Tax Court Upholds IRS Rejection of Marijuana Dispensary’s $65K Offer-in-Compromise, Citing § 280E Consistency

Mission Organic Center, Inc. v. Commissioner: The Tax Court’s $5.2M Warning to Cannabis Businesses

The Tax Court’s December 16, 2025 ruling in Mission Organic Center, Inc. v. Commissioner delivered a stark warning to state-legal marijuana businesses: the IRS’s collection power trumps even the most aggressive settlement offers when nondeductible §280E expenses are involved. In a 13-3 decision, the court upheld the IRS’s rejection of Mission Organic Center’s $65,000 offer-in-compromise (OIC) against a $5.246 million tax liability, finding no abuse of discretion in the agency’s refusal to consider §280E-barred expenses when calculating reasonable collection potential (RCP). The dissent’s argument; that the IRS’s Internal Revenue Manual (IRM) illegally overrides Treasury regulations; further underscored the high-stakes clash between statutory tax policy and administrative discretion.

The case spotlights a brutal reality for cannabis operators: federal tax law’s §280E, which disallows all ordinary business deductions for Schedule I/II drug trafficking, now extends its reach into the OIC process itself. By rejecting Mission’s OIC; calculated after stripping out nondeductible expenses; the Tax Court effectively ruled that §280E’s policy objectives supersede even the IRS’s own settlement guidelines under §7122. The ruling cements the IRS’s authority to enforce §280E not just at audit, but in collection proceedings, leaving marijuana businesses with little recourse beyond paying the full liability or facing levies.

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From State-Legal Success to Federal Tax Nightmare: The Story of Mission Organic Center

Mission Organic Center, a San Francisco-based marijuana dispensary, grew from a modest $2 million operation in 2016 to a $16 million business by 2021. Its success mirrored the broader boom of California’s legal cannabis industry, where state regulators had licensed its operations and consumers flocked to its doors. But behind the growth lay a federal tax time bomb: Section 280E of the Internal Revenue Code.

Section 280E, enacted in 1970 as part of the War on Drugs, disallows all ordinary business deductions for businesses trafficking in controlled substances; including marijuana, which remains classified as a Schedule I drug under federal law. Unlike most businesses, which can deduct rent, wages, utilities, and marketing, Mission could not. The IRS allowed only deductions for the cost of goods sold (COGS), under Section 471, leaving the dispensary with taxable income that vastly exceeded its after-tax profits.

By 2021, Mission’s gross receipts had ballooned to over $16 million, but its taxable income; after COGS deductions; remained disproportionately high. The result was a growing federal tax liability that Mission could not pay in full. The IRS issued Notices of Intent to Levy in 2021 and 2022, triggering Mission’s right to a Collection Due Process hearing and an opportunity to seek alternative resolution.

Mission responded by filing Forms 12153, requesting both an installment agreement and an Offer-in-Compromise (OIC). On its OIC application, Mission calculated its reasonable collection potential by subtracting nondeductible expenses from projected income; a move it argued reflected its actual ability to pay. It submitted a $65,000 settlement offer, arguing that paying the full $5.2 million liability would cripple operations and violate the spirit of the OIC program, which is designed to resolve debts where full payment would cause economic hardship.

But the IRS’s revenue officer rejected Mission’s approach. In calculating Mission’s reasonable collection potential, the officer disregarded all operating expenses rendered nondeductible under Section 280E, including rent, payroll, utilities, and supplies. The result was a staggering $57.8 million reasonable collection potential; nearly 11 times Mission’s outstanding tax debt. The IRS’s settlement officer sustained the rejection, concluding that Mission’s offer was “substantially lower” than its ability to pay.

