IRS is in the Early Stages of a War to Kill Medical Marijuana Dispensaries

Question:  Does a medical marijuana dispensary that is legal under state law have anything to fear from the Internal Revenue Service?

Answer:  Yes.  In 2007 the United States Tax Court issued its opinion in the case of Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner of Internal Revenue.  The issue in this case was what business expenses could a California medical marijuana dispensary deduct on its federal income tax return in light of Internal Revenue Code Section 280E, which states:

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 CHAMPS case, the IRS conceded that the taxpayer could deduct its cost of goods sold, which included $575,317 for marijuana.  Based on news reports about recent IRS audits of big California medical marijuana collectives, it appears that the IRS wants to revisit Section 280E and how it applies to medical marijuana dispensaries.

Warning to All Would-Be and Existing Medical Marijuana Dispensaries about Federal Income Taxes

The IRS is auditing a number of high dollar revenue medical marijuana dispensaries in California.  See for example “IRS tells California Medical Marijuana Dispensary it Owes Millions in Unpaid Taxes” and “Millions at Stake in IRS Audit of Oakland Medical Marijuana Dispensary.”  I believe that the ultimate goal of the IRS is to change the result in the CHAMPS case, which will have the practical affect of putting almost all state legal medical marijuana dispensaries out of business.  If a dispensary spends $1,000,000 to grow its marijuana in 2011 and none of that expense is deductible because of Section 280E, then the dispensary will pay federal income taxes of $340,000 that it would not pay if the expense were deductible.  This means it actually will cost the dispensary $1,340,000 to grow $1,000,000 of marijuana.

I do not know why the IRS conceded in CHAMPS that the taxpayer could deduct the cost of goods sold.  COGS was the taxpayer’s biggest expense.  I believe the IRS regrets conceding in CHAMPS that the COGS was deductible.  I predict the IRS  will disallow the  COGS of the medical marijuana dispensaries it audits.  I believe the IRS wants to litigate this issue in federal district court rather than in Tax Court with the ultimate goal of having the 9th Circuit Court of Appeals rule that COGS is not deductible by a state legal medical marijuana dispensary.  If the IRS can get one or more appellate courts to agree that the COGS is not deductible, the practical result may be to kill the medical marijuana industry in every state that has legalized it.

Tax Court vs. Federal District Court & Circuit Courts of Appeal

The CHAMPS case was a U.S. Tax Court case that had a good result for the medical marijuana dispensaries in states that have legalized the growing and sale of medical marijuana.  Neither federal district courts nor Circuit Courts of Appeal are required to follow the decisions of the Tax Court.  That is why the IRS wants to relitigate Section 280E in the federal district courts and then the appropriate Circuit Court of Appeals.   The IRS wants to reverse the CHAMPS case by winning at the Circuit Court of Appeals level.

When the IRS conducts an audit and demands more taxes from a taxpayer, the taxpayer who wants to dispute the results of the audit has two choices:

  1. Pay the entire amount of taxes in dispute and ask the U.S. Tax Court to determine how much additional taxes, if any, the taxpayer owes, or
  2. Pay none or less than all of the amount of taxes demanded by the IRS and ask the U.S. district court to determine how much additional taxes, if any, the taxpayer owes.

Tax court decisions cannot be appealed.  Federal district court decisions can be appealed by the losing party to the appropriate Circuit Court of Appeals, which is the 9th Circuit for California and Arizona. district courts.   Any legal medical  marijuana dispensary that is assessed additional taxes by the IRS will want to pay the additional taxes and have the Tax Court rule on the dispute.  The practical problem with this tactic, however, is that most dispensary taxpayers will not have the cash to pay the amount of taxes in dispute and will be forced to litigate in the federal district court.

The choice of venue to litigate the dispute is significant.  Dispensaries will want to pay the tax and go to the Tax Court where they expect the Court to apply the holdings of the CHAMPS case.  Clearly the IRS does not want these medical marijuana dispensary Section 280E cases to go to the Tax Court where the CHAMPS case is bad precedent for the IRS.  What the IRS is doing is going after dispensaries that have high income and expenses so that when it demands more taxes, the dispensaries most likely will not have the money to pay the amount in dispute and must then go to the U.S. district court.  Because the amount of tax dollars in dispute will be so big, the loser in the district court will appeal to the 9th Circuit Court of Appeals where the IRS hopes it will get a favorable Section 280E ruling that will effectively allow it to tax legal medical marijuana dispensaries out of existence.

The Marin Alliance for Medical Marijuana is being audited by the IRS.  When asked how much the IRS is demanding in back federal income taxes, Lynnette Shaw, the owner of this dispensary, would not disclose the amount, but she said, “It’s a staggering sum, millions and millions.”  I’m guessing this dispensary does not have a few spare millions of dollars lying around to pay the IRS so it can litigate the dispute in tax court.

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Disclaimer

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.

IRS tells California Medical Marijuana Dispensary it Owes Millions in Unpaid Taxes

Marin Independent Journal:  “The Internal Revenue Service has notified the Marin Alliance for Medical Marijuana in Fairfax that it owes millions of dollars in unpaid back taxes, according to the alliance’s founder and director, Lynnette Shaw.  Shaw said the IRS audited the alliance’s tax returns for 2008 and 2009 and disallowed all of its business deductions. She said that although dispensaries throughout the state are being audited by the IRS, the alliance is the first to be told it can’t deduct business expenses.  ‘Every dispensary in the nation, past, present and future is dead if this is upheld,’ Shaw said. . . . Shaw said the IRS disallowed her deductions — for buying marijuana, hiring employees, securing office space and more — based on section 280E of the federal tax code, which states that no deduction shall be allowed for any business trafficking in controlled substances.”

This story is a wake-up call and warning to all prospective Arizona medical marijuana dispensaries.  Despite the CHAMPS case, which was decided in the U.S. Tax Court, the IRS apparently is disallowing ALL deductions of medical marijuana dispensaries.  Prospective Arizona medical marijuana dispensaries should consider this fact when doing budgets and financial projections for their dispensary businesses.  See “Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner of Internal Revenue.”

By |2019-06-14T08:24:54-07:00March 18th, 2011|California News, Federal Dispensary Attacks, Tax Issues|Comments Off on IRS tells California Medical Marijuana Dispensary it Owes Millions in Unpaid Taxes

Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner of Internal Revenue

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
v.
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…)

By |2010-12-27T19:00:28-07:00December 27th, 2010|Tax Issues|1 Comment