Perhaps the biggest problem facing medical marijuana dispensaries are the federal tax consequences of operating such a business. While Colorado state voters have legalized marijuana, the IRS still considers marijuana dispensaries to be drug traffickers under federal law and IRS audits of marijuana dispensaries are on the rise. Section 280E of the United States Tax Code provides that no deduction or credit shall be allowed for any amount paid or incurred during the taxable year when the expenses are incurred in connection with the trafficking of a controlled substance. The disallowance of expenses is a very harsh punishment for businesses because businesses typically pay taxes on their net, not their gross income. It is important to note that cost of goods sold is not a deduction but is subtracted from gross receipts in order to determine a taxpayer’s gross income. Thus, a dispensary who maintains sufficient records should be permitted to reduce their gross receipts by their cost of goods sold. Ultimately, the federal tax consequences could effectively put dispensaries out of business.
The United States Tax Court has provided some relief in recent decisions including the decision in the case of Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner of Internal Revenue , 128 T.C. No. 14 (2007). The Tax Court reasoned that Section 280E and its legislative history express a congressional intent to disallow deductions attributable to a trade or business of trafficking in controlled substances and did not express an intent to deny the deduction of all of a taxpayer’s business expenses simply because the taxpayer was involved in trafficking in a controlled substance. In this case, the Tax Court found that the Petitioner operated with a dual purpose. Its primary purpose was to provide care giving services to its members. Its secondary purpose was to provide its members with medical marijuana. The Tax Court held that the Petitioner could not deduct expenses relating to its provision of medical marijuana, but could deduct expenses related to its provision of care giving services.
Good record keeping will be essential to proving costs of goods sold and in proving if the business had a dual purpose. Such record keeping is extremely difficult if the business has operated on a cash basis.
Finally, it should also be noted that taxpayers who are using marijuana for medicinal purposes are not permitted to deduct medical marijuana expenses on the medical expense line on Schedule A of their individual tax return.