In January 2026, a cannabis dispensary operator asked a federal court a deceptively simple question: if the government hands you a refund check instead of a deduction, does the tax code's harshest anti-drug-trafficking provision still apply? The Court of Federal Claims answered with a firm yes — and in doing so, closed off a $322,000 lifeline that thousands of other cannabis operators had been quietly hoping to claim too.
The case is Gravenstein 116, LLC v. United States, and while it involves a single dispensary group operating under the "Solful" brand in California, its reasoning reaches every cannabis business in the country that filed — or was considering filing — an Employee Retention Credit claim. If you run a cannabis business, advise one, or are just trying to understand how far Section 280E's reach actually extends, this ruling is worth understanding in detail.
The Backstory: A Familiar COVID-Era Credit, an Unfamiliar Plaintiff
The Employee Retention Credit was one of the biggest tax incentives to come out of the CARES Act in 2020. In broad strokes, it let employers who kept staff on payroll during pandemic-related shutdowns or revenue declines claim a refundable credit worth up to 70% of qualifying wages per employee, per quarter. "Refundable" is the operative word — unlike most business credits, which can only offset a tax bill you already owe, the ERC could generate an actual check from the Treasury even if your business owed no tax at all.
Gravenstein 116, LLC operated three licensed cannabis dispensaries in California. Like countless other small businesses, its operations were disrupted by state and local COVID-19 health orders — reduced hours, capacity limits, and higher compliance costs cut into an already thin-margin retail business. Believing it qualified under the same rules that applied to any other retailer, Gravenstein filed Forms 941-X claiming a refundable ERC of $322,016: $150,786 for the first quarter of 2021 and $171,230 for the second quarter.
The IRS didn't act on the claims within the statutory window, so Gravenstein did what taxpayers are entitled to do in that situation — it sued for the refund in the U.S. Court of Federal Claims.
Section 280E: The Provision That Treats Legal Cannabis Like Illegal Trafficking
To understand why this case turned into a genuine legal fight rather than a routine refund dispute, you have to understand Section 280E of the Internal Revenue Code. It's a short provision with an outsized effect:
"No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business... consists of trafficking in controlled substances."
Congress wrote this in 1982, originally aimed at cocaine and other hard-drug traffickers who were audaciously deducting business expenses on their tax returns. Marijuana has remained a Schedule I controlled substance under the federal Controlled Substances Act since 1970 — the same tier as heroin — even as dozens of states legalized medical or recreational use. That mismatch means state-licensed, fully compliant cannabis businesses have been taxed federally as if they were running an illegal drug operation, denied virtually every ordinary business deduction that any other company takes for granted: rent, payroll, marketing, insurance, and (as this case tested) tax credits.
The one thing 280E doesn't touch is cost of goods sold, because COGS reduces gross income rather than counting as a "deduction" in the technical sense. That narrow exception is why cannabis accounting became its own specialty, with operators fighting hard over inventory costing methods to shift as many costs as legally possible into COGS.
Gravenstein's Argument: "This Isn't Really a Credit"
Gravenstein's legal team didn't dispute that the business trafficked in a controlled substance for 280E purposes — recreational and medical marijuana sales in California are still illegal under federal law regardless of state licensing. Instead, they tried a more creative angle: they argued the ERC's refundable portion wasn't a "credit" at all in the sense 280E prohibits.
The argument went like this: while the ERC has the form of a tax credit, the substance of the refundable amount — the part that exceeds what the employer actually owed in tax — functions as a direct wage subsidy, not a tax benefit tied to income tax liability. If it's really a wage subsidy in economic substance, the argument continued, then Section 280E's bar on "credits" shouldn't reach it, because 280E is fundamentally about denying favorable federal income tax treatment to drug traffickers, not blocking pandemic relief payments.
Gravenstein also leaned on equitable and policy arguments: the business was operating entirely lawfully under California law, its employees were real people affected by real public health orders, and denying pandemic relief to an otherwise-compliant employer seemed to run against the purpose of the CARES Act.
Why the Court Rejected It
Judge Roumel's decision was direct on both the statutory and policy fronts.