Mission protested, arguing that the IRS’s policy of ignoring nondeductible expenses in OIC calculations conflicted with the purpose of the program and the realities of operating a state-legal cannabis business. But the IRS stood firm, relying on its Internal Revenue Manual (IRM) to justify the exclusion of Section 280E-barred expenses from the OIC analysis. The stage was set for a legal showdown; one that would test whether Section 280E’s punitive tax policy could override even the IRS’s own settlement guidelines.

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The IRS’s Calculation: Why $65K Was ‘Substantially Lower’ Than Reasonable Collection Potential

The IRS’s rejection of Mission Organic Center’s $65,000 offer-in-compromise hinged on a single, unyielding calculation: reasonable collection potential (RCP). Under the Internal Revenue Manual (IRM), the IRS defines RCP as “the amount that can be collected from all available means” when evaluating an offer to settle a tax debt. For businesses like Mission Organic; a state-legal cannabis dispensary operating under the punitive tax regime of IRC § 280E; this calculation became a financial death sentence.

The revenue officer assigned to Mission’s case followed the IRM’s strict methodology. First, they projected Mission’s future income by taking its gross monthly income of $1,323,951 and subtracting allowable expenses of $812,258, which included only cost of goods sold (COGS) and vehicle expenses. The remaining $511,693 in monthly disposable income was then multiplied by 113 months; the standard term for an offer-in-compromise; yielding a future income projection of $57,821,293. To this figure, the officer added Mission’s total assets of $30,785, resulting in an RCP of $57,852,078.

This staggering number dwarfed Mission’s $5,246,293 tax liability and its $65,000 settlement offer. The IRS’s preliminary determination was unequivocal: Mission had the ability to pay its liability in full and thus did not qualify for an offer-in-compromise under IRC § 7122, which permits settlements only when doubt exists as to collectibility or when special circumstances justify hardship. The revenue officer and his supervisor found no such doubt or hardship, leaving Mission’s $65,000 offer; already a concession from its calculated minimum of $78,582; laughably inadequate in the eyes of the IRS.

The calculation’s harshness stemmed from the IRS’s refusal to account for nondeductible §280E expenses in Mission’s financial analysis. IRC § 280E prohibits cannabis businesses from deducting ordinary business expenses like rent, salaries, or marketing, even if state law permits them. While the IRS allows deductions for cost of goods sold (COGS) under IRC § 471, it excludes all other expenses when determining a taxpayer’s ability to pay. This policy, embedded in IRM 5.8.5.25.2, ensured that Mission’s $1,490,236 in reported expenses; including wages, rent, and utilities; were stripped from its RCP calculation, artificially inflating its disposable income and leaving no room for compromise.

For Mission, the IRS’s RCP calculation was not just a rejection of its offer; it was a declaration that §280E’s punitive tax burden overrides even the IRS’s own settlement guidelines. The stage was set for a legal confrontation over whether the IRS could enforce its rigid interpretation of RCP against a business trapped in the crosshairs of federal tax policy and state-legal operations.

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Clash of Arguments: Can the IRS Ignore Nondeductible Expenses When Calculating Ability to Pay?

Mission Organic Center’s fight with the IRS over its rejected $65,000 offer-in-compromise hinges on a single, explosive question: when calculating a taxpayer’s ability to pay, can the IRS disregard nondeductible business expenses; even if those expenses are statutorily barred under §280E?

The dispute is not merely procedural but existential for cannabis businesses trapped in the IRS’s crosshairs. Mission argues the IRS’s refusal to account for its nondeductible §280E expenses in its Reasonable Collection Potential (RCP) calculation was an abuse of discretion that defies both statute and regulation. The IRS, however, counters that its policy is a faithful application of congressional intent, ensuring that businesses operating in violation of federal law cannot artificially inflate their financial hardship to secure favorable settlements.

