Key Points

• Test case. A pending U.S. Tax Court case, New Mexico Top Organics, Inc. d/b/a Ultra Health v. Commissioner, could reshape how Section 280E applies to state-legal medical cannabis businesses.
• Statutory interpretation. Ultra Health argues that Section 280E turns on the Controlled Substances Act’s scheduling criteria — not its listed schedules — and that marijuana no longer meets the criteria for a Schedule I or II controlled substance.
• Federal enforcement limits. Ultra Health contends that congressional appropriations riders, which prohibit the Department of Justice from interfering with state medical cannabis programs, mean its activities are not “prohibited by Federal law.”
• State tax implications. A Tax Court ruling narrowing Section 280E’s reach could impact state-level tax regimes that conform to federal law, potentially opening refund opportunities for compliant medical cannabis operators.

A case before the U.S. Tax Court could significantly change how Section 280E of the Internal Revenue Code applies to state-legal medical cannabis businesses.

If successful, the arguments could materially reduce the effective federal tax burden for compliant medical providers.

Background and Procedural Posture

Ultra Health operates licensed medical cannabis dispensaries and cultivation facilities in New Mexico. On Oct. 2, 2024, the Internal Revenue Service (IRS) issued Ultra Health a notice of deficiency for its tax years ending June 30, 2018; June 30, 2019; and June 30, 2020. The notice of deficiency disallowed all of Ultra Health’s cost of goods sold (COGS) and, citing Section 280E, denied Ultra Health’s deductions and credits. This resulted in proposed multimillion‑dollar tax deficiencies and penalties.

Ultra Health filed a Petition in the U.S. Tax Court, challenging the COGS disallowance, the application of Section 280E and the penalties, while also seeking overpayment determinations under Section 6512(b) for each year, which would enable it to preserve its right to tax refunds. The Petition alleged that extensive substantiation existed for the COGS. It also argued that Section 280E does not apply to its state‑compliant medical cannabis business on multiple independent grounds.

In 2025, the parties resolved the factual issues by stipulation, leaving open only the question of whether Section 280E enabled the IRS to deny deductions and credits to a state-legal cannabis business. On Oct. 17, 2025, Ultra Health filed its opening brief and submitted the case without trial under Tax Court Rule 122 on fully stipulated facts. Ultra Health presented three independent grounds — two statutory and one constitutional — supporting its argument that Section 280E does not bar the deduction of its ordinary and necessary business expenses or its claim of credits for the years at issue.

Argument 1: Section 280E Turns on the Controlled Substances Act’s Scheduling Criteria, Not the Schedules’ Lists

Ultra Health argued that Section 280E denies deductions only if a trade or business consists of trafficking in controlled substances that are prohibited by federal or state law “within the meaning of schedule I and II of the Controlled Substances Act.” According to Ultra Health, the phrase “within the meaning” incorporates the statutory criteria for scheduling found in 21 U.S.C. §§ 812(b)(1)–(2), rather than the substances “listed” in § 812(c). This analysis is consistent with the application of the Internal Revenue Code, where “within the meaning of” typically incorporates a definition or criteria. When Congress intends to cross‑reference a list, it instead uses “listed on” or “listed in” as the statutory text.

Applying those criteria, Ultra Health contends that marijuana is not “within the meaning” of Schedules I or II of the Controlled Substances Act. Ultra Health relies on current federal determinations following scientific review by both the Department of Health and Human Services and the Food and Drug Administration, as well as the Attorney General’s 2024 notice of proposed rulemaking, each of which concludes that marijuana has accepted medical uses, a lower abuse potential than Schedule I and II substances and dependence characteristics consistent with Schedule III substances. Ultra Health emphasized that these are scientific findings about the substance itself and are therefore probative for the earlier tax years. Ultra Health further supported its argument by citing to a 2024 Office of Legal Counsel opinion criticizing the Drug Enforcement Agency’s prior five‑factor “accepted medical use” test as impermissibly narrow under the text of the Controlled Substances Act.

