Tax Court Delivers Double Blow to Cannabis Operators in Savage Decision

The U.S. Tax Court’s recent decision in Ayla A. Savage v. Commissioner (165 T.C. No. 5, September 11, 2025) delivers another significant setback to cannabis businesses, effectively shutting them out of tax benefits available to other industries. The ruling demonstrates how Section 280E’s restrictions continue to ripple through the tax code, limiting cannabis operators’ access to newer tax advantages.

The Core Issue: Section 199A and W-2 Wages

The case centers on whether cannabis businesses can use their total W-2 wages, including wages that aren’t deductible under Section 280E, to calculate their qualified business income (QBI) deduction under Section 199A. This deduction, introduced by the Tax Cuts and Jobs Act, allows eligible taxpayers to deduct up to 20% of their qualified business income, subject to various limitations including a cap based on W-2 wages paid.

Petitioners Ayla Savage and Patricia Torres, shareholders in three S corporations (two cannabis-related), argued they should be able to use all wages reported on W-2 forms when calculating their Section 199A wage limitation, even though Section 280E prevented them from deducting many of these wages for income tax purposes.

The Court’s Analysis

The Tax Court disagreed, ruling 17-1 that only wages deductible after applying Section 280E can count toward the Section 199A calculation. The majority opinion, written by Judge Toro, relied on a careful parsing of the statutory language.

Key Statutory Framework

Section 199A(b)(4)(B) states that “W-2 wages” for purposes of the QBI deduction cannot include amounts that are “not properly allocable to qualified business income.” The court found this language decisive, reasoning that:

1. Qualified business income is defined as the net amount of qualified items of income, gain, deduction, and loss
2. Qualified items must be “included or allowed in determining taxable income”
3. Wages disallowed under Section 280E cannot be “qualified items” and therefore cannot be part of qualified business income
4. Non-qualifying wages cannot be “properly allocable” to qualified business income

The Numbers Tell the Story

The financial impact was substantial. For the cannabis corporations in 2018 and 2019:

2018:

• Total W-2 wages: $613,695
• Deductible W-2 wages after 280E: $152,773
• Difference: $460,922

2019:

• Total W-2 wages: $869,880
• Deductible W-2 wages after 280E: $247,346
• Difference: $622,534

Using the lower deductible amounts significantly reduced the taxpayers’ Section 199A wage limitation, resulting in deficiencies of over $500,000 combined for Ms. Savage and $478,866 for Ms. Torres across both years.

A Lone Dissent

Judge Jenkins authored a vigorous dissent, arguing the majority misread the statute. He contended that:

• Section 199A(b)(4)(B) requires wages be “properly allocable” to qualified business income, not that they be “allowed in determining taxable income”
• Congress used different language intentionally, if it meant the same thing as Section 199A(c)(3)(A)(ii)’s “allowed in determining” language, it would have said so
• The proper allocation should be to gross income from the business, not the net qualified business income figure

Judge Jenkins also noted policy concerns, arguing that completely zeroing out the wage limitation undermines Section 199A’s job creation purpose, even for businesses subject to Section 280E.

Broader Implications for Cannabis Businesses

This decision reinforces the cascading effects of Section 280E throughout the tax code. Cannabis businesses now face a double penalty:

1. Direct impact: Many business expenses remain non-deductible under Section 280E
2. Indirect impact: The inability to deduct these expenses reduces access to other tax benefits like the Section 199A deduction

Effective Tax Rates Remain Punitive

The decision ensures cannabis businesses continue facing effective tax rates far exceeding those of comparable businesses in other industries. While other businesses can potentially reduce their effective rates through the 20% QBI deduction, cannabis operators find this benefit significantly curtailed or eliminated entirely.

Strategic Considerations

Cannabis businesses should consider:

1. Careful entity structuring to segregate truly separate business activities that might qualify for different treatment
2. Detailed record-keeping to maximize any wages that can be properly allocated to non-280E activities
3. Legislative advocacy for Section 280E reform, as the judicial path appears increasingly narrow

Looking Forward

The Savage decision reflects the Tax Court’s consistently restrictive interpretation of tax benefits for cannabis businesses. With cannabis legal in numerous states but federally controlled substances remaining subject to Section 280E, the tension between state and federal law continues to create significant tax disadvantages.

Unless Congress acts to reform or repeal Section 280E, cannabis businesses can expect to remain largely excluded from tax benefits available to other industries. The decision serves as another reminder that despite growing state-level legalization, federal tax policy continues to treat cannabis businesses as distinctly disfavored taxpayers.

Need Help Navigating Cannabis Tax Issues?

The Savage decision underscores the complex and evolving nature of cannabis taxation. If your cannabis business is grappling with Section 280E compliance, Section 199A calculations, or other tax planning challenges, don’t navigate these waters alone.

Contact HBK Cannabis Solutions today to speak with tax professionals who specialize in cannabis industry issues and stay current with the latest court decisions and regulatory developments.

Cannabis businesses should consult qualified tax professionals familiar with Section 280E and related issues when making strategic tax decisions.