Medical Marijuana Dispensary's Claimed Deductions Properly Disallowed (Canna Care, Inc., TCM)
In 1996, the state of California became the first state in the nation to legalize the sale of medicinal marijuana. However, the feds still consider the sale of marijuana illegal and use Section 280E to wield its tax power. Section 280E was passed into law during the Reagan Administration with its focused war on drugs initiative. It bars those who sell marijuana from deducting business expenses and only allows a deduction for the cost of goods sold (COGS).
A Strange Dichotomy of IRS Rulings
One medical marijuana dispensary in California was not able to deduct its operating expenses because its business was considered “trafficking a controlled substance.” The taxpayer fought back stating that since its activities were not illegal under California law, Section 280E did not apply. But, the tax court ruled that it did. Its take was that the taxpayer regularly bought and sold marijuana, which constituted “trafficking.”
On the flip side, Helping to Alleviate Medical Problems (CHAMP) was entitled to deduct some its business expenses. Why? Because this marijuana dispensary had an adjunct that provided social services to extremely sick individuals. It was a partial win for CHAMP. General and administrative business expenses, such as rent and utilities, weren’t allowed deduction but other expenses were. CHAMP convinced the court that only part of its business involved the trafficking of marijuana, as much of its operations focused on counseling customers on what type of marijuana would be best for their specific ailment. The end result was that the business expenses relating to the “adjunct services” were not barred by Section 280E.
More Rules and Regulations
Section 263A was enacted four years after Section 280E. It increased the types of costs that are inventoried. Both producers and resellers of marijuana are required to capitalize storage expenses, payroll costs and personnel functions. Some deductions are inventoriable. Taxpayers trafficking Schedule I or Schedule II controlled substances are entitled to determine inventoriable costs using the applicable inventory-costing regulations under Section 471.
Because the feds consider medical marijuana dispensaries to be illegal businesses, bank accounts and credit cards are not accessible. Most medical marijuana dispensaries and other state-authorized marijuana operations function soley on a cash basis. As a result, some have been hit with a 10 percent penalty for paying federal payroll tax deposits in cash.
Since the marijuana industry is blessed by state law but persecuted by the IRS, Section 280E will continue to be a thorn in its side, as long as marijuana remains on the list of controlled substances.