At the heart of the conflict is IRC §280E, a provision Congress enacted in 1982 to deny tax deductions to businesses trafficking in controlled substances. The statute explicitly bars deductions under §162 (ordinary and necessary business expenses) and §167/168 (depreciation and amortization) for businesses engaged in the sale of Schedule I or II drugs, including marijuana. The IRS interprets this to mean that all operating expenses; rent, payroll, utilities, marketing; are nondeductible, leaving only the cost of goods sold (COGS) deductible under §471. Mission does not dispute this interpretation of §280E. Instead, it challenges the IRS’s decision to extend §280E’s punitive logic beyond deductions and into the OIC process itself.

The IRS’s position rests on IRM 5.8.5.25.2, which instructs settlement officers to exclude §280E-barred expenses when projecting a taxpayer’s future income. The agency argues this approach aligns with the congressional intent behind §280E: to prevent businesses engaged in federally illegal activity from benefiting from tax subsidies, even in settlement negotiations. The IRS contends that allowing Mission to deduct these expenses in its RCP calculation would undermine the statute’s purpose by effectively subsidizing its federal tax liability through a backdoor settlement.

Mission fires back that the IRS’s policy violates the plain text of §7122(d), which grants the Secretary broad discretion to prescribe guidelines for offers-in-compromise but does not authorize the IRS to rewrite the Code. The taxpayer points to Treas. Reg. §301.7122-1(b), which outlines the three grounds for compromise; doubt as to liability, doubt as to collectibility, or effective tax administration; but nowhere mentions §280E as a factor in RCP calculations. Mission further argues that the IRM’s special rule for cannabis businesses conflicts with other IRS guidance, including Rev. Proc. 2003-71, which requires settlement offers to reflect a taxpayer’s actual ability to pay, not a hypothetical one inflated by nondeductible expenses.

The IRS dismisses these objections, asserting that its policy is consistent with the legislative history of §280E, which was designed to "prevent drug dealers from writing off business expenses" while still requiring them to pay taxes on gross income. The agency argues that allowing Mission to deduct §280E-barred expenses in its RCP calculation would create a perverse incentive, encouraging other cannabis businesses to inflate their expenses to secure lower settlement offers. The IRS also points to IRM 5.8.5.25.2(3), which states that settlement officers must consider a taxpayer’s net income after all allowable deductions; but crucially, not those barred by statute.

The clash exposes a fundamental tension: Can the IRS use a taxpayer’s statutorily nondeductible expenses as a sword to deny settlement relief, even when those expenses are legally required to be excluded from taxable income? Mission’s attorneys argue that the IRS’s position turns §280E into a super-statute, overriding not just deductions but the entire framework of collection potential. The IRS, however, sees its policy as a necessary extension of congressional intent, ensuring that businesses operating in defiance of federal law cannot leverage their own illegal operations to secure financial concessions from the government.

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The Court’s Analysis: Why the IRS’s Policy Was Upheld

Mission Organic Center’s fight to settle its $5.2M tax debt for $65K is now a battle over the IRS’s power to define public policy; not just tax law. The Tax Court held that the IRS’s decision to disallow marijuana business expenses in calculating reasonable collection potential (RCP) was not a §280E super-statute violation, but rather a valid public policy exercise under its discretionary authority in offers-in-compromise (OIC). The court’s analysis hinged on two plausible readings of §280E, rejecting the first while upholding the second; a rare exercise of judicial power over the IRS or other courts and exercises its power.

Why §280E’s Policy Applies to OICs (Not Just Taxable Income)

The court first defined the two relevant Code Sections before applying them.

§280E (enacted in 1970 as part of the War on Drugs) prohibits businesses engaged in trafficking controlled substances (as defined by the Controlled Substances Act) from deducting ordinary business expenses under §162(a) or claiming credits under subtitle A. The statute is found in subchapter B (computation of taxable income), part IX (nondeductible items). Its text is unambiguous in scope:

“No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business . . . of trafficking in controlled substances . . . .”

