Yet another important case came up while I am on vacation. Martin Olive operates the Vapor Room, a medical marijuana dispensary in California. He was audited, and the IRS held:
- That the dispensary underreported gross receipts;
- Could only deduct a small fraction of the claimed gross receipts;
- Couldn’t deduct any of the business expenses; and
- Was liable for the accuracy-related penalty.
Mr. Olive took his case to the Tax Court, and the Court made a full decision today (which serves as a precedent). And it’s not good news for the medical marijuana industry in California (or elsewhere).
First, let’s give the (somewhat) good news. The Court held that the Cost of Goods Sold (COGS) could be deducted where proven. But the petitioner (Mr. Olive) conducted his business in cash (rather than checks), and didn’t keep good records. Mr. Olive stated that the medical marijuana industry, “shun[s] formal ‘substantiation’ in the form of receipts.” That may be true, but:
The substantiation rules require a taxpayer to maintain sufficient reliable records to allow the Commissioner to verify the taxpayer’s income and expenditures…Neither Congress nor the Commissioner has prescribed a rule stating that a medical marijuana dispensary may meet that substantiation requirement merely by maintaining a self-prepared ledger listing the amounts and general categories of its expenditures. It is not this Court’s role to prescribe the special substantiation rule that petitioner desires for medical marijuana dispensaries and we decline to do so.
Still, the Court did allow an estimated COGS of just over 70% of gross receipts.
After that, the news was not good for the dispensary. First, the cash receipts were understated. The ledgers used had omissions, and the Court believed that the IRS’s calculated additional receipts were accurate.
Second, we turn to the “ordinary and necessary” business expenses. Most taxpayers can deduct these. However, Section 280E of the Tax Code prohibits deducting expenses for a trade or business that consists of trafficking in controlled substances in violation of federal law. “We have previously held, and the parties agree, that medical marijuana is a controlled substance under section 280E.”
Petitioner argues that he may deduct the Vapor Room’s expenses notwithstanding section 280E because, he claims, the Vapor Room’s business did not consist of the illegal trafficking in a controlled substance. He argues that the illegal trafficking in controlled substances is the only activity covered by section 280E. We disagree that section 280E is that narrow and does not apply here. We therefore reject petitioner’s contention that section 280E does not apply because the Vapor Room was a legitimate operation under California law. We have previously held that a California medical marijuana dispensary’s dispensing of medical marijuana pursuant to the CCUA was “trafficking” within the meaning of section 280E. See CHAMP, 128 T.C. at 182-183. That holding applies here with full force…
Congress in section 280E has set an illegality under Federal law as one trigger to preclude a taxpayer from deducting expenses incurred in a medical marijuana dispensary business. This is true even if the business is legal under State law.
Mr. Olive attempted to show his business had two components (providing medical marijuana and ‘caregiving’), but the Tax Court didn’t buy that. There were no revenues for caregiving, and the Tax Court,
…perceive[d] his claim now that the Vapor Room actually consists of two businesses as simply an after-the-fact attempt to artificially equate the Vapor Room with the medical marijuana dispensary in CHAMP so as to avoid the disallowance of all of the Vapor Room’s expenses under section 280E.
This decision does not bode well at all for the medical marijuana cases that are moving through audit and the Tax Court. This is a full precedential case and I don’t see the Tax Court changing its view on the issues in the future.