Internal Revenue Service Victorious in Denying Deduction of Business Expenses for Cannabis Dispensary

Monday, December 3, 2018

On November 29, 2018, the U.S. Tax Court once again ruled that a corporation engaged in the cannabis industry was not entitled to deduct ordinary and necessary business expenses incurred in the operation of its day-to-day business operations. Patients Mutual Assistance Collective Corporation v. Commissioner, 151 T.C. No. 11 (November 29, 2018).  The case confirms the long-standing position of the Internal Revenue Service and the Tax Court denying the deduction of business expenses for federal tax purposes for those businesses engaged in the cannabis industry even if state law permits such business activity.

Summary

The taxpayer, one of the largest cannabis dispensaries in the United States, attempted to deduct expenses associated with the operation of its dispensary business in California on its corporate tax return.  Upon audit, the Internal Revenue Service disallowed most of these deductions under Section 280E of the Internal Revenue Code and also assessed millions of dollars in deficiencies and penalties.  Section 280E prohibits the deduction of trade or business expenses for federal tax purposes that are incurred in the trafficking of controlled substances.  As the Federal government classifies cannabis as a Schedule I controlled substance, Section 280E prohibits business deductions related therefrom for federal tax purposes even though California has a legal cannabis industry.

The taxpayer offered other services incident to the sale of cannabis products at its dispensary facility, including community outreach and therapeutic programs and the sale of non-cannabis related products such as clothing and other merchandise.  Nonetheless, the Tax Court held that the only trade or business the taxpayer was engaged in was the sale of cannabis.  The Tax Court reviewed the statutory language and relevant case law and concluded that, since the only trade or business in which the taxpayer was engaged was for the sale of cannabis, Section 280E prohibits the deduction of all ordinary and necessary business expenses related thereto, even those activities that were not related to the sale of its cannabis products.

Takeaway

While the taxpayer lost in this matter, the Tax Court makes it clear that deducting business expenses for businesses involved in the cannabis industry is still possible if it can be established that there is a trade or business that is separate from the trafficking of narcotics.  The structure of any ancillary businesses other than those directly involved with the sale of cannabis is key.  In this case, the other services provided by the dispensary were incident to the trafficking of controlled substances so there was only one trade of business but that may not be true for other businesses involved in the cannabis industry.

To learn more about this case or for insight on corporate and tax structure related issues for businesses involved in the cannabis industry, please feel free to contact the author or other member of Butzel Long’s Cannabis Specialty Team.

Robert M. Nemzin
248 258 2909
nemzin@butzel.com

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