Question: I know that in 2007 the U.S. Tax Court ruled in the CHAMPS case that Section 280E of the Internal Revenue Code prohibits deducting from gross income any business expenses that are paid or incurred in connection with trafficking in marijuana. Is there a way that my nonprofit entity that operates an Arizona medical marijuana dispensary can deduct any of its expenses from its gross income on the dispensary’s federal income tax return?
Answer: Yes. In the CHAMPS case, the IRS conceded that the taxpayer could deduct its cost of goods sold, which included $575,317 paid for marijuana. The fight in the CHAMPS case was over what business expenses the taxpayer could deduct. The IRS argued that the taxpayer had only one business – trafficking in marijuana – and therefore none of its business expenses other than its cost of goods sold were deductible. The taxpayer successfully argued that it operated two businesses – its medical marijuana sales business and its care-giver business. The Tax Court agreed with the taxpayer and allowed the taxpayer to allocate its expenses to its two separate businesses and deduct expenses attributable to the care-giver business.
If your Arizona medical marijuana dispensary wants to be able to deduct anything from its gross income above and beyond its cost of goods sold, the dispensary must engage in one or more trades or businesses that do not involve medical marijuana. Every would-be dispensary should carefully study the CHAMPS case and learn how CHAMPS operated its care-giver business, which was very extensive and real. The case illustrates that the sale of medical marijuana was in fact a small portion of everything that the dispensary offered to its patients. Note also that the salaries paid to management and staff were very nominal – $14,914 paid to officers and directors and $44,799 salaries paid to 25 employees of a dispensary that collected just over $1,000,000 in gross revenue.
Example 1: Dispensary 1 operates a 2,000 square foot retail dispensary in Phoenix where its sole activity is displaying its products and selling products to patients over the counter. This dispensary’s entire business involves trafficking in marijuana so it cannot deduct any of its expenses from its federal income tax return.
Example 2: Dispensary 2 operates a 2,000 square foot retail dispensary in Phoenix, but next door to the dispensary it has an additional 2,000 square feet of space where it provides other services and products to the public such as:
- yoga classes
- massage therapy
- classroom instruction on the use of medical marijuana and other pain medications
- classroom instruction on health care related topics
- library of books, DVDs and other materials about medical marijuana that patients of the dispensary can use for reading on the premises or to check out and view at home.
- coffee bar with pastries where people can congregate and relax
Dispensary 2 can now:
- allocate occupancy expenses to retail and nonretail
- allocate payroll expenses to retail and nonretail
- apply a transactional factor
Consider this simple allocation of dispensary 2’s expenses:
- Since 1/2 of the leased space is not used for the sale of marijuana, fifty percent of the total rent expense is deductible. This includes ancillary expenses such as security for the premises, utilities, landscaping, common area expenses and maintenance, janitorial service and premises maintenance.
- Dispensary 2 can deduct its payroll expenses attributable to personnel who work solely in the non-marijuana side of the business. For personnel that work in both aspects of the business, the dispensary must have a method for allocating their payroll to the marijuana related services and the non-marijuana related services.
For more on this important topic, see “IRS is in the Early Stages of a War to Kill Medical Marijuana Dispensaries.”
Although I have a masters degree in income tax law from New York University Law School, I am no longer a practicing tax lawyer. I recommend that every dispensary hire a good experienced tax CPA or tax lawyer to advise the dispensary on the federal and state income tax issues arising from the operation of a medical marijuana dispensary.
Circular 230 Notice: Pursuant to recently-enacted U.S. Treasury Department regulations, I am required to advise you that, unless otherwise expressly indicated, any federal tax advice contained in this communication, including websites linked to, is not intended or written to be used, and may not be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein.