Medical Marijuana Business Expenses

Medical Marijuana Business Expenses

by Joel S. Newman *

... Legal and Illegal [business enterprises] are treated the same way [for tax purposes] because of Comm'r v. Sullivan, 356 U.S. 27 (U.S. 1958). In Sullivan, the Commissioner denied salary and rent deductions to an illegal gambling enterprise. Justice Douglas wrote:

If we enforce as federal policy the rule espoused by the Commissioner in this case, we would come close to making this type of business taxable on the basis of its gross receipts, while all other businesses would be taxable on the basis of net income. If that choice is to be made, Congress should do it. [Sullivan, at 29.] Thus, generally, the cost of goods sold, and other operating expenses (a.k.a. ordinary and necessary business expenses), are deductible, regardless of the underlying legality or illegality of the business. Legal and Illegal might be treated differently with respect to criminal law, but, for tax law, they are treated the same. [On the same day that Sullivan was decided, the Supreme Court handed down Tank Truck Rentals v. Comm'r, 356 U.S. 30 (U.S. 1958). That decision created the "public policy exception": that deductions would be disallowed "...if allowance of the deduction would frustrate sharply defined national or state policies proscribing particular types of conduct, evidenced by some governmental declaration thereof." The public policy exception has been codified in part in Sections 162(c) and (f), and the Foreign Corrupt Practices Act, 15 USCS § 78dd-1. However, there is also a case law component. For example, in part due to the public policy doctrine, the expenses incurred when assets of a criminal enterprise are forfeited or condemned are not deductible... However, legal fees in defending against criminal prosecution are usually deductible...]

Why, then, is MMJ treated differently? Recall that, in Sullivan, Justice Douglas conceded that Congress had the power to deny deductions to certain kinds of businesses, if it so chose. [Sullivan, at 27. See also Comm'r v. Tellier, 383 U.S. 687 (U.S. 1966) "Deduction of expenses falling within the general definition of s 162(a) may, to be sure, be disallowed by specific legislation, since deductions 'are a matter of grade and Congress can, of course, disallow them as it chooses.'" Tellier at 693, quoting US v. Sullivan.] Congress made that choice in 1982. Congress was apparently reacting to the Tax Court decision in Edmondson v. Commissioner, T.C. Memo 1981-623 (T.C. 1981). See generally, Joel S. Newman, "CHAMP: How the Tax Court Finessed a Bad Statute," taxanalysts® Tax Notes Today, September 3, 2007.

In Edmondson, a drug dealer was busted, and then audited. The IRS wanted to tax him on the unreported income from his drug-related activities. He countered that, if he was to be taxed on the income, then he should be allowed to deduct his expenses, including travel expenses, and the purchase of an accurate scale. The Tax Court allowed the deductions.

Congress was horrified. It enacted
IRC Section 280E, which provides:

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.


... [E]ven though Legal and Illegal may deduct Cost of Goods Sold and other operating expenses, MMJ can subtract its costs of goods sold, but not other operating expenses, because Congress said so in IRC Section 280E.

... Now at least eighteen states, plus the District of Columbia, have legalized medical marijuana. In addition, in the past year, two states have legalized the possession and sale of small amounts of recreational marijuana, even if no medical need can be shown. How have these state developments impacted IRC Section 280E?

First, can the federal government continue to criminalize marijuana, even in states which have declared it to be legal for certain purposes? The Supreme Court says that it can. In Gonzales v. Raich, 545 U.S. 1 (U.S. 2005), the Court held that, under the Commerce Clause, the federal government can do just that. [Id. See Mikos, "State Taxation of Marijuana Distribution and Other Federal Crimes," 2010 Chi Legal F 223; Mikos, "On the Limits of Supremacy: Medical Marijuana and the States' Overlooked Power to Legalize Federal Crime," 62 Vand L Rev 1421 (2009).


* Joel S. Newman is a Professor of Law at Wake Forest School of Law in North Carolina. Before teaching at Wake Forest, he taught as a visiting professor at the University of Hawaii, University of Florida, Notre Dame and Xiamen University, in the People's Republic of China. Professor Newman has also served as a consultant for CEELI, the ABA's rule of law initiative, for projects in Lithuania, Macedonia, Slovakia, Uzbekistan, Ukraine, and St. Petersburg, Russia. He has also been an Associate with Shearman & Sterling in New York, and with Frederickson, Byron, Colborn, Bisbee & Hansen, in Minneapolis.

Information referenced herein is provided for educational purposes only. For legal advice applicable to the facts of your particular situation, you should obtain the services of a qualified attorney licensed to practice law in your state.


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