I had lunch
recently with a friend who has been diagnosed with Multiple Sclerosis. I learned about MS primarily through him, and
the disease is frightening. He went on to explain the neural degeneration and
the pain that it can – and does – cause. His doctors have prescribed any number
of pain medicines, but sometimes - many times - he does not need the full power
of those prescriptions. He needs more than an aspirin but much less than an
opioid.
It appears
that marijuana does work for pain management.
Granted, this
can be a problem where we live, as marijuana is not legal in either Kentucky or
Ohio.
Over twenty
states permit the medical use of marijuana, and four permit its recreational
use. The problem arises from its status as a Schedule I controlled substance,
meaning that it is illegal under federal law. I doubt too many tax CPAs get
involved with businesses selling illegal products, and those that do are
probably not in public practice.
The White
House has encouraged the Justice Department not to prosecute marijuana
distributors who comply with state law. Granted, the next White House may change
course on this matter, but for the moment there is temporary stability.
I have no
idea how a state Board of Accountancy would react.
Remember
that the tax Code is federal tax law.
It also contains Code section 280E, which was passed in 1982, 14 years before
California became the first state to legalize medical marijuana.
Let’s look
at this polished pearl of prose.
Sec
280E Expenditures in connection with the illegal sale of drugs
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 the trade or business is conducted.
This section
was created in response to the 1981 Edmonson
case, in which the Tax Court allowed a seller of amphetamines, cocaine and
marijuana to deduct expenses. The decision did not go over well.
So Congress responded
with “no deduction or credit shall be allowed” on public policy grounds.
However that
language does not mean what it first appears to say.
Section 280E
does allow a cost-of-goods-sold deduction. The reason goes back to accounting
theory. Let’s say that you sell Supreme Court clown hats. You sell a million of
them for $5 each. You have to have them manufactured, which you outsource and
pay $3 each. Let’s step into a tax accounting
class and the professor asks you: what is your income?
·
Is
it 1 million times $5 = $5 million
·
Or
is it 1 million times ($5 - $3) = $2 million
The answer
is $2 million, as you get to deduct the cost of a product when your business involves
selling a product.
And the Tax
Court agreed in the Olive case.
Following Olive, we know that we can deduct the
cost of the marijuana from the revenues received from selling marijuana. What
about everything else: payroll, rent, lights, cell phone, computers and
software, stationary, and so forth?
Now we run
full-face into Section 280E. There is no deduction.
That has to
hurt come April 15th.
Surely the tax
accountants can do something, right?
Yes, up to a
point.
Remember
that we said that you are allowed to deduct the cost of a product when your
business involves selling a product? Another word for product is inventory, and
there are things an accountant can do to tack some of those otherwise
nondeductible expenses onto the inventory. You would then deduct those expenses
as cost of goods sold when the product sells. I suspect you will still be
leaving most of those expenses on the floor, but it is something.
More useful
is to have another line of business that does not involve the sale of
marijuana. Let’s say that one sets up a caregiving activity involving marijuana,
providing support groups, lunches, counseling, social events and so on. As long
as the primary business is not the sale of marijuana, the accountant could
shift expenses (within reason; be fair) to that activity and sidestep the
Section 280E disallowance. This was the Californians
Helping to Alleviate Medical Problems (CHAMP)
case, and it received the Tax Court’s approval. Introduce creative minds and I
am certain there are a thousand variations on the theme.
There is a
San Francisco marijuana business (Canna Care) that has taken Section 280E to
Tax Court. In their case it means a $2.6
million deduction. They do not have a CHAMP fact pattern but are instead
arguing that the disallowance is punitive and hence unconstitutional.
There has
been no decision as of this writing, but I would not be optimistic.
Why? The
Ninth Circuit very recently decided on the appeal of Olive mentioned above. Martin Olive operates the Vapor Room, a
medical marijuana dispensary in California. In addition to selling marijuana, it offers a number of
services as well as food – both for free. It made a CHAMP
argument, wanting to allocate expenses between the two lines of business.
The Ninth
Circuit said no, basing its decision primarily on the “free” part of the food
and services. To allocate expenses to two or more trades or businesses, one
must in fact be in business. There is no hope of a profit when the activity is
giving things away for free, so that activity cannot rise to the level of a
trade or business.
But the
Ninth Circuit also slapped down Olive’s direct challenge to Section 280E,
saying the tax disallowance is not based on marijuana being legal or illegal.
Rather the disallowance is based on marijuana being a controlled substance,
which it is and continues to be.
And there
you have the federal taxation of marijuana in a nutshell.
My thoughts?
It appears
that the 1982 Section 280E addition to the tax Code is a bit out-of-step with
contemporary society. Perhaps Congress could change one word:
… which is prohibited by Federal
law AND the law of
any State in which such trade or business is conducted”.
And no, I
don’t want any credit for the suggestion. I am more of a bourbon fan myself.
