Recently the IRS has used I.R.C. § 280E to disallow claimed deductions taken by taxpayers in relation to medical marijuana dispensaries. A recent court case has strengthened the IRS’s position in this regard. I.R.C. § 280E says
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 (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.
In a case by Tax Court Judge Kroupa called Olive v. Commissioner, 139 T.C. No. 2 (2012), the taxpayer tried to argue the phrase “consists of trafficking” in I.R.C. § 280E means that a taxpayer can bifurcate expenses between those that consist of trafficking marijuana and those that do not. In an earlier case by Tax Court Judge Laro called, Californians Helping to Alleviate Medical Problems Inc. (CHAMP) v. Commissioner, the tax court allowed certain expenses that were linked to caregiving services and decided that taxpayer was in two businesses one being caregiving services and the other being trafficking marijuana. The facts of the two cases are extremely different; Olive did not overturn Champ but was distinguished from it. However, Olive does change the way in which taxpayers should plan and structure medical marijuana dispensaries in order to achieve the best tax effect. A taxpayer needs to link less expenses to marijuana trafficking and more to other business activities.
The court in Olive did clear up that cost of goods sold is allowed when calculating gross income. Depending on the way business is done, some deductions can more properly be categorized as cost of goods sold, which is not a deduction affected by I.R.C. § 280E since it is not a deduction under I.R.C. § 162(a).
Another important factor is to limit liability in structuring a dispensary. The risk of individual liability is high when operating a medical marijuana dispensary. One should plan accordingly.
At Abajian Law, our tax litigation lawyers have advised several medical marijuana dispensaries across the nation (including San Francisco, Los Angeles and Colorado), all of which had gross receipts of millions of dollars. We can represent you in tax court or help structure your business in the best possible way to be both compliant and tax efficient. The IRS has not provided guidance to dispensaries; however tax court cases provide some guidelines.