Medical Marijuana

Ninth Circuit Denies Deductions For Marijuana Businesses

marijuana-sign-thOregon has joined the growing list of states that have legalized the sale of marijuana, but that doesn’t mean pot dealers can light up and relax. Marijuana sales may be legal in the state, but it is firmly established that Internal Revenue Code Section 280E prohibits taxpayers from deducting any expenses of a trade or business that consists of trafficking in controlled substances.

Make no mistake, marijuana is a controlled substance under federal law. This means that Oregon marijuana businesses will be forced to pay federal income tax on 100 percent of their gross profits. Unless you can classify your expenses as Costs of Goods Sold (COGS), deductions for payroll, utilities, advertising, and miscellaneous expenses will be disallowed in full. Last week, the U.S. Court of Appeals for the Ninth Circuit made clear that Section 280E applies even in states that have legalized marijuana, either for medical or recreational use.

The case, Olive v. Commissioner of Internal Revenue, No. 13-70510 (July 9, 2015), involved a medical marijuana dispensary in San Francisco called the Vapor Room. Although 100 percent of the Vapor Room’s gross income came from marijuana sales, the business also offered a variety of other goods and services at no cost. Customers could enjoy free movies, yoga, and massage therapy, as well as complementary drinks and snacks. Vapor Room staff also provided free counseling to customers on personal, legal, and health matters. The dispensary wanted to deduct not only these expenses, but also the expenses that could be directly attributed to marijuana sales.

But, because the Vapor Room’s only source of income came from marijuana sales, the court found that trafficking in a controlled substance was its only “trade or business” and disallowed all deductions for expenses incurred in its operations. Expenses for the benign, completely legal perks (like pizza and yoga) were held to be non-deductible under Section 280E because they were designed to benefit the marijuana sales business as inducements for potential customers.

This result might seem harsh, but the Ninth Circuit offered some useful guidance in its approval of a well-known 2007 Tax Court case, Californians Helping To Alleviate Medical Problems, Inc., v. Commissioner, 128 T.C. 14 (2007) (CHAMP). In that case, the court acknowledged that the taxpayer had more than one trade or business and was allowed to allocate expenses between the two. Expenses incurred in the course of care-giving (the taxpayer’s primary trade or business) were clearly deductible. All expenses attributable to the trade or business of selling marijuana, however, were disallowed. Taxpayer CHAMP, of course, charged a fee for its care-giving services and intended to make a profit from those activities. Had the Vapor Room followed suit and asked its customers to pay for the munchies, at least some of its expenses could have been deductible.

Oregon marijuana businesses take heed: If you operate a business that sells marijuana, but also offers other goods or services, work with your accountant and your tax attorney to establish the existence of a non-trafficking “trade or business.” Careful accounting procedures and appropriate business structures must be put in place to allocate expenses between the trade or business of trafficking in marijuana and any other trade or business you operate, such as care-giving or selling marijuana accessories. Without these safeguards, you put yourself at the mercy of IRS auditors who will be all too eager to allocate your expenses for you. If you are proactive, you may be able avoid the fate of the Vapor Room, which was hit with a $1.9 million tax bill as a result of inadequate planning and sloppy bookkeeping.

There is a faint glimmer of hope for the “cannabusiness” community: Oregon’s U.S. Representative Earl Blumenauer recently introduced a bill that would reverse the draconian effects of Section 280E in states that have legalized marijuana. The bill, known as The Small Business Tax Equity Act, is co-sponsored in the Senate by Oregon’s own Ron Wyden and Jeff Merkley. To date, twenty-three states and the District of Columbia have legalized medical marijuana. Voters in Colorado, Washington, Oregon and Alaska have passed measures legalizing recreational marijuana, and more states are lining up to do the same. Even so, it’s doubtful that our esteemed legislators will succeed in maneuvering the Small Business Tax Equity Act through the House and Senate, at least in the foreseeable future. In the meantime, Oregon marijuana businesses should plan for Section 280E. Contact your tax attorney to discuss steps you can take to minimize the impact of Section 280E and protect every deduction you’re entitled to.

Medical Marijuana Is Not Tax Deductible

Congress enacted the Tax Equity and Fiscal Responsibility Tax Act of 1982 and amended the federal tax code to prohibit deduction of ordinary and necessary expenses related to the illegal sale of controlled substances.  A recent Tax Court decision highlights this law as another challenge to the feasibility of marijuana growing operations.  Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner, 128 T.C. No. 4 (5/15/07), demonstrated how the Federal tax code is being used to inhibit the medical marijuana industry.  In the California case IRC 280E was held to disallow the deduction of expenses attributed to the provision of medical marijuana because it was considered “trafficking” in a controlled substance.

The IRS has been unambiguous in its position on the issue of medical marijuana as a prohibited controlled substance.  Citing the 2007 Tax Court opinion and a 2001 US Supreme Court case, U.S. v. Oakland Cannabis Buyers’ Co-op., 532 U.S. 483 (2001).  IRS Chief Counsel Letter (2011-0005) makes it clear that absent a change in the tax code, medical marijuana will be treated as a controlled substance under 280E.  This could saddle any growing operation with a substantial federal income tax burden.  If growing marijuana is considered “trafficking”, federal income tax will be calculated on gross revenue without a deduction for expenses associated with its production.

By |Oct 16, 2011|Categories: Tax Law|Tags: , |