Legal, But Not Taxed Equal: Marijuana Providers Losing Fight to Deduct Business Expenses

There is nothing more boring than U.S. tax law.

But like many things at the pinnacle of tedium, marijuana is here is help—though technically, for those looking to deduct business expenses on their federal income taxes, it is here to hurt. A lot.

Just ask Martin Olive.

In 2004, Olive left college to start The Vapor Room, a medical marijuana dispensary in San Francisco serving local clients, including some with terminal illnesses. According to U.S. Tax Court documents, and Olive's own HIGH TIMES Interview back in 2007, The Vapor Room, legal under the California Compassionate Use Act of 1996, was a community-focused establishment.

Anyone was free to visit and use its vaporizers, games, books, art supplies or board games; participate in its yoga classes, therapist chair massages and movie nights; or partake in its complimentary food and beverages, without having to first buy its medical marijuana.

What Olive's establishment didn't offer, however, were expense receipts or permanent business records, which can prove particularly vexing when being audited by the IRS.

Though The Vapor Room experienced robust sales in its first two years—over $1 million in 2004 and over $3 million in 2005 by its own account—its high overhead costs meant it never broke more than $65,000 in profit in 2004 or 2005, according to its tax returns.  But the IRS wasn't buying Olive's accounting—and ultimately fined The Vapor Room around $380,000 in total for both years.

Olive fought back, and ended up in U.S. tax court in 2012. The court, however, was unsympathetic, deeming his, his witness', and his accountant's testimony "insincere and unrealizable."

But that, in the end, didn't matter, because the court also ruled that the business expense deductions that The Vapor Room claimed were illegal under federal Internal Revenue Code section 280E—a 1982 law barring such deductions for any trade or business trafficking in federally-defined schedule I or II drugs.

Olive appealed, but in a decision three years later, the U.S. Court of Appeals for the Ninth Circuit upheld the ruling in its entirety .

Neither court gave much credence to Olive's claim that The Vapor Room provided caregiving services alongside medical marijuana, and as such should be able to deduct some business expenses.

Olive's failed argument was based off of a seminal marijuana tax law ruling in 2007. At the time, a U.S tax court ruled that Californians Helping to Alleviate Medical Problems, Inc. (CHAMPS)—a caregiver provider and medical marijuana dispenser—was not completely disqualified from businesses expense deductions because of its diversified operations. As long as the expenses related to marijuana were separated out from others, one could still claim deductions.

A nonprofit public health center for patients with terminal illnesses, CHAMPS was  similar to The Vapor Room—it provided a host of counseling services, social events, complimentary food and necessary supplies, in addition to offering medical marijuana .

But unlike Olive's dispensary, all of its services were paid for by its clientele through a single membership fee.  

In comparing the two establishments, the U.S. Court of Appeals for the Ninth Circuit said the difference was analogous to a bookstore operating a cafe inside its establishment, thereby selling books, coffee and pastries, to one that enticed buyers in to purchase books with free coffee and pastries. 

Though they cannot claim business expense deductions, marijuana businesses can deduct the actual cost of purchasing, or the growing and producing, of the pot they sell (the cost of goods sold). And for some time, this allowed them to workaround section 280E.

This is because another section of the tax code (263A) required businesses to transfer indirect general costs related to inventory, such as all those incurred during the transportation of marijuana from farm to shop, to inventory expenses. This essentially transformed business expenses into cost of goods sold . 

The loophole worked up until 2015, when the IRS issued a memorandum for taxpayers "trafficking in a Schedule I or Schedule II Controlled Substance." While providing much needed clarification on many complex issues, the memorandum also once and for all ended the practice.

There is hope that the federal government may come to the aid of overburdened businesses, given the shift in Congress' attitude towards marijuana. 

There has been proposed legislation, such as the Small Business Tax Equity Act of 2013 , which would exclude marijuana from section 280E, and the Marijuana Tax Equity Act of 2015, which would end federal marijuana prohibition but charge a 50 percent excise tax on all sales.         

Some though, have suggested creative ways to use the complicated tax code against the IRS in the meantime.

In an article in Slate magazine, for example, Ben Leff, a tax professor at American University's Washington College of Law, suggested marijuana providers incorporate as social welfare organizations and argued that they help improve communities and are entitled to subsequent tax deductions.

But whatever one does, it is important take heed—there's only a few certainties in life: death, taxes and, as Olive found out, the ability of marijuana to complicate what should have been fairly simple accounting.  

(Photo Courtesy of Medical Daily)

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