While state legalization of medical and recreational marijuana use has quickly gained momentum, the Federal government remains obstinate on the issue and continues to treat marijuana as a Schedule I controlled substance. Federal income tax law does not differentiate between income derived from legal sources and income derived from illegal sources. The IRS further imposes tax restrictions on cannabis businesses bringing tax planning to the forefront of all money matters.
Cannabis Taxation: How did we get here?
Section 280e: No tax deductions allowed for businesses trafficking a controlled substance.
Edmonson v. Commissioner, T.C. Memo. 1981-623 (1982)
Petitioner Jeffrey Edmondson reported income and expenses from his business of selling amphetamines, cocaine and marijuana in response to a jeopardy assessment issued by The Commissioner. The Tax Court allowed the illegal business to recover the cost of the controlled substances as well as certain business deductions incurred while operating his business.
The IRS in response enacted Section 280e in 1982 to overturn the result in Edmondson and deny all illegal drug trafficking business deductions from gross income in computing taxable income. Congress did not attempt to prevent taxpayers however from using Cost of Goods Sold (COGS) to compute gross income.
Greentenders can help businesses reduce the impact of 280e by applying the applicable inventory costing regulations under IRC Section 471 to maximize COGS in computing taxable income.
CHAMP: Cannabis vs. non-cannabis business activities
Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner (CHAMP), 128 T.C. 173 (2007)
Petitioner CHAMP operated a dispensary available to its paying members in addition to providing them with caregiving services. In response to The Commissioner's determination that the business expenses were non-deductible under Section 280e, CHAMP argued that their provision of caregiving services were a separate trade from their provision of medical marijuana. The Tax Court held that the services were substantially different and allowed tax deductions for services that embody a separate trade or business from that of selling marijuana.
Careful considerations to determine the eligibility of deductions under a clearly defined separate trade or business are needed as demonstrated by Olive v. Commissioner, 139 T.C. No 2. (2012).
Greentenders are experts in implementing the proper classifications and allocations to clearly identify financial activities from cannabis and non-cannabis activities.
Alterman: Deductions are denied due to poor record keeping
Alterman v. Commissioner, T.C. Memo. 2018-83 (2018)
The Tax Court in a more recent case denied the application of 280e to petitioner Laurel Alterman and William A. Gibson who operated a medical marijuana grow and dispensary in addition to selling non-cannabis retail goods i.e., clothing and paraphernalia. Where Alterman may have been allowed to deduct Cost of Goods sold under the 280e tax code as well as deductions under their non-cannabis trade, The Court denied allowance simply because of insufficient records as Alterman failed to substantiate the expenses. Poor application of accounting allocations and inventory costing along with unauditable records lead to hundreds of thousands in owed taxes and heavy penalties in another punishing defeat.
Recordkeeping should go without saying. Greeentenders are meticulous in retaining support for every transaction within the business and clearly providing records that allow for audit from high level consolidated reporting back to single point of sale entry.
We welcome the opportunity to provide a complimentary consultation to discuss how we can help your cannabis business stay in tax compliance.