Rationale of Deductions Under Section 280E
You probably believe that the only solution to Section 280E is for it to be repealed because cannabis businesses are being taxed at extremely high levels. There is however, some hope in two respects. First, IRS Code Section 280E is limited to the sale of (or “trafficking in”) marijuana.
Thus, if a taxpayer is involved in selling medical or recreational marijuana and also in another business in the same location, the taxpayer could possibly be in a position to write off business expenses in association with the other business as related to their marijuana operation. This could be any other type of business such as a coffee or sandwich shop, printing operation or even a used car dealership. However, we find the easiest and most cost effective business to implement is an event ticket brokerage and that is why we are recommending it.
For example, in Californians Helping to Alleviate Medical Problems (CHAMP), the Tax Court held IRS Code Section 280E would not preclude the taxpayer from deducting expenses as a result of a trade or business apart from that of illegal trafficking in controlled substances, basically because the taxpayer is also engaged in trafficking a controlled substance. Of course, practically speaking, the taxpayer’s characterization of a deduction will not be rubber-stamped by the IRS if it appears to be artificial and cannot be reasonably reinforced by the facts and circumstances of the individual case.
Second, while IRC § 280E disallows any kind of business deduction for a marijuana seller’s ordinary and necessary business expenses, costs of goods sold – that may be, the carrying value of goods sold within a particular period – are excluded using this rule. Senate Report 97-494(I) explained the reasoning for this as follows:
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In the 2007 case, Californians Helping to Alleviate Medical Problems (CHAMP), the Tax Court allowed business deductions for the “patient care” portion of a medical marijuana dispensary in addition to the firm’s costs of goods sold. CHAMP was a not-for-profit entity under California law with a mission to provide caregiving services to members of the community with debilitating diseases. As such, business deductions under Sec. 162(a) for the caregiving portion of the business were permitted, and Sec. 280E would not prohibit these deductions “simply because the taxpayer was also involved in trafficking in a controlled substance.” The Tax Court further stated that the IRS regularly permits a taxpayer to engage in more than one business unless the separate characterization is artificial or unreasonable. This is why we set up the entity “CannaTixx.com” This is a related business having its physical location in the same location as a cannabis business. It has separate expenses that are shared with an existing business which are all legally deductible.
In 2012, the United States Tax Court assessed penalties and interest against Vapor Room Herbal Center, a California medical marijuana dispensary owned by Martin Olive, The Ninth Circuit agreed with the Tax Court that the Vapor Room’s only “trade or business” was the sale of marijuana. It noted that the test for determining if an activity is a “trade or business” is whether the activity was entered into with the intent of making a profit. As the Vapor Room’s other services were offered for free, the only activity that could raise a profit was the sale of marijuana. Olive v. Commissioner of Internal Revenue, No. 13-70510 (9th Cir. July 9, 2015). As stated previously, the ticket business can be very profitable and the cannabis business owner would be entering into this with the intent to make money. The ticket brokerage is also providing other services to their customers to enhance their existing cannabis business. We believe the original CHAMPS decision will hold here because it is a related non-cannabis business entered into with the intent to make a profit.
There is also a case to be made that the application of Section 280E against cannabis businesses violates the 10th Amendment to the U.S. Constitution. The legal state approved cannabis businesses are being targeted by the federal government for excessive taxation. By definition the 10th Amendment specifically mentions the federal government possesses only those powers delegated to it by the Constitution. All remaining powers are reserved for the states or the people. This aspect can and should be adjudicated in a court of law as we believe 280E applied to cannabis operations is unconstitutional, especially when they are state sanctioned to be legal.
The IRS Code Section 280E will probably never be repealed and was put in place to punish criminal activity that traffics in controlled substances such as Schedule I narcotics heroin and LSD along with Schedule II narcotics cocaine and methamphetamine. The Code states that:
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.
There are basically two means of handling this problem, On one side, Congress – working together with the Drug Enforcement Administration and Attorney General – will have to reclassify cannabis as a Schedule III or less narcotic. On the other hand, Congress will need to modify IRS Code Section 280E in order to allow ordinary and necessary business write offs for genuine state licensed marijuana dispensaries and recreational stores.
If this does occur, the IRS will probably allow marijuana dispensaries and recreational stores to go back and amend previous tax return for a period of 3-5 years. However, there is no guarantee this will occur either. That being said the only way to amend the returns and claim any type of deductions at all will require meticulous record keeping on the part of the business owner. So don’t expect the IRS to take your word that you had deductions. Make sure your ducks are in a row now and document your expenses now.