Cannabis dispensary denied ERC

The Court of Federal Claims held that as a trafficker in a controlled substance, a cannabis business was not eligible to receive an ERC or its refundable portion.

Facts: Gravenstein 116 LLC operated three cannabis dispensaries in California during 2020 and 2021. As a marijuana business, Gravenstein was subject to Sec. 280E, which prohibits deductions and credits for amounts paid or incurred in carrying on trades or businesses that consist of trafficking in controlled substances listed in Schedules I and II of the Controlled Substances Act (CSA).

The ERC, enacted by the Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136, and codified at Sec. was a refundable tax credit available to employers that were forced to close or suspend operations due to COVID-19 pandemic-related health orders. The credit was applied against employment taxes paid, with any excess credit claimable as a cash refund. It equaled 70% of qualified wages paid to employees during the pandemic-related shutdowns and was available only for wages paid before Oct. 1, 2021 (or Jan. 1, 2022, for “recovery startup businesses”). Gravenstein alleged that government health orders during the pandemic significantly affected its operations by increasing costs, decreasing revenue, and forcing a transition from in-person retail sales to almost exclusively curbside pickup orders.

In 2024, Gravenstein filed Forms 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund, to amend its previously filed Forms 941, Employer’s Quarterly Federal Tax Return, for each of the first two quarters of 2021. On the original Forms 941, Gravenstein reported that it had no outstanding employment tax liability for the first or second quarter of 2021. On the Form 941-X for the first quarter of 2021, the LLC claimed a refundable ERC of $150,786, and on the Form 941-X for the second quarter of 2021, it claimed a refundable ERC of $171,230.

When the IRS did not respond to its refund requests within six months of receiving them, Gravenstein filed a refund suit in the Court of Federal Claims seeking a refund of $322,016. The IRS moved to dismiss the suit, asserting that Sec. 280E prohibited Gravenstein from claiming the refundable portion of the ERC.

Issues: The Court of Federal Claims analyzed the plain text of Sec. 3134, which describes both the ERC and its refundable portion as a “credit.” Sec. 280E also states that it applies to a credit. Applying the canon of statutory construction that identical words in the same act are presumed to have identical meaning absent demonstrable contrary legislative intent, the court found no evidence that “credit” was intended to mean different things in the two sections. Accordingly, the court concluded that “credit” should be defined identically in both provisions.

Gravenstein argued that even if the ERC is a tax credit, its refundable portion is not one, due to its structure. It contended that “while the form of the ERC is that of a tax credit, the substance of the amounts in excess of an employer’s tax liabilities is that of a non-tax refund of wages paid.” The Court of Federal Claims rejected this argument, citing Sorenson v. Secretary of Treasury, 475 U.S. 851, 853—54 (1986), in which the Supreme Court held that the Code’s definition of the refundable portion of the earned income credit as an “overpayment” did not change its structure as a tax credit. The Court of Federal Claims emphasized that “the Internal Revenue Code does not discriminate between a refundable credit and other credits” (citing Sorenson, 475 U.S. at 863). Because the Code does not discriminate between a refundable credit and other credits, and Gravenstein made no credible, supported argument to the contrary, the court rejected the LLC’s argument.

The Court of Federal Claims also rejected Gravenstein’s contention that the ERC’s purported policy purpose of subsidizing employment made it structurally different from other credits. Citing Israel, 356 F.3d 221, 223—24 (2d Cir. 2004), the court held that terms used throughout the Code do not change their meaning when applied to a refundable credit, even when that credit supports a social policy. “Accordingly,” the court stated, “the term ‘credit’ in the ERC has the same meaning in the Code as the term ‘credit’ in Section 280E and … the Section 280E bar thus applies to the ERC, including any refundable portion of the credit.”

Gravenstein further argued that the social purpose of the ERC should override the Sec. 280E bar against drug traffickers’ claiming it. The court stated, though, that where statutory text and structure are clear, it would not analyze the statute’s purpose in a way that undermines its text. Thus, Gravenstein’s social-purpose argument was beyond the court’s role to consider because the text of Sec. 280E was unambiguous. The court added, however, that the argument would fail even if it had the authority to consider it.

Gravenstein also attempted to distinguish itself from a hypothetical “illegal cocaine dealer” by arguing that it contributed to the economy and operated legally at the state level. The Court of Federal Claims noted that relevant federal law does not distinguish between different types of drug traffickers, applying equally to any business that “consists of trafficking in controlled substances” (Sec. 280E). The court also observed that at the time of the decision, under CSA Schedule I, marijuana was more heavily restricted than cocaine under Schedule II, and therefore the distinction between a marijuana dealer and an illegal cocaine dealer did “not reflect well” upon Gravenstein.

Holding: The Court of Federal Claims held that Sec. 280E applies to the refundable portion of the ERC and dismissed Gravenstein’s complaint. The court found that the refundable portion of the ERC is a credit within the meaning of Sec. 280E, and, therefore, the IRS correctly denied the credit to Gravenstein as a trafficker in a federally controlled substance under the CSA.

(Note that on April 23, 2026, the U.S. Justice Department and Drug Enforcement Administration, in accordance with an earlier presidential order, placed certain FDA-approved products containing marijuana and marijuana products regulated by a state medical marijuana license under CSA Schedule III and scheduled a public hearing toward finalizing regulations proposed in May 2024 to similarly reschedule marijuana more broadly.)

• Gravenstein 116, LLC, No. 25-997 (Fed. Cl. 1/30/26)

— Thomas Godwin, CPA, CGMA, Ph.D., and John McKinley, CPA, CGMA, J.D., LL.M., are both professors of the practice in accounting and taxation in the SC Johnson College of Business, and Jack Horner is a student in the Dyson School of Applied Economics and Management in the SC Johnson College of Business, all at Cornell University. To comment on this column, contact Paul Bonner, the JofA’s tax editor.