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The Internal Revenue Code provides that, for the purpose of computing taxable income, an individual's or a business's gross income includes all income from whatever source derived, including income derived from business. 26 U.S.C.S. § 61(a)(2). It further allows a business to deduct from its gross income all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on the trade or business. 26 U.S.C.S. § 162(a). But there are exceptions to § 162(a). 26 U.S.C.S. §§ 261-280H list items not deductible. One such exception applies when the amount paid or incurred during the taxable year is for the purpose of carrying on any trade or business consisting of trafficking in controlled substances. 26 U.S.C.S. § 280E. While the use and sale of medical marijuana are legal under California state law, see Cal. Health & Safety Code § 11362.5, the use and sale of marijuana remain prohibited under federal law.
Petitioner was operating the Vapor Room Herbal Center (Vapor Room), a medical marijuana dispensary in San Francisco. Petitioner filed business income tax returns for tax years 2004 and 2005, which reported the Vapor Room’s net income during those years as $64,670 and $33,778, respectively. Although Petitioner reported $236,502 and $417,569 in Vapor Room business expenses for 2004 and 2005, the Tax Court concluded that § 280E of the Internal Revenue Code precluded Petitioner from deducting any of those expenses because Vapor Room was a “trade or business consisting of trafficking in controlled substances.” The Tax Court, therefore, assessed deficiencies and penalties against petitioner for tax years 2004 and 2005. Petitioner appealed, arguing that because the Vapor Room was providing caregiving services and selling medical marijuana, its business did not “consist of” either one alone, and therefore did not fall within the ambit of § 280E.
For the purposes of taxation, could the petitioner deduct the expenses associated with the Vapor Room, a medical marijuana dispensary in California?
The Court noted that under the Internal Revenue Code, a business was allowed to deduct from its gross income “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on the trade or business.” It was found that petitioner’s “trade or business” was limited to medical marijuana sales. The Court noted that although the use and sale of medical marijuana were legal under California state law, the use and sale of marijuana remained prohibited under federal law. Therefore, under § 280E of the Internal Revenue Code, the expenses that petitioner incurred in the course of operating the Vapor Room cannot be deducted for federal tax purposes.