§7122 (added in 1954 as part of the Internal Revenue Code’s settlement authority) authorizes the IRS to compromise tax liabilities for less than the full amount owed through an Offer-in-Compromise (OIC). The statute provides three grounds for acceptance:

1. Doubt as to Liability (DATL) – Genuine dispute over the tax debt’s validity.
2. Doubt as to Collectibility (DATC) – Taxpayer cannot pay the full amount.
3. Effective Tax Administration (ETA) – Collection would create economic hardship or be unfair.

The Treasury Regulations (26 CFR §301.7122-1) further outline that the IRS may, at its discretion, compromise a liability based on reasonable collection potential (RCP). The regulations, however, are silent on how to calculate RCP for businesses, leaving the IRS to set forth its own procedures in the Internal Revenue Manual (IRM).

The Court’s Two Plausible Readings of §280E

The Tax Court explicitly rejected the argument that §280E mandates disallowing expenses in RCP calculations, as the statute’s text and location make clear it applies only to taxable income, not ability to pay:

“One plausible reading is that the revenue officer and the reviewing settlement officer rejected the offer-in-compromise because they thought section 280E required the disallowance of business expenses in a marijuana business when calculating the reasonable collection potential. But section 280E addresses deductions and credits, not the computation of reasonable collection potential. It is found in subtitle A, which relates to income tax, subchapter B, which relates to the computation of taxable income, and part IX, which identifies items that are not deductible.”

The court emphasized that while the location of Code sections is not legally effective (see §7806(b)), the text of §261 (the first nondeductible item in part IX) makes clear it relates to taxable income:

“In computing taxable income no deduction shall in any case be allowed in respect of the items specified in this part.”

Similarly, §280E’s text makes clear it applies only to deductions or credits in computing taxable income:

“No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business . . . of trafficking in controlled substances . . . .”

Simply stated, the court held that §280E does not extend to OICs because it does not address what expenses may or may not be considered for the purpose of calculating a taxpayer’s reasonable collection potential. Rejecting Mission’s offer-in-compromise solely on the basis of an understanding that §280E required that result would have been an error.

The Court’s Upholding of the IRS’s Policy as a Valid Public Policy Exercise

The court then upheld the second plausible reading; that the IRS’s decision to disallow marijuana business expenses in calculating RCP was not a §280E violation, but rather a discretionary public policy exercise consistent with congressional intent:

“The other plausible reading is that the revenue officer and the reviewing settlement officer disallowed such expenses as a policy matter, relying on section 280E as the foundation for establishing that policy and the IRM as the articulation of that policy.”

The court relied heavily on the IRM’s discretionary authority, noting that settlement officers ordinarily do not abuse their discretion when they adhere to collection guidelines published in the IRM. The IRM directly addresses the RCP of businesses engaged in the trafficking of controlled substances, instructing that:

“When calculating the future income of a marijuana business, the IRM states: ‘The value of future income used in the determination of an acceptable offer amount is calculated in a different manner when a taxpayer is involved in the cultivation and sale of marijuana, in accordance with applicable state laws.’ The method of calculating future income will be based on the following guidance: a. Determine the taxpayer’s gross income over a specific time period (normally annually); b. Limit allowable expenses consistent with Internal Revenue Code 280E . . . .”

The court concluded that the IRS’s policy was not an abuse of discretion, but rather a valid public policy rationale under §280E’s congressional intent to disallow deductions attributable to a trade or business of trafficking in controlled substances. By disallowing these same items for purposes of calculating a taxpayer’s RCP, the IRS was adhering to the public policy underlying the enactment of §280E.

The Court’s Reliance on the IRM and Its Conclusion That the IRS’s Policy Is a Valid Public Policy Rationale

The court specifically addressed the IRS’s reliance on the IRM’s public policy rationale, noting that:

“The Commissioner expressly identifies his method of computing reasonable collection potential for businesses engaged in the trafficking of controlled substances as a matter of public policy. See IRM 5.8.5.25.2(3) (‘If the taxpayer is unwilling to increase their offer to the value of the equity in assets plus a future income component calculated based on this subsection, the offer will be rejected under public policy.’)”

