Tax Court limits section 199A W-2 wage cap when section 280E disallows deductions
Savage v. Commissioner, No. 21606-22, 165 T.C. No. 5, 2025 BL 323936, 2025 Us Tax CT Lexis 2135 (Sept. 11, 2025), Court Opinion
On September 11, 2025, the U.S. Tax Court decided Savage v. Commissioner, 165 T.C. No. 5, holding that wages disallowed under section 280E do not count as “W-2 wages” for the section 199A limitation.
Shareholders of S corporations operating cannabis businesses claimed section 199A deductions using total W-2 wages reported on Forms W-2.
The IRS limited the wage factor to only the deductible portion after section 280E, and the court agreed with the IRS.
Why It Matters
The ruling ties the section 199A W-2 wage cap to deductible wage expense. For businesses subject to section 280E, the decision can reduce the available 199A deduction even when employees were paid.
Key Facts
Parties: Petitioners Ayla A. Savage and Patricia A. Torres, shareholders of three S corporations.
Businesses: Tru Greenthumb, Inc., and Fillabong, Inc., engaged in cannabis sales and were subject to section 280E. Fillabong and Glass, Inc. was not subject to section 280E.
Years: 2018 and 2019.
Issue: Whether “W-2 wages” under section 199A(b)(4) include wages that are nondeductible due to section 280E.
Petitioners’ position: Use all amounts paid and reported on Forms W-2.
IRS position: Use only wage amounts “properly allocable” to qualified business income, which excludes wages not allowed in determining taxable income under section 199A(c)(3).
Wage amounts stipulated:
2018 total W-2 wages across the two 280E entities: $613,695. Deductible after section 280E: $152,773.
2019 total W-2 wages across the two 280E entities: $810,020. Deductible after section 280E: $187,486.
Holding: The IRS correctly applied section 199A. Wages disallowed by section 280E are not “properly allocable” to qualified business income and therefore are not “W-2 wages” for the section 199A limitation.
Timeline
2017: Other issues for petitioners resolved by agreement.
2018–2019: Relevant tax years for section 199A and 280E computations.
April 4, 2023: Cases consolidated for trial, briefing, and opinion.
September 11, 2025: Opinion filed and decided by the U.S. Tax Court.
Court Findings
Section 199A(b)(4) defines “W-2 wages” with a general rule and a limitation.
The limitation in section 199A(b)(4)(B) excludes amounts not “properly allocable to qualified business income” for purposes of section 199A(c)(1).
Section 199A(c)(3)(A)(ii) includes only items “included or allowed in determining taxable income.” Nondeductible wages are outside the set of qualified items and cannot be part of qualified business income.
Because nondeductible wages are not part of qualified business income, they are not “properly allocable” to it, and they are excluded from “W-2 wages” under section 199A(b)(4)(B).
The statutory cross-references and structure require giving effect to the limitation, not just the general rule that points to section 6051(a) wage reporting.
The court noted that Treasury regulations align with this reading, stating W-2 wages are properly allocable to QBI only if the associated wage expense is considered in computing QBI.
Judgment Details
Deficiencies determined based on stipulated computations:
Ayla A. Savage: $313,900 for 2018 and $187,325 for 2019.
Patricia A. Torres: $292,759 for 2018 and $186,107 for 2019.
No Rule 155 computations were required due to the parties’ stipulations.
Decisions entered consistent with the opinion.
Outcome
The Tax Court entered decisions for the Commissioner, limiting the petitioners’ section 199A deductions by excluding wages disallowed under section 280E from the W-2 wage limitation.
The Takeaway
For taxpayers subject to section 280E, the section 199A wage cap tracks deductible wage expense, not merely wages reported on Forms W-2. Cannabis operators and similar businesses should expect lower 199A wage limitations when section 280E disallows wage deductions.
List of citations
Internal Revenue Code § 199A(a), (b)(2), (b)(4), (c)(1), (c)(3): Defines the 199A deduction, wage limitation, and qualified business income.
