Marijuana Business Is Prohibited from Claiming Employee Retention Credit

(Parker Tax Publishing February 2026)

The Court of Federal Claims held that a business operating marijuana dispensaries was not entitled to the refundable portion of the employee retention credit (ERC) in Code Sec. 3134 for its first and second quarters of 2021. The court concluded that Code Sec. 280E's bar to taking tax deductions and credits squarely applied to the ERC, including the refundable portion of the credit, and thus, as a trafficker of a federally controlled substance, the taxpayer was ineligible for the credit. Gravenstein 116, LLC v. U.S., 2026 PTC 20 (Fed. Cl. 2026).

Facts

Gravenstein 116, LLC (Gravenstein) is a business that operates cannabis dispensaries in California. In 2020, when the COVID-19 pandemic began, Gravenstein operated three cannabis dispensaries. For nearly two years - through most of 2020 and all of 2021 - state and local health departments issued orders that significantly limited Gravenstein's business. During this time, Gravenstein had to transition from in-person retail operations to curbside pickup orders. The pandemic safety practices it adopted significantly increased costs and blunted output.

In March of 2020, Congress enacted the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The CARES Act included an Employee Retention Credit (ERC), a refundable tax credit in Code Sec. 3134 that subsidized employers who were forced to close or suspend operations due to COVID-19-related public health orders. By using the ERC, eligible employers could reduce the amount paid in employment taxes by 70 percent of the amount paid to employees during the pandemic-related shutdowns. If the credit exceeded the amount of employment taxes paid, employers could claim the difference as a cash refund. The ERC only applies to wages paid before October 1, 2021. Generally, eligible employers qualified for the ERC if their operations were fully or partially suspended due to orders from an appropriate governmental authority due to the coronavirus disease. The ERC does not specify a suspension of any rules related to a taxpayer's general eligibility to claim credits or deductions.

Code Sec. 280E denies any deduction or credit to a taxpayer whose business consists of trafficking in controlled substances (Section 280E bar). Marijuana is a controlled substance for purposes of the Section 280E bar.

According to Gravenstein, it met all requirements to claim the refundable ERC. It filed its original Form 941 for employment taxes for the first quarter of 2021 and subsequently filed an amended Form 941 claiming it was entitled to a refundable ERC of approximately $150,800. Gravenstein also filed a Form 941-X claiming a refund of approximately $171,000 for the ERC for the second quarter of 2021. When the IRS failed to refund the amounts requested, Gravenstein filed suit in the Court of Federal Claims, arguing that it was eligible to claim the ERC because (1) it paid qualifying wages; (2) it was harmed by COVID-19 related shutdowns; and (3) it met all requirements to claim the refundable ERC during that time period. The government moved to dismiss the complaint on the basis that Gravenstein, as a business subject to the Section 280E bar, was ineligible to claim the refundable portion of the ERC.

While acknowledging that it trafficked in controlled substances and was therefore covered by Code Sec. 280E, Gravenstein nonetheless argued that it should still be eligible for the ERC. Gravenstein further contended that even if the ERC is a tax credit, the refundable portion of the ERC is not a tax credit due to its structure as a refundable credit. It characterized the ERC's refundable portion as a subsidy for employment rather than a tax credit. Finally, Gravenstein sought to salvage its argument with an appeal to the ERC's policy aims.

Analysis

The Court of Federal Claims agreed with the IRS and held that Gravenstein was not eligible for the ERC. The court began by looking at the text of Code Sec. 3134 to determine if the ERC is a tax "credit" barred by Code Sec. 280E. The court noted that it is a well-established canon of statutory construction that Congress is presumed to have intended for identical words used in different parts of the same legislation to have the same meaning. In this case, the court found the text of the statute to be unambiguous. Code Sec. 3134(a), the court observed, states that "there shall be allowed as a credit," and unequivocally labels the ERC as "a credit."

The court then rejected Gravenstein's argument that the refundable portion of the ERC is not a tax credit due to its structure as a refundable credit and is instead a subsidy for employment rather than a tax credit. The court stated that it is well-established that refundable tax credits are still tax credits subject to restrictions in the Code and cited the Supreme Court's consideration of this issue in Sorenson v. Secretary of Treasury, 475 U.S. 851 (1986), which involved the applicability of overpayments arising due to the refundable earned income credit (EIC) to a law that permitted the IRS to intercept tax refunds of individuals who had failed to make child-support payments. The Court held that the refundable credit was subject to the intercept law because the Code defined the refundable EIC as an "overpayment" of taxes and the intercept law applied to any "overpayment." The Court specifically rejected an argument that the refundable nature of the EIC changed the definition of "overpayment." Instead, the Court held that the structure of a refundable credit did not change the meaning of words in the Code.

Finally, the court similarly rejected Gravenstein's argument appealing to the ERC's policy aims. The court said that where statutory text and structure are clear, it would not engage in a purposivist analysis that undermines the statute.

For a discussion of the rules in Code Sec. 280E relating to expenditures in connection with the sale of controlled substances, see Parker Tax ¶96,512.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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