On the "it's not really a credit" argument: The court pointed to the statute that created the ERC — Section 3134 of the Internal Revenue Code — which explicitly and repeatedly labels the benefit a "credit." Under standard rules of statutory interpretation, identical terms used across the tax code are presumed to carry the same meaning unless Congress says otherwise. Section 280E denies "credit[s]"; Section 3134 creates a "credit"; the court found no textual basis to treat the refundable portion as something else just because it functions differently in practice than a nonrefundable credit does.
The court also cited the Supreme Court's decision in Sorenson v. Secretary of Treasury, 475 U.S. 851 (1986), which held that refundable tax credits are still tax credits subject to the Code's general rules — refundability changes how a benefit is paid, not what it legally is. As the opinion put it, "the Internal Revenue Code does not discriminate between a refundable credit and other credits."
On the policy and equity arguments: The court was equally unmoved, characterizing the weighing of "competing social policies" — pandemic relief for employers versus the federal government's continued prohibition on marijuana — as "a quintessentially legislative function," not a judicial one. In other words: if Congress wanted to carve out an ERC exception for cannabis businesses, it could have written one into the CARES Act or a later amendment. It didn't, and the court declined to write one in through interpretation.
The result: Gravenstein's $322,016 refund claim was dismissed, and the precedent now stands as the clearest statement yet that 280E's bar applies with essentially no exceptions — not to ordinary deductions, not to modern refundable credits, and not based on how sympathetic or state-compliant the underlying business is.
What This Means If You Run — or Bank at — a Cannabis Business
If you're a cannabis operator who already claimed the ERC, or filed one that's still pending: This ruling doesn't automatically invalidate your claim, but it substantially strengthens the IRS's hand if it wants to deny or claw one back. The IRS has been actively working through a backlog of ERC claims across all industries, with heightened scrutiny for higher-risk categories — and a cannabis business with an ERC claim on file is now a business sitting on a claim a federal court has explicitly said shouldn't succeed. If you're in this position, get in front of it: talk to a tax professional about whether withdrawing the claim, if it's still pending, or building a defense file, if it's already been paid, makes more sense for your situation.
If you're a cannabis operator considering an ERC claim you haven't filed yet: Don't. The window for new ERC claims has effectively closed under normal timing rules for the periods in question, but if you're weighing whether a similar refundable-credit argument might apply to something else on your return, this case is a strong signal that "creative characterization" arguments against 280E are a losing strategy in court.
If you're watching the rescheduling news and wondering whether this still matters: It does, more than you might expect. In April 2026, cannabis products dispensed under state medical licenses were moved to Schedule III of the Controlled Substances Act, which took certain medical operators out of 280E's reach going forward. But that relief is prospective — it doesn't reach back to unlock 2020–2021 wages, and it doesn't touch recreational-only sales at all, which remain fully subject to 280E regardless of the Gravenstein outcome. A mixed medical/recreational operator with an old ERC claim tied to recreational-side employees is squarely inside the reasoning this case just affirmed.
For any business — cannabis or otherwise — evaluating a tax position built on "this benefit isn't technically what the statute calls it": Gravenstein is a useful cautionary tale about how courts read refundability. If Congress labels something a credit, expect it to be treated as a credit for every downstream provision that mentions credits, including the ones you'd rather it didn't apply to.
Why Clean Records Matter Even When the Answer Is "No"
There's a quieter lesson buried in this case that has nothing to do with cannabis specifically. Gravenstein was able to precisely quantify its claim — $150,786 for Q1 2021, $171,230 for Q2 2021 — down to the dollar, tied to specific quarters, specific health orders, and specific payroll periods. That level of detail didn't win the case, but it's exactly the kind of documentation any business needs on hand the moment the IRS or a court asks "how did you calculate this?" A business with muddled books, wages mixed across entities, or no clear audit trail from payroll records to the credit calculation would have had a much harder time even getting a hearing.
This is where day-to-day bookkeeping discipline pays off long before a dispute ever reaches a courtroom. Every eligible wage, every disallowed expense under a provision like 280E, and every credit claim needs to trace cleanly back to source records — because when the IRS or a federal court is deciding whether your numbers hold up, "trust me" is not a legal argument.
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