IRS Denies Medical Marijuana Business Deductions

By Jeralyn, Section Crime Policy
Posted on Wed Oct 05, 2011 at 06:56:31 PM EST
Tags: marijuana reform, medical marijuana (all tags)

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The IRS has now jumped into the fray of medical marijuana businesses -- including dispensaries operating legally under the laws of their states.

The IRS is asserting that dispensaries cannot deduct ordinary business expenses like salaries, rent and security costs.

Here are the letters the IRS has sent. Its position: [More...]

The IRS ruling is based on an obscure portion of the tax code -- section 280E -- passed into law by Congress in 1982, at the height of Reagan administration’s “war on drugs.” The law, originally targeted at drug kingpins and cartels, bans any tax deductions related to "trafficking in controlled substances."

Is any other business taxed on gross revenue? This is quite unfair. The dispensaries say it will drive them out of business. It's also counter-productive as it will drive more patients back to the black market, which is what the Government wants to avoid. Dispensaries pay taxes, and if they go out of business, the feds and state won't get that money. They also provide jobs. This is just bad policy all around.

Update: Ask your congresspersons to support H.R. 1985, Small Business Tax Equity Act of 2011.

C. 2. DEDUCTION ALLOWED FOR EXPENSES IN CONNECTION WITH SALES OF MARIJUANA.
(a) In General- Section 280E of the Internal Revenue Code of 1986 is amended--
(1) by striking ‘No deduction’ and inserting ‘(a) IN GENERAL- No deduction’, and
(2) by adding at the end the following new subsection:
‘(b) Exception- Subsection (a) shall not apply to amounts paid or incurred in connection with the portion of the trade or business consisting of sales of marihuana (as defined by section 102(16) of the Controlled Substances Act) intended for patients for medical purposes pursuant to the law of a State.’.

The bill was introduced in May Mr. STARK, Mr. ROHRABACHER, Mr. POLIS, Mr. PAUL, and Mr. FRANK of Massachusetts) and referred to the Committee on Ways and Means

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IRS Denies Medical Marijuana Business Deductions | 27 comments (27 topical)

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Note that under section 280E (5.00 / 0) (#2)
by Peter G on Wed Oct 05, 2011 at 07:12:08 PM EST

medical marijuana businesses would be able to deduct their ordinary and necessary business expenses if marijuana were not improperly classified in Schedule I under the Controlled Substances Act. You are right, TL, that other illegal businesses are entitled to take normal business deductions, not including payments which are themselves illegal (such as bribes) and not including criminal penalties (such as fines).

Question (none / 0) (#4)
by nycstray on Wed Oct 05, 2011 at 07:27:20 PM EST

if the IRS says you can't deduct ordinary and necessary biz expenses, does that make you not a biz?


No, it doesn't mean that (none / 0) (#8)
by Peter G on Wed Oct 05, 2011 at 07:44:29 PM EST

It means that Congress has written a discriminatory tax law which targets businesses which "traffic" in Sched I and Sched II controlled substances, and denies them tax benefits that all other illegal businesses enjoy. Unless that discrimination is unconstitutional, the MMDs are SOL. I'm sure that one or more MMDs will be appealing this ruling to the U.S. Tax Court promptly, and from there to a federal circuit appeals court and then possibly to the Supreme Court. IMHO, a long shot to win but not unimaginable.


Thanks for the clarification . . . (none / 0) (#10)
by nycstray on Wed Oct 05, 2011 at 07:55:18 PM EST

as a gal with a degree in paint and pastels, sometimes these things don't compute for me :)

Any chance a city or state (vs a MMD) would take on the challenge? Oakland, Ca comes to mind as a city that wants this type of business (from what I understand on the news) . . .


A win would be totally unimaginable. (none / 0) (#19)
by jpe on Thu Oct 06, 2011 at 06:17:36 AM EST

There's no way the law fails rational basis test, and we know from Angel v Raich that the feds can ban pot.


The issue is not whether it is rational (none / 0) (#26)
by Peter G on Thu Oct 06, 2011 at 09:31:49 AM EST

to keep marijuana illegal at the federal level, even under circumstances legalized by local law, or when needed for medical purposes (as in Raich), but rather whether it is rational to deny a tax exemption for the ordinary expenses of an illegal "drug trafficking" business (in Sched I and Sched II substances) while allowing the same deductions to all other illegal businesses -- gambling, prostitution, telemarketing fraud schemes, illegal gun sales, production and distribution of child pornography, etc. etc.