Argument 2: Appropriation Riders Prevent the Federal Prohibition of State‑Legal Medical Cannabis

Ultra Health argued that even if marijuana were “within the meaning” of Schedules I and II, Section 280E applies only when its sale, or “trafficking,” is “prohibited by Federal law.” Since fiscal year 2015 and throughout the years at issue in the Tax Court litigation, however, Congress has annually prohibited the Department of Justice from using appropriated funds to prevent states from implementing their medical cannabis laws. Courts have recognized that these riders bar federal prosecution of conduct compliant with state medical programs. Because federal law mandates no enforcement against state‑compliant medical cannabis activity, Ultra Health contends that its ‘trafficking’ of marijuana is not “prohibited by Federal law” and so Section 280E does not apply.

Argument 3: Raich Deference No Longer Applies to Intrastate, State‑Licensed Medical Cannabis

Ultra Health also argued that even if federal law continues to “prohibit” the intrastate sale of medical cannabis notwithstanding the appropriations riders, the prohibition is unconstitutional due to Congress’s judgment — reflected in the appropriation riders — that federal interference with state medical cannabis programs is unnecessary to the Controlled Substance Act’s interstate regulatory scheme. In Gonzales v. Raich, the Supreme Court deferred to Congress’s judgment that prohibiting intrastate medical cannabis was necessary to prevent a “gaping hole” in the Controlled Substance Act. Ultra Health argued that the underlying premises have changed since that opinion: Congress now bars federal interference with state medical programs, undermining the “necessity” predicate for Raich deference in the medical context. This argument does not ask the Court to overrule Raich, but instead to apply its reasoning to current congressional enactments. Ultra Health also notes that this argument would be distinguishable from similar challenges by recreational operators to whom the appropriation riders do not apply. As a result, if federal prohibition of state‑licensed, intrastate medical cannabis is no longer a necessary means of regulating interstate commerce, the prohibition is unconstitutional and cannot trigger Section 280E.

Practical Implications

If the Tax Court adopts any of Ultra Health’s arguments, state‑compliant medical cannabis businesses could claim deductions for ordinary and necessary expenses — and potentially credits —as well as refunds through the court’s overpayment jurisdiction for open years.

The reasoning advanced by Ultra Health also has potential implications at the state level, particularly in those jurisdictions that deny deductions to cannabis licensees for expenses that are prohibited from deduction under federal law. Many states either tether their corporate and personal income tax bases to the federal income tax rules or incorporate state-specific addbacks that mirror the effect of Section 280E. If the Tax Court were to conclude that Section 280E does not apply to state‑compliant medical cannabis businesses — or otherwise limit its reach — the federal disallowance that some states rely upon could be narrowed or eliminated for affected taxpayers.

In states where both medical and adult‑use cannabis are legal, but deductions remain restricted under state law, a decision in Ultra Health could open the door to refund claims for open years to the extent those restrictions are expressly predicated on federal disallowance or on the same interpretive premises at issue in Ultra Health. Taxpayers would need to carefully parse the specific statutory language governing their state-specific treatment, distinguish between medical and adult‑use operations in light of the federal appropriations riders, and evaluate procedural steps and limitations periods to preserve potential refund claims.

For taxpayers currently under examination or in litigation, this case offers a strategic roadmap. The parties’ stipulations — resolving COGS and penalties, stipulating to underlying facts and preserving refund positions under Section 6512(b) — illustrate how to frame issues efficiently and protect recovery pathways while a test case proceeds.

We will continue to follow the Ultra Health tax case, through additional briefing by the IRS and potentially Ultra Health, and the Tax Court’s final opinion.

For more information, please contact Kristy Caron at kcaron@foxrothschild.com, Brian C. Bernhardt at bbernhardt@foxrothschild.com, or another member of Fox Rothschild’s Taxation & Wealth Planning Department.