The court held that the IRS’s policy was not an illegal override of Treasury Regulations but rather a valid public policy exercise under its discretionary authority in OICs. The IRS’s decision to disallow marijuana business expenses in calculating RCP was not a §280E super-statute violation, but rather a valid public policy rationale consistent with §280E’s congressional intent.

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What This Means for Future Taxpayers

The Tax Court’s decision expands the IRS’s power in the OIC program, allowing the agency to disallow expenses based on public policy rationale; even when those expenses are legally required to be excluded from taxable income. Future taxpayers in highly regulated industries (e.g., cannabis, gambling, alcohol) may face increased scrutiny in OIC calculations, as the IRS asserts more authority over public policy rationale in its discretionary authority.

The court’s decision does not change §280E’s applicability to taxable income, but it does extend §280E’s congressional intent to public policy rationale in OIC calculations. Future taxpayers in highly regulated industries may face increased challenges in securing financial concessions from the government, as the IRS asserts more authority over public policy rationale in its discretionary authority.

In short: The IRS’s public policy rationale in disallowing marijuana business expenses in calculating RCP was upheld as a valid public policy exercise; not a §280E violation. Future taxpayers in highly regulated industries may face increased scrutiny in OIC calculations, as the IRS asserts more authority over public policy rationale in its discretionary authority.

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The Dissent’s Warning: Does the IRM Illegally Override Treasury Regulations?

The majority’s deference to the IRS’s public policy rationale in disallowing Mission Organic Center’s expenses under §280E masks a deeper constitutional and administrative law concern raised by Judges Landy, Jenkins, and Holmes. Their dissent does not challenge the outcome per se but instead warns that the Tax Court has abdicated its role as a check on executive overreach by permitting the IRS to substitute its internal manuals for binding Treasury regulations; a move that undermines the separation of powers and the rule of law.

At the heart of the dissent’s critique is the Chenery doctrine, a bedrock principle of administrative law that requires agencies like the IRS to justify their actions based on their own stated reasons rather than post-hoc rationalizations. The judges argue that the majority’s opinion implicitly adopts an exception to Chenery by accepting two plausible but unsupported interpretations of the IRS’s determinations; one tied to §280E’s policy rationale and another to the agency’s discretion under §7122; neither of which were articulated in the Notices of Determination or supported by the administrative record. In doing so, the court steps into the role of a settlement officer, effectively rewriting the IRS’s reasoning rather than enforcing the agency’s own stated policies.

The dissent’s procedural critique centers on the IRS’s reliance on the Internal Revenue Manual (IRM) to impose a special rule for marijuana businesses that contradicts the plain text of Treasury regulations governing Reasonable Collection Potential (RCP). Under IRM 5.8.5.25.2, the IRS applies a public policy override to disallow nondeductible expenses (such as those barred by §280E) when calculating a taxpayer’s ability to pay in an Offer-in-Compromise (OIC). The judges argue this is legally indefensible for three reasons.

First, the IRM’s public policy exception violates the notice-and-comment rulemaking requirements of the Administrative Procedure Act (APA). Treasury regulations, which carry the force of law, are subject to formal rulemaking under 5 U.S.C. §553, whereas the IRM is merely an internal guidance document with no legal authority. The dissent contends that the IRS cannot circumvent the regulatory process by embedding policy preferences in the IRM, particularly when those preferences directly contradict the regulations’ focus on ability to pay. As the judges note, the Treasury’s regulations under §7122 explicitly tie OIC acceptance to RCP, which is calculated based on a taxpayer’s actual financial circumstances; not a categorical disallowance of expenses based on the nature of the business.

