Taxable Talk

Martin Olive operates “The Vapor Room,” a medical marijuana dispensary in San Francisco. His business, a sole proprietorship, was audited by the IRS for 2004 and 2005. He lost. He took that case to Tax Court. Back in August 2012 he lost (Olive v. Commissioner, 139 T.C. No. 2). He appealed that decision to the Ninth Circuit Court of Appeals. On Thursday the Ninth Circuit agreed with the Tax Court.

The issue in this case was 26 U.S.C. § 280E. That section of law prohibits a taxpayer from deducting any expenses (but not Cost of Goods Sold) related to a trade or business of trafficking in a controlled substance prohibited by Federal law. Marijuana–which may be legal under state law–is decidedly a controlled substance under Federal law.

The first argument of Mr. Olive was that he had multiple lines of businesses. The Court disagreed.

An analogy may help to illustrate the difference between the Vapor Room and the business at issue in CHAMP. Bookstore A sells books. It also provides some complimentary amenities: Patrons can sit in comfortable seating areas while considering whether to buy a book; they can drink coffee or tea and eat cookies, all of which the bookstore offers at no charge; they can obtain advice from the staff about new authors, book clubs, community events, and the like; they can bring their children to a weekend story time or an after-school reading circle. The “trade or business” of Bookstore A “consists of” selling books. Its many amenities do not alter that conclusion; presumably, the owner hopes to attract buyers of books by creating an alluring atmosphere. By contrast, Bookstore B sells books but also sells coffee and pastries, which customers can consume in a cafe-like seating area. Bookstore B has two “trade[s] or business[es],” one of which “consists of” selling books and the other of which “consists of” selling food and beverages.

Mr. Olive also argued that congressional intent and public policy should have § 280E not apply to medical marijuana.

Application of the statute does not depend on the illegality of marijuana sales under state law; the only question Congress allows us to ask is whether marijuana is a controlled substance “prohibited by Federal law.” I.R.C. § 280E. If Congress now thinks that the policy embodied in § 280E is unwise as applied to medical marijuana sold in conformance with state law, it can change the statute. We may not.

What this means for marijuana distributors and sellers is that they can deduct their Cost of Goods Sold but that they cannot deduct business expenses on their federal tax returns. It is likely, though, that on many state tax returns those business expenses will be deductible; after all, the business is selling a legal product on the state level. (This will likely depend on both the legality of marijuana under state law and the degree of conformity between the state and federal tax law in that state.)

Case: Olive v. Commissioner, No. 13-70510 (July 9, 2015)