: Legitimate, not rational. (none / 0) (#27)
by jpe on Thu Oct 06, 2011 at 09:52:32 AM EST

Is banning drugs a legitimate goal of the state? That's an obvious "yes." Is prohibiting deductions for people that sell illegal drugs rationally related to that goal? That's an obvious "yes."
"Drug sellers" aren't a protected class, so analysis doesn't need to rise above that level.

I find it interesting that (none / 0) (#13)
by Jeralyn on Wed Oct 05, 2011 at 10:10:05 PM EST

drug "trafficking" itself is not a federal crime. But federal felony drug crimes (distribution, possession with intent to distribute, conspiracy to distribute or to pwid, importation and using the telephone to facilitate a drug offense, to name a few, are deemed to be "federal drug trafficking" crimes in other parts of the code. All felony drug offenses are now deemed to be "trafficking" but there is no offense called "trafficking." It's like Congress used the word "trafficking" as a catch-all phrase so as to include all drug crimes, but doesn't directly prohibit "trafficking."

In the old days, trafficking referred to smugglers, who brought or transported a drug from one jurisdiction to another. The crime was geographic in nature. Some states still have "trafficking" offenses which seem to be based on weight. Greater weights of drug render the offense trafficking.

It's too bad that the umbrella is so wide.


Example? (none / 0) (#20)
by coast on Thu Oct 06, 2011 at 07:20:33 AM EST

Just curious to know what type of illegal businesses are allowed to take normal business deductions.


: Neat little Wikipedia article: (none / 0) (#23)
by jpe on Thu Oct 06, 2011 at 08:05:36 AM EST

here.

: Each and every type of illegal business, (none / 0) (#24)
by Peter G on Thu Oct 06, 2011 at 09:14:18 AM EST

if it files a tax return, is entitled to take the same kinds of "ordinary and necessary" business expenses as lawful businesses ... except the business of "trafficking" in Sched I or Sched II drugs.

first off, (5.00 / 1) (#14)
by cpinva on Wed Oct 05, 2011 at 10:30:58 PM EST

congress is in charge of legislating tax law, not the IRS. IRC 280E was part of TEFRA, and it isn't particularly obscure to those of us in the tax business. it's also pretty useless in reality, because most of the people targeted (drug dealers) have little in the way of tangible assets that could be seized to pay off the liability generated as a result.

it's used mostly as a negotiating tool by the tax section of DOJ, when dealing with civil settlements of tax fraud cases involving drug dealers (who tend to not file tax returns): "we'll give you expenses, thereby reducing your tax liability, in return for you signing off on this plea bargain."

in actuality, congress could easily change the wording of IRC 280E, to allow those business expenses for medical marijuana providers, in states where it's legal. they could then claim "ordinary and necessary expenses of a trade or business" under IRC 162, for the taxable year.
it would also require a change in the appropriate regulations.

see, simple really. well, except for that whole "get a congressperson to propose such a change" thing.

to answer your question jeralyn:

Is any other business taxed on gross revenue?

yes, actually. any expenditure in violation of public policy (which obviously the medical pot issue would fall under) is disallowed. so any illegal business would fall under the same rules: gross income is reportable (under IRC 61), expenses related to that gross income are disallowed.

it's been like that since at least the code of 1954.

: The Supreme Court disagrees with you, (none / 0) (#25)
by Peter G on Thu Oct 06, 2011 at 09:25:59 AM EST

when you suggest the argument that "any expenditure in violation of public policy (which obviously the medical pot issue would fall under) is disallowed. so any illegal business would fall under the same rules: gross income is reportable (under IRC 61), expenses related to that gross income are disallowed." See Tellier (1966), explaining Sullivan (1958).

The IRS is breaking the law, IMO (none / 0) (#3)
by Dadler on Wed Oct 05, 2011 at 07:26:27 PM EST

Pure discrimination based on nothing that can be linked to anything even marginally based on reason. Orwellian is more like it.

