Academic journal article Harvard Law Review

Internal Revenue Code - Medical Marijuana - Ninth Circuit Holds Medical Marijuana Dispensary Ineligible for Federal Tax Deductions

Academic journal article Harvard Law Review

Internal Revenue Code - Medical Marijuana - Ninth Circuit Holds Medical Marijuana Dispensary Ineligible for Federal Tax Deductions

Article excerpt

Internal Revenue Code--Medical Marijuana--Ninth Circuit Holds Medical Marijuana Dispensary Ineligible for Federal Tax Deductions.--Olive v. Commissioner, 792 F.3d 1146 (9th Cir. 2015).

As of mid-2015, twenty-three states and the District of Columbia had legalized medical marijuana under varying restrictions and regulations. (1) For example, in 1996, California passed the Compassionate Use Act, (2) which legalized the use of medical marijuana in the state. By August 2006, over 200 dispensaries were providing medical marijuana to about 200,000 patients in California. (3) Perhaps surprisingly, federal criminal law (4) has not proven to be the most substantial hurdle for these dispensaries; instead "[t]he federal tax situation is the biggest threat to [state-sanctioned marijuana] businesses and could push the entire industry underground." (5) Under [section] 162 of the Internal Revenue Code (I.R.C.), "ordinary and necessary" business expenses are tax deductible. (6) However, I.R.C. [section] 280E specifically states that "[n]o 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 ... consists of trafficking in controlled substances ... which is prohibited by Federal law." (7) Thus, medical marijuana dispensaries, at least to the extent that they traffic marijuana, are excluded from the tax benefits of [section] 162.

Commentators have suggested various methods for dispensaries to plan around this additional tax burden. (8) One suggestion that has been implemented is bundling together the provision of caregiving services with the sale of medical marijuana. (9) Since the expenses associated with these caregiving services are tax deductible under I.R.C. [section] 162, the dispensary might reduce its tax liability by allocating as much of its shared expenses as it can toward the caregiving services. Recently, the Ninth Circuit addressed the tax treatment of this particular method. In Olive v. Commissioner, (10) the court held that the owner of a medical marijuana dispensary was not entitled to any business tax deductions--even for expenses associated with caregiving services provided alongside the sale of marijuana--because his business consisted solely of trafficking marijuana and thus fell under the exception listed in I.R.C. [section] 280E. (11)

Despite this outcome, Olive suggests that the Ninth Circuit might endorse a previous U.S. Tax Court case, Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner (12) (CHAMP). If the Ninth Circuit were to adopt CHAMP's framework, medical marijuana dispensaries would be able to deduct the business expenses associated with their caregiving services from their tax liability, as long as those caregiving services embody a "trade or business" that is separate from the sale of medical marijuana. While some unsettled questions would remain on the margins, Olive, together with CHAMP, would provide much guidance on what it means for caregiving services to constitute a separate "trade or business" in the medical marijuana dispensary context. The substance of this guidance, in turn, would discourage marijuana dispensaries from attempting to use caregiving services to circumvent their tax liability.

In 2004, Martin Olive opened a medical marijuana dispensary, the Vapor Room Herbal Center ("Vapor Room"), in San Francisco, California. (13) In addition to selling medical marijuana, the dispensary provided vaporizers, games, books, and art supplies for customers to use and also held regular activities--such as yoga classes, massages, and movie showings --all free of charge. (14) The Internal Revenue Service (IRS) audited Olive's 2004 and 2005 tax returns and issued a notice of deficiency, stating that Olive was not allowed to deduct either the reported cost of goods sold (COGS) or the reported business expenses, both due to lack of substantiation. (15) The IRS later conceded that Olive's reported business expenses were substantiated but argued that [section] 280E precluded these expenses from being deductible. …

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