Internal Revenue Code § 280E: Disallows deductions and credits for businesses trafficking in Schedule I or II substances.
Internal Revenue Code § 6051(a)(3), (8): W-2 reporting provisions referenced by § 199A(b)(4)(A).
Tax Cuts and Jobs Act, Pub. L. 115-97, §§ 11011(a), 13001, 131 Stat. 2063–70, 2096: Enacted section 199A and lowered corporate rates, providing context for parity.
Treasury Reg. § 1.199A-2(b)(4): States W-2 wages are allocated adequately to QBI if the related wage expense is considered in computing QBI.
Treasury Reg. § 1.199A-3(b)(5), (b)(2)(ii)(H): Addresses allocation of items to a trade or business and when compensation reduces QBI.
T.D. 9847, 84 Fed. Reg. 2952 (Feb. 8, 2019): Final section 199A regulations and applicability.
Prop. Reg. § 1.199A-2(b)(4), 83 Fed. Reg. 40884, 40918 (Aug. 16, 2018): Proposed guidance consistent with the final rule.
Jimenez v. Quarterman, 555 U.S. 113 (2009): Plain language canon cited for statutory interpretation.
Lamie v. U.S. Trustee, 540 U.S. 526 (2004): Emphasizes starting with statutory text.
Tanzin v. Tanvir, 592 U.S. 43 (2020): Courts must follow explicit statutory definitions.
Digital Realty Tr., Inc. v. Somers, 583 U.S. 149 (2018): Different statutory phrasing implies different meaning; supports reading cross-references as written.
Dep’t of Agric. Rural Dev. v. Kirtz, 601 U.S. 42 (2024): Defined terms are binding within the section.
Food Mktg. Inst. v. Argus Leader Media, 588 U.S. 427 (2019): Ordinary meaning when no definition exists.
Burgess v. United States, 553 U.S. 124 (2008), and Colautti v. Franklin, 439 U.S. 379 (1979): The effect of definitions and limits.
United Therapeutics Corp. v. Commissioner, 160 T.C. 491 (2023), aff’d, 105 F.4th 183 (4th Cir. 2024): Give effect to every clause.
Cyan, Inc. v. Beaver County Employees Retirement Fund, 583 U.S. 416 (2018): Do not cherry-pick cross-referenced material.
Knight v. Commissioner, 552 U.S. 181 (2008) and Loughrin v. United States, 573 U.S. 351 (2014): Different terms signal different meanings.
Thomas v. Commissioner, 160 T.C. 371 (2023) and Varian Med. Sys., Inc. & Subs. v. Commissioner, 163 T.C. 76 (2024): Read enacted text as written.
Hartford Underwriters Ins. Co. v. Union Planters Bank, 530 U.S. 1 (2000): Policy choices belong to Congress.
Crowe v. Wormuth, 74 F.4th 1011 (9th Cir. 2023) and Tex. Brine Co. v. Am. Arb. Ass’n, 955 F.3d 482 (5th Cir. 2020): Courts do not rewrite statutes.
Patients Mutual Assistance Collective Corp. v. Commissioner, 151 T.C. 176 (2018), aff’d, 995 F.3d 671 (9th Cir. 2021): Section 280E scope across activities.
Californians Helping to Alleviate Med. Probs., Inc. v. Commissioner, 128 T.C. 173 (2007): Allocation concepts in 280E context.
Estate of Saia v. Commissioner, 61 T.C. 515 (1974) and Estate of Sanford v. Commissioner, 308 U.S. 39 (1939): Stipulations do not bind on legal conclusions.
NLRB v. SW General, Inc., 580 U.S. 288 (2017): Hierarchical statutory cross-reference usage.
Davis v. Michigan Dep’t of Treasury, 489 U.S. 803 (1989) and K Mart Corp. v. Cartier, Inc., 486 U.S. 281 (1988): Read words in overall statutory scheme.
Russello v. United States, 464 U.S. 16 (1983): Differing language in subsections implies differing meaning.
United States v. Merriam, 263 U.S. 179 (1923): Tax ambiguity canon cited in dissent.