The IRS didn't make this up (none / 0) (#7)
by Peter G on Wed Oct 05, 2011 at 07:35:39 PM EST

It's in the tax law passed by Congress. The agency just enforces it as written. I provided a link to the text of the law in my earlier comment (#2). Read it yourself and see if you can find any language that allows you to argue that the IRS is wrong.


President Obama and the (none / 0) (#21)
by MO Blue on Thu Oct 06, 2011 at 07:37:55 AM EST

department of HHS have given waivers to companies so they do not have to comply with provisions of the health insurance legislation that was passed by Congress.

More than 1000 waivers granted for health care law

Could the Obama administration give waivers to the Medical Marijuana industry if they chose to do so?


: Nope. (none / 0) (#22)
by jpe on Thu Oct 06, 2011 at 08:03:21 AM EST

There's a waiver provision in the PPACA. There's no such waiver in the internal revenue code. The IRS is required by law to disallow the deductions and assess back tax.

The cities won't get that tax revenue either, (none / 0) (#5)
by MileHi Hawkeye on Wed Oct 05, 2011 at 07:31:07 PM EST

Well, at least the ones that haven't already restricted/outlawed the dispensaries out of existence by now. I'd rather not think about how much worse Denver's budget would be without that revenue.

How many drug dealers/cartels file tax returns anyway?

Ollie North would know... (none / 0) (#11)
by kdog on Wed Oct 05, 2011 at 08:55:02 PM EST

lets ask him:)

Any dispensary trying to do "right" and walk the tightrope of legality is gonna have to jack up their prices or go under...it's a war on health care/class war/drug war trifecta.

I guess that'll teach ya that trying to follow the law is a fool's errand in a land so lacking in equality under the law. Maybe we are in fact better off under prohibition, perish the thought, at least ya know where you stand.


It is a double whammy here. (none / 0) (#15)
by MileHi Hawkeye on Wed Oct 05, 2011 at 10:32:12 PM EST

The State has been making them come up with various kinds of special permits and registration fees and whatnot--it takes a sizable amount of cash to even get an operation off the ground.

Not to mention the other restrictions (zoning, inspection, reporting, etc., that truly are restrictive. It's almost like they don't want them around...


: Oh, I forgot (5.00 / 1) (#16)
by MileHi Hawkeye on Wed Oct 05, 2011 at 10:40:09 PM EST

...that no bank, not one, will do business with them. The ones that did just stopped recently. So they have to run on all cash without access to credit or any place to put all that cash. Hard to run a business like that--not to mention making them inviting targets for real criminal activity.
Thanks for the OWS report--good stuff.

Stupid action (none / 0) (#6)
by MO Blue on Wed Oct 05, 2011 at 07:35:35 PM EST

resulting from a stupid law.

But what they heck, people don't need jobs and the states don't need the revenue. When the unemployment rate goes up to 10 or 11%, maybe Obama will realize what a stupid move it was to put the dispensaries out of business.

The IRS is a power that is (none / 0) (#9)
by BTAL on Wed Oct 05, 2011 at 07:55:17 PM EST

beyond common sense let alone the Constitution.
an entity that needs to be pulled back.

Having been the "fortunate" beneficiary of IRS attention, I wish Congress would have appropriated funds for minimal lubricants in the budget.

Now, the $64K question. For those that want to set the IRS loose on the "rich", be careful what you wish for.

: That's funny... (none / 0) (#12)
by kdog on Wed Oct 05, 2011 at 08:56:18 PM EST

I was kinda hoping on setting something loose on the IRS and the ill-gotten rich myself:)

well there ya go jeralyn! (none / 0) (#17)
by cpinva on Thu Oct 06, 2011 at 12:21:30 AM EST

however, given the lunatic asylum that is the republican majority house, i wouldn't bet the rent money on this getting passed. it didn't even need to be that long, just amend it with an exception to the general rule, for licensed medical marijuana growers/processors/distributors in states allowing such.

but, leave it to a bunch of lawyers! :)

The IRS was right as a matter of tax law. (none / 0) (#18)
by jpe on Thu Oct 06, 2011 at 06:15:25 AM EST

IRC 280E denies any deductions for drug sales. Congress has to fix it.

Further expert analysis available, (none / 0) (#28)
by Peter G on Thu Oct 06, 2011 at 12:10:30 PM EST

along with some legal citations and other references, at the TaxProf Blog, here and here.