The owners of a marijuana dispensary in Colorado are challenging a provision of U.S. Tax Code that the Internal Revenue Service has interpreted to mean state-legal marijuana businesses should not be allowed to take deductions or claim credits.
The couple asserts in a brief filed in U.S. Tax Court that the IRS’ determination of their taxes owed for 2010 through 2012 were unjust, and that they were unfairly taxed compared to other business owners. A marijuana attorney representing the pair characterized the specific section of the code as “absurd.”
Section 280E, deals with expenditures in connection with illegal sale of drugs. As noted in a 2015 internal memo within the IRS, although a marijuana business is illegal under federal law, it remains obligated to pay federal income tax because Section 61(a) doesn’t differentiate between income derived from legal sources and those derived from illegal sources (See the 1961 case of James v. U.S.).
The couple alleges Section 280E, enacted back in 1982, was not based on accounting principles, but rather on the idea that public policy was not to allow regulation of marijuana operations and that drug dealers are inherently bad for society. However in 2017, we live in a world where voters in 29 states and D.C. have opted to allow access to medicinal cannabis and several more – including California – have approved measures to allow for recreational cannabis use.
The tax court brief notes that plaintiffs classified their business as a S Corp, which under the tax code requires officers to be paid “reasonable wages.” All income from the marijuana business flowed through their wage income, and when the IRS decided to classify “trafficking” as an expense, the couple were not allowed a deduction under Section 280ESo in effect, the company was taxed twice – once as wages and again as part of S Corp earnings.
Whether the couple will prevail remains uncertain, but we do know the decision will be made weeks after the IRS won another recent 280E tax case filed by former dispensary owners in Colorado. In that case, there was a somewhat similar set of circumstances, wherein the company filed their income tax returns as an S Corp and sought deductions for ordinary and necessary business expenses. The IRS decided any business expense not classified as a “cost of goods sold” could not be deducted, and based on this, the taxable income was increased (meaning they had to pay substantially more in taxes).
The U.S. Tax Court judge, however, didn’t even get to the point of determining whether 280E was applicable because, she ruled, the marijuana dispensary owners failed to meet their proof burden because they failed to produce any business records or supporting documents, so they were unable to probe the IRS’s determinations were wrong. This is a problematic issue for many California marijuana distributors as well, as they are often left to their own devices when it comes to business plans and banking. It’s one of the reasons having a marijuana business lawyer in Los Angeles is so valuable. Our attorneys have been helping dispensaries properly arrange their operations to avoid similar issues cropping up in the future.
The Los Angeles CANNABIS LAW Group represents growers, dispensaries, collectives, patients and those facing marijuana charges. Call us at 949-375-4734.
Additional Resources:
Internal Revenue Service Memorandum No. 201504011, Jan. 1, 2015, IRS
More Blog Entries:
New California Marijuana Regulations Finally Released, Nov. 26, 2017, Marijuana Business Attorney Blog