Archive for Marijuana

Trafficking under IRC § 280E

February 9, 2013 Appeals & Audit Resolution, Asset Classification, Business Expense, Cash Transaction, COGS, IRS Mediation, Marijuana, Net Operating Loss, NOL, Tax Abuse, Tax Court, Tax Guidance & Preparation, Tax Problems & Requests

The Internal Revenue Code is a complex beast.  In the lunacy of it all I’ve been asked to define ‘trafficking’ as it relates to 26 USC § 280E – Expenditures in connection with the illegal sale of drugs which states as follows:

“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.”

As I understand the Controlled Substance Act the word trafficking is more often than not used in conjunction with the word ‘illicit’ as in nefarious or illegal.  This begs the very question as to whether the cultivating, possessing and distributing of marijuana in a state (Colorado) where the substance is fully legal under state law rises to the threshold of trafficking as it is used in the Controlled Substances Act.

Naturally the laws of interstate commerce should in my opinion generally prevail.  If however marijuana does not cross state borders then in my humble layman’s opinion the federal government in theory under our constitution has no basis for intervention.  Of course you will always find the pundits from the other side pontificating the evils of the drug as they swirl down their martinis and pop their pills but let’s not get into name calling.

When it comes to the IRS, the Service is obligated to enforce the letter of the federal law.  Marijuana is federally illegal and if taxpayers are in the business of cultivating it and distributing it for profit or otherwise then the argument goes they are by the letter of the federal law guilty of ‘trafficking’ in a controlled substance regardless of state law.

Presently and with all due respect the IRS seems to be lacking a standard of enforcement over dispensaries, cultivators and bakeries in these regards.  The recent court case of Olive v. Commissioner seems to make the efficacy of a dispensary’s income tax return achieve an allowable threshold when Cost of Goods sold are allowed as offsets to gross receipts but general business expenses are disallowed. This attempt at a standard is overtly far reaching in that the intent of IRC 280E as it pertains to the Controlled Substances Act was to curtail illicit activity.  If the activity is not illicit by state law then moving it around inside that state’s border should by default be transportation not trafficking.

It is my personal opinion that moving a fully legal product inside a state border is NOT ILLICIT NOR IS IT TRAFFICKING. If the substance is fully legal by state law than possessing it, cultivating it and even distributing it in no way reaches the threshold of ‘illicit activity’.

Until further tax court cases help iron out a standard I believe a reasonable solution is to narrowly define ‘trafficking’ under IRC 280E as a transaction where marijuana dispensary employee ‘X’ hands a product containing marijuana to a customer and the customer in turn hands employee ‘X’ money for the marijuana product.  In this limited time and space a transaction happens that could be argued to be perceived as trafficking and as such the expenses associated with that limited transaction should perhaps not be deductible under 280E of the Internal Revenue Code.

When trafficking is narrowly defined all other costs should by default in theory become legitimate business expenses be they general and administrative or cost of goods sold. This is just one simple man’s opinion and the Service presently has a vastly different opinion.  There is a middle ground somewhere and it appears the courts will have to find it for us. Because like it or not this is a growth industry. Tread lightly.  Stay tuned…

 

Pursuant to the requirements related to practice before the Internal Revenue Service, any tax advice contained in this communication (including any attachments) is not intended to be used, and cannot be used, for purposes of:  Avoiding penalties imposed under the United States Internal Revenue Code, or Promoting or recommending to another person any tax-related matter

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IRS and Medical Marijuana Dispensaries – Olive v. Commissioner

August 17, 2012 Marijuana

Dispensary owners now finally have some precedent to follow in arriving at federal taxable income. In Olive v. Comm’r, 139 T.C. No. 2 (8/2/12), Mr. Martin Olive the owner of an operation called the Vapor Room was required to prove among other things that he was entitled to deduct the Vapor Room’s claimed amounts of cost of goods sold (COGS). The Tax Court essentially made the following decisions:

1. The Vapor Room’s cost of goods sold (COGS) was not over stated and in fact the Court decided based on oral testimony that 75.16 % of revenue was a reasonable measure of the Vapor Room’s Cost Of Goods Sold and generally allowed that percentage of sales as COGS offset for both years at issue.

2. Mr. Oliver could not deduct any of the Vapor Room’s ‘expenses’ citing both Internal Revenue Code Section 280(e) and its previous decision in Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner, 128 T.C. 173 (2007) (CHAMPS), holding that medical marijuana was a controlled substance and thus related business ‘expenses’ were not deductible.

3. The accuracy-related penalties imposed by the IRS were essentially upheld but because Code Sec. 280(e) relevant to medical marijuana dispensaries had not yet been decided when Mr. Olive filed his federal income tax returns for 2004 and 2005, the accuracy-related penalty did not apply to the portion of each underpayment that would not have resulted had Martin been allowed to deduct his substantiated expenses.

Basically COGS in accounting standards is considered a ‘revenue offset’ reported as a subtraction from revenue on the ‘income’ portion of an income statement which is separate and distinct from actual ‘expenses.’ Evidently it appears this is where the tax court is choosing to draw the line in applying IRC 280(e). So be sure to understand the distinction between cost of goods sold and expenses when arriving at your taxable income.  COGS will bring down your taxable income and ‘expenses’ will not.

