Taxes.com: “Henry Wykowski . . . represented Californians Helping to Alleviate Medical Problems . . . in that dispensary’s landmark 2007 case against the IRS. Now, many of the growing number of California dispensaries facing what could amount to debilitating audits have sought out Wkyowski’s services. . . . ‘The most successful dispensaries do more than strictly offer cannabis.’ Says Wykowski, ‘I personally believe that a large part of the government decided that because they had not been successful through the DEA to shut [the dispensaries] down, maybe they could tax them out of business’.”
Luigi Zamarra, CPA is the Chief Financial Officer of Harborside Health Center, recognized as one of the largest medical cannabis dispensaries in the United States. Mr. Zamarra has written an interesting article entitled “Medical Cannabis Dispensaries: Minimizing the Cost of IRC Section 280E” that is a must read for all prospective owners of Arizona medical marijuana dispensaries. The article explains how a medical marijuana business that is legal under state law can allocate its expenses between deductible and nondeductible expenses so as to comply with the Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner of Internal Revenue Tax Court case and also deduct a substantial portion of its “nontrafficking” expenses. Mr. Zamarra says:
“Making a 280E calculation is a three-step process. First, allocate all occupancy costs between Retail (this term is used herein to denote those operations, a portion of which would ordinarily be considered “trafficking” as this term is used in Section 280E) and Non-Retail operations. Second, make the same allocation for all payroll-related costs. Third, apply the ‘Transactional Factor’.”
Circular 230 Notice: Pursuant to 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 links, 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.
How to Calculate the Taxable Income of a Medical Marijuana Dispensary Business Under Section 280E of the Internal Revenue Code
In the U.S. Tax Court case of Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner of Internal Revenue, 128 T.C. No. 14 (2007), the issue before the court was whether the Petitioner (CHAMP) could deduct ordinary expenses of $213,000 incurred in its medical marijuana business, a business that was legal under California law. The Tax Court held that Internal Revenue Code Section 280E prohibited the deductions. Here are some relevant statements made by the Court in its opinion:
Accrual method taxpayers such as petitioner may generally deduct the ordinary and necessary expenses incurred in carrying on a trade or business. See sec. 162(a).
Items specified in section 162(a) are allowed as deductions, subject to exceptions listed in section 261. See sec. 161. Section 261 provides that“no deduction shall in any case be allowed in respect of the items specified in this part.”
The phrase “this part” refers to part IX of subchapter B of chapter 1, entitled “Items NotDeductible”. “Expenditures in Connection With the Illegal Sale of Drugs” is an item specified in part IX. Section 280E provides:
“No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.”
In the context of section 280E, marijuana is a schedule I controlled substance. See, e.g., Sundel v. Commissioner, T.C. Memo. 1998-78, affd. without published opinion 201 F.3d 428(1st Cir. 1999). Such is so even when the marijuana is medical marijuana recommended by a physician as appropriate to benefit the health of the user.
As a result of the CHAMP case and Section 280E of the Internal Revenue Code, it is very easy to calculate the taxable income of a business that’s only business is growing or selling medical marijuana. Here’s how it works:
Gross Income – Cost of Goods Sold = Taxable Income
In 2007 the U.S. Tax Court held that Internal Revenue Code Section 280E prevents expenses incurred in a business of growing or selling medical marijuana that is legal under California law from being deductible in determining the taxable income of the business for federal income tax purposes.
128 T.C. No. 14
UNITED STATES TAX COURT
CALIFORNIANS HELPING TO ALLEVIATE MEDICAL PROBLEMS, INC., Petitioner
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 20795-05
Filed May 15, 2007
P provided counseling and other caregiving services (collectively, caregiving services) to its members, who were individuals with debilitating diseases. P also provided its members with medical marijuana pursuant to the California Compassionate Use Act of 1996, codified at Cal. Health & Safety Code sec. 11362.5 (West Supp. 2007). P charged its members a membership fee that generally reimbursed P for its costs of the caregiving services and its costs of the medical marijuana. R determined that all of P’s expenses were nondeductible under sec. 280E, I.R.C., because, R determined, the expenses were incurred in connection with the trafficking of a controlled substance.
Held: Sec. 280E, I.R.C., precludes P from deducting its expenses attributable to its provision of medical marijuana.
Held, further, P’s provision of its caregiving services and its provision of medical marijuana were separate trades or businesses for purposes of sec. 280E, I.R.C.; thus, sec. 280E, I.R.C., does not preclude P from deducting the expenses attributable to the caregiving services.
Matthew Kumin, Henry G. Wykowski, and Willian G. Panzer, for petitioner.
Margaret A. Martin, for respondent.
LARO, Judge: Respondent determined a $355,056 deficiency in petitioner’s 2002 Federal income tax and a $71,011 accuracy related penalty under section 6662(a) . (Note 1) Following concessions by respondent, including a concession that petitioner is not liable for the determined accuracy-related penalty, we decide whether section 280E precludes petitioner from deducting the ordinary and necessary expenses attributable to its provision of medical marijuana pursuant to the California Compassionate Use Act of 1996, codified at Cal. Health & Safety Code sec. 11362.5 (WestSupp. 2007). (Note 2) We hold that those deductions are precluded. We also decide whether section 280E precludes petitioner from deducting the ordinary and necessary expenses attributable to its provision of counseling and other caregiving services (collectively, caregiving services). We hold that those deductions are not precluded.
FINDINGS OF FACT
Certain facts were stipulated and are so found. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference. When the petition was filed, petitioner was an inactive California corporation whose mailing address was in San Francisco, California. Petitioner was organized on December 24, 1996, pursuant to the California Nonprofit Public Benefit Corporation Law, Cal. Corp. Code secs. 5110-6910. (West 1990). (Note 3) Its articles of incorporation stated that it “is organized and operated exclusively for charitable, educational and scientific purposes” and “The property of this corporation is irrevocably dedicated to charitable purposes”. Petitioner did not have Federal tax-exempt status, and it operated as an approximately break-even (i.e., the amount of its income approximated the amount of its expenses) community center for members with debilitating diseases. Approximately 47 percent of petitioner’s members suffered from Acquired Immune Deficiency Syndrome (AIDS); the remainder suffered from cancer, multiple sclerosis, and other serious illnesses. Before joining petitioner, petitioner’s executive director had 13 years of experience in health services as a coordinator of a statewide program that trained outreach workers in AIDS prevention work. (more…)