Code Sec. 280E, the Tax Court recently held, barred a taxpayer from deducting expenses from his state-authorized medical marijuana dispensary (Olive v. Commissioner, Dec. 59,156, 139 TC No. 2). The court found that the taxpayer’s dispensary was engaged solely in trafficking in a controlled substance.
A cash-method taxpayer may generally deduct all ordinary and necessary expenses incurred when engaged in a trade or business for profit. Under Code Sec. 280E, a taxpayer may not deduct any amount of expenses where the trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances within the meaning of the Controlled Substance Act. In Californians Helping to Alleviate Med. Problems, Inc., Dec. 56,935, 128 TC 173 (CHAMP), the Tax Court held that medical marijuana is a controlled substance under Code Sec. 280E, despite its legalization in California.
In 1996, California approved the operation of medical marijuana dispensaries. The taxpayer operated a medical marijuana dispensary as a sole proprietorship. The patrons, individuals with serious illnesses, consumed the marijuana on the premises of the dispensary. Patrons had to show either a doctor’s recommendation to use medical marijuana or a similar certificate issued by the municipal government.
The business sold to the patrons for cash 93.5 percent of the marijuana that the taxpayer had acquired and gave the rest to patrons and staff for free. The business’s sole source of revenue was its sale of medical marijuana.
The taxpayer argued that he could deduct the business’s expenses notwithstanding Code Sec. 280E. Alternatively, the taxpayer argued that he could deduct the business’s expenses attributable to its caregiving services. The court first noted that state law authorized the taxpayer to dispense medical marijuana. Federal law, however, prohibits taxpayers from deducting any expense of a trade or business that consists of the trafficking of a controlled substance.
The court declined to depart from its holding in CHAMP that a California medical marijuana dispensary’s dispensing of medical marijuana under state law constituted trafficking within the meaning of Code Sec. 280E. Congress, the court found, has set illegality under federal law as one trigger to preclude a taxpayer from deducting expenses incurred in a medical marijuana dispensary business. This is true even if the business is legal under state law, the court concluded.
The court further found that the taxpayer could not deduct the expenses as caregiving expenditures. In CHAMP, the court had found that the taxpayer operated two businesses: a medical marijuana dispensary and a caregiving service. The dispensary in CHAMP was operated exclusively for charitable, educational, and scientific purposes, and its income was slightly less than its expenses. Here, the court found that the taxpayer operated a single business: a medical marijuana dispensary. The taxpayer stressed the sale of marijuana.
In an interesting twist, the Tax Court did allow the taxpayer a deduction for the cost of goods sold (COGS), an issue that the IRS had conceded in CHAMP. The court determined that the COGS equaled approximately 75 percent of the total sales, less an adjustment for personal use, despite finding the evidence and testimony was self-serving and not wholly believable.