Second, the dissent argues that the IRS’s erroneous view of §280E further undermines its position. While §280E prohibits deductions for businesses trafficking in controlled substances, it does not address OIC calculations or RCP determinations. The judges emphasize that the statute’s policy rationale; denying tax benefits to illegal drug traffickers; does not logically extend to settlement negotiations, where the IRS is statutorily empowered to compromise liabilities based on collectibility and hardship. By conflating §280E’s substantive tax rules with the IRS’s discretionary authority under §7122, the agency overreaches its statutory bounds, effectively rewriting the law through administrative fiat.

Finally, the dissent warns that the majority’s decision grants the IRS unchecked discretion to override Treasury regulations whenever it deems a taxpayer’s industry morally or politically disfavored. This, they argue, sets a dangerous precedent for highly regulated industries beyond marijuana, from cryptocurrency to firearms businesses, where the IRS could similarly disregard financial realities in favor of public policy whims. The judges stress that such an approach undermines the rule of law, as it allows the IRS to pick winners and losers based on unwritten policy preferences rather than statutory text or regulatory guidance.

In short, the dissent does not dispute the IRS’s authority to reject Mission Organic Center’s OIC; only the legal and procedural mechanisms it used to do so. By endorsing the IRM’s public policy override without requiring the IRS to justify its actions through formal rulemaking, the majority, in the dissent’s view, abdicates its duty to police executive overreach and erodes the foundational principles of administrative law. The judges leave no doubt: if the IRS wishes to impose such sweeping restrictions, it must do so through the proper channels; not through the backdoor of an internal manual.

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What This Means for Marijuana Businesses and the IRS’s OIC Program

The Tax Court’s ruling in Mission Organic Center cements a harsh reality for state-legal marijuana businesses: §280E’s punitive tax burden extends beyond annual filings into the IRS’s collection process, particularly when settling tax debts through Offers-in-Compromise (OICs). By upholding the IRS’s policy of disallowing nondeductible §280E expenses when calculating Reasonable Collection Potential (RCP), the court has effectively barred marijuana businesses from leveraging the OIC program as a lifeline; even when they demonstrate genuine financial distress. This decision underscores the federal government’s refusal to reconcile state-legal cannabis operations with its own tax policy, leaving businesses trapped between state compliance and federal financial ruin.

For practitioners, the implications are stark. The IRS’s internal manual (IRM 5.8.5.25.2) now carries de facto legal weight in OIC negotiations, allowing the agency to systematically undervalue a taxpayer’s ability to pay by excluding §280E-barred expenses from RCP calculations. This means a dispensary with $1 million in tax debt and $800,000 in nondeductible expenses may be forced to offer $200,000 or more; or face rejection; because the IRS treats those expenses as if they never existed. The court’s deference to the IRM’s policy override, without requiring formal rulemaking, erodes the safeguards of administrative law and sets a precedent where internal IRS guidance trumps statutory intent.

The dissent’s warning; that the IRS is circumventing Treasury regulations through backdoor manuals; hints at future challenges. Taxpayers and advocacy groups may now argue that the IRM’s §280E policy violates the Chenery Doctrine, which requires agencies to justify policy shifts through formal channels. If courts begin scrutinizing the IRS’s lack of transparency in adopting this policy, the OIC program could become a battleground for broader challenges to §280E itself. Until then, marijuana businesses face a double bind: they must comply with state laws to operate, but federal tax law ensures they cannot survive the consequences of that compliance.

For practitioners advising clients, the takeaway is clear: OICs are no longer a viable escape hatch for §280E liabilities. The IRS’s RCP calculations will always favor full collection, and the Tax Court’s endorsement of this approach leaves little room for appeal. The only recourse may lie in legislative action; such as rescheduling marijuana to Schedule III; or state-level tax reforms that provide alternative relief. In the meantime, businesses and their advisors must plan for the worst: audits, aggressive collection, and the near-certainty that an OIC will be rejected unless the offer exceeds an artificially inflated RCP. The federal government has spoken: state-legal cannabis does not deserve tax mercy.