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IRS Implications for Medical Marijuana Dispensaries Update

January 5, 2012 Marijuana

I was at the IRS Practitioner Liaison Meeting yesterday morning in downtown Denver where local IRS officials in positions of authority presented operational updates. In regards to medical marijuana dispensaries Matthew Houtsma, acting Associate Area Council spoke. I found his words intriguingly worth a blog post. This is my interpretation. The notes of the meeting are expected to be published next week and I’ll be sure to post them on this blog as well. The bottom line is that no one at a federal level wants to take a leadership position on the issue of tax deductible expenses for medical marijuana dispensaries in an election year – duh. Besides federal ‘leadership’ in any regards is proving to be an oxymoron. Nevertheless Mr. Houtsma’s candidness proved refreshing and I truly appreciated his knowledge on the topic as well as the time he spent with me conveying it. This is what I learned…

IRS tax cases in Colorado are being referred to associate area council as soon as the IRS examination or audit function learns that the operation under the microscope involves dispensing marijuana. Area council has determined that ‘cost of goods sold’ for medical marijuana dispensaries is a revenue offset and NOT and EXPENSE according to generally accepted accounting practice and is subsequently indeed at least for the time being ALLOWED. In plain terms that means growing and cultivating medical marijuana albeit federally illegal is essentially as far as I can tell NOT an EXPENSE associated with dispensing medical marijuana. It is a revenue offset or ‘cost of goods sold.’ Stripping proprietors of this requires constitutional considerations and again no one at the federal level will presently address the distinction.

The act of taking money and handing a patient marijuana albeit as a ‘medication’ however is evidently indeed representative of ‘narcotic traffic’ making the expenses associated with facilitating that transaction NONDEDUCTIBLE accordiung to the US Justice department. In plain terms that means that for the time being the expenses associated with the employee conducting the transaction of collecting money in exchange for physically handing the patient medical marijuana along with the expenses associated with storage of medical marijuana etc are recognized under IRC 280(e) as narcotic traffic and subsequently NOT deductible.

Basically hairs are being split here because I think the bottom line is that Colorado wants to fly under the radar as much as possible until pusillanimous reprobates at the federal level grow the political kahunas to take a leadership position on the issue. Which really at the end of the day is not that dysfunctional.

In order to remain under the radar as it were the solution for the moment seems to lie in providing multiple services in the same physical location as the area in which the medication or ‘narcotic’ is dispensed. Some folks are providing a wide range of services from holistic medicine to massage therapy. Nevertheless three things became very clear to me today:

1. Simply hanging a shingle in a strip mall to solely sell weed will attract attention, the wrong kind of attention, don’t do it. Be sure to provide periphery services in conjunction with dispensing.

2. The survival strategy is to remain under the radar of a sleepy US attorney general for the time being. In other words if you have the intestinal fortitude to jump into this business don’t try to pull in 7 figures right off the bat. For the time being it seems bigger is not better.

3. IRS Criminal Investigation is in my opinion (even though they don’t use these exact words) profiling and targeting taxpayers that operate medical marijuana dispensaries with cross border operations. So don’t be a wise guy and try to grow in say California and dispense in Colorado. Chances are they already know ALL ABOUT YOU. If you are dispensing in Colorado be sure to cultivate your medicine inside Colorado borders or buy from a wholesaler that cultivates inside Colorado borders.

The next step in my opinion lies in defining exactly what costs fit under the accounting lexicon of ‘costs of goods sold’ and what costs are actual nondeductible expenses associated with ‘narcotics traffic.’ On a personal note it just seems ridiculous to me for a dispensary to incur employee costs, including employment tax liability, but cannot deduct the expense in calculating federal adjusted gross income.

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IRS Treatment of Marijuana Dispensary Expenses

October 11, 2011 Business Expense, Business Income, Cost Segregation, Deductible Expense, Marijuana

If you are in the business of dispensing marijuana according to the United States Office of Homeland Security you are selling an illegal drug not a medicine like many individual states believe. Nevertheless Internal Revenue Code IRC 280(E) states that the expenses associated with selling illegal drugs are not deductible from revenue when calculating federal income for federal income tax purposes. This means that the usual and customary business expenses associated with your business model cannot be deducted on your federal income tax return, be it a 1040 Schedule C, 1120, 1120S, or 1065 form, etc.

IRC 280(E) clear stipulates, “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.”

As I write this one large California dispensary has been issued a Statutory Notices of Deficiency from the IRS in excess of one million dollars.  Others are sure to follow and perhaps bankruptcy to ensue. Here in Colorado or any state in which marijuana is considered a medicine if you are capable of staying compliant with the state statutes regarding the matter and wish to stay compliant with the IRS it is my personal opinion that you should report all revenue derived from selling marijuana to the IRS as income and pay federal income tax on all revenue.  Also be sure to pay federal employment tax for your employees (IRS Forms 941, 940, 945) but do NOT deduct the employment tax liability as an expense at the federal level.  It too is not a deductible expense.  Report NO EXPENSES WHATSOEVER $0.00.

It is widely believed, perhaps wrongly so, that legitimate dispensaries should be safe passing costs on to customers provided local authorities are successful in weeding out (as it were) non-compliant dispensaries and creating a level playing field in the local communities. In the states where marijuana dispensing is a legal activity at the state level I am currently of the opinion, perhaps wrongly so, that business expenses associated with selling marijuana would be deductible on the state income tax return for the states in which the business operates.  This is relatively new territory though so anyone with more insight is welcome to accordingly respond. If I were to sign a tax return of this nature I would start by asking the state department of revenue in which the business operates to provide direction on the matter from their perspective.

What I do know as a matter of fact is that engaging a strategy of cost segregation specifically separating out the peripheral or indirect costs of selling marijuana from the direct costs of selling marijuana and claiming those indirect costs to be deductible at the federal level is a violation of IRC 280(E). Don’t do it.

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