i t s m em b ers , an dev en th en o n l y i f t he m em b ers
u s ed H arb o rs i d e’ s cl o n es (wh i ch th ey ei th er b o u g h to r recei vedfo r free), t o o k Harb o rs i d e’ s g ro wi n g cl as s , fo l l o wedHarb o rs i d e’ s b es tp ract ices , an d m et Harb o rs i d e’ s qu al i ty -co n tro l s tan d ard s . Bu tth ere was m o re t o Su zy ’ s Zo o. Th ere t h e t ax p ay er acq u iredo wn ers h i p wh en i tfi rs td es i g n edth e ch aract ers b ecau s e t h atwas th e m o s t i m p o rt an ts t ep an d th e o n e th atreq u i redthe m o s ts k i l l an dex p ert i s e. Su zy ’ s Zo o , 1 1 4 T.C. at8
. Su zy ’ s Zo o ’ s co n tract ors co u l dn ’ t s el l , co p y , o r u s e t h o s e ch aract ers wi th o u t b reach i n g Su zy ’ s Zo o’ s l i cen s e. Id . Su zy ’ s Zo o ret ai n edth e “ ex cl u s i v e ri g h tt o
s el l th e fi n i s h ed p ro du ct ,” i d. at9 , an di t accep t ed al l th e fi n i s h edp ro duct s i t
o rd ered , s ee Su zy ’ s Zo o , 2 7 3 F.3 dat8 7 7
. Harb o rs id e, u n l i k e Su zy ’ s Zo o , s ee i d
. ; Su zy ’ s Zo o , 1 1 4 T.C. at8 -1 0 , d i dn’ t creat e t h e cl o n es , m ai nt ai n t i gh tco n tro l o v er t h em , o rd er s p eci fi c qu an t i t ies , p rev en t s al es t o th i rdp art ies , o r t ak e p o s s es s i o n o f ev eryth i n g p ro du ced
. Harb o rs i d e b o ug h tcl o n es fro m n u rs eri es an dei th er s o l dthem t o g ro wers wi th n o
s tri n g s at t ach edo r g av e cl o n es t o g ro wers ex p ect i ng th atth ey ’ d s el l b u d b ackt o Harb o rs i d e. No th i ng p rev en tedei th er t y pe o f g ro wer fro m

s el l i n g t o an ot her- 6 2 -

co l l ect i v e, an dDeAn g el o tho u g h ti two u l db e fu t i l e t o try t o u s e t h e co u rt s t o s t o p th em . 2 5 Harb o rs i d e h adco m p l et e d i s cret i o n o v er wh et h er t o p urch as e wh atb u d g ro wers b ro u g h ti n , p ai dg ro wers o n l y i f i tp u rch as edth ei r b u d , an datt i m es reject edth e “ v as tm ajo ri ty ” o f i t s g ro w ers ’ b u d . An dHarb o rs id e t h o ug h t g ro wers
co u ldd o wh at ev er t h ey

wan t edwi th th e reject edb u d
. Th i s was n o tth e t y

p e o f co n tract -m anu fact u ri ng arran g em en t we s aw i n Su zy ’ s Zo o , 2 73 F.3 d at8 7 7 , wh ere a d es ig n er h i redo th ers t o m ak e i t s p ro du ct s b u to wn edth o s e p ro du ct s atal l s t ag es o f t h ei r creat i o n. Harb o rs id e m erel y s o l do r g av e m em

b ers cl o n es th ati th adp u rch as ed fro m n u rs eri es an db o u g h t b ackb u di f
an d wh en i twan t ed . Inb etween th es e t wo s t ep s i th ad n o o wn ers h i p i n teres ti n th e
m ari ju an a p l an t s. Harb o rs i de i s th erefo re a res el ler fo r p u rp o s es o f s ect i o n 4 7 1
an d m u s tad ju stfo r i ts COGS acco rd i n g t o s ect i on 1 .4 7 1 -3 (b ), In co m e Tax Reg s . 2 6 Th i s l eav es o n l y

th e i s s u e o f wh ether Harb o rs i de o wes accu racy -rel at ed p en al t i es u n d er s ect i o n 6 6 6 2 (a). W e wi l l ad dres s thi s i s s u e i n a s ep arat e o p i n i o n .

2 5 DeAn gel o s ai dh e n ev er s u edan y o ne fo r b reach o f co nt ract b ecau s e “ th e p o s s i b i l i ty

o [f] p rev ai l in g o n co n tract d i s p u t es i n s o m et h i n g t h ati nv o l v es a co n tro l l eds ub st an ce i s s l i m an dwo u l db e ex pen s i ve.”
2 6 Harb o rs i d e d i dh av e a “ p ro ces s i n g ro om .” See s up ra p . 8 . Bu tth e “p ro ces s i n g ” t h atwen to n there--rei n s p ect i o n , p ack ag i n g, an dl ab el i n g--fal l wi t h i n th e cat eg o ry

o f “p u rch as i n g, h an d l i n g , an ds t orag e” t hatres el l ers d o wi th o u tl o s i n g th ei r ch aract er as res el lers . See s ec. 1 .2 63 A-3 (c), In co m e Tax Reg s .