Tax Savings Strategies for the Marijuana Industry by David Potts
December 26, 2018
By: David T. Potts
The Journal Record
Internal Revenue Code Section 280E, the most discriminatory section of the US tax code to the legal marijuana industry, denies businesses involved in the sale or trafficking of controlled substances listed on Schedule I or Schedule II of the Controlled Substances Act from deducting all ordinary and necessary business expenses they pay or incur. Currently, the Controlled Substances Act lists marijuana as a Schedule I drug. Furthermore, federal courts have held that the sale of marijuana constitutes trafficking, regardless of legality at the state level. Despite being legal in 33 states, the federal government still classifies marijuana as a Schedule I drug thus making it subject to Section 280E. Therefore, the ordinary and necessary tax deductions available to most businesses are denied to a marijuana business and limits their tax deductions to only Cost of Goods Sold ("COGS").
Section 280E was enacted in 1982 to overturn the result in the Tax Court case Jeffrey Edmondson v. Commissioner, 42 T.C.M. 1533 (1981) that held the taxpayer, who was engaged in an illegal drug dealing business selling marijuana, amphetamines and cocaine, was entitled to deductions for expenses he incurred in his business. The Tax Court allowed these deductions, holding they were ordinary and necessary in his business, despite the criminality of the business. Congress, who was in the middle of waging a war on drugs, infuriated by the ruling in Edmonson v. Commissioner passed Section 280E to limit deductions a business could claim when the business consisted of the sale of illegal drugs.
However, there are some tax saving strategies a business involved in the marijuana industry can utilize. One such strategy for maximizing deductible expenses was established in Californians Helping to Alleviate Medical Problems ("CHAMP”) vs Commissioner, 183 TC 173. CHAMP was organized and operated exclusively for charitable, educational and scientific purposes for its members with debilitating diseases by providing caregiving services and provide its members with medical marijuana. The Tax Court held since CHAMP operated two separate businesses, providing caregiver services, along with a dispensary, it could deduct expenses incurred in the operation of the non-marijuana business.
Another tax saving strategy is for a marijuana business to operate on a full accrual basis and follow Uniform Capitalization rules, then some expenses, normally considered non-deductible, can be capitalized into inventory and deducted as COGS.
The keeping of meticulous thorough records is the only way to accomplish either of these tax saving strategies.