California Cannabis Businesses May Face Difficult Income Tax Issues

Attorneys Helping California Businesses with Cannabis Tax Issues

Business startups often face a host of challenges. Inadequate capitalization, lack of credit, attracting qualified employees, and difficulties in the supply chain are some of the common hurdles that must be scaled to achieve success. For the business owner who hopes to build a successful business as a California recreational marijuana retailer, there are additional issues that must be considered. One such issue relates to federal income taxes. How will “pot shops” be treated by the IRS?

Friction Between the Feds and the Golden State Law

Most California business owners are aware of the fact that although the state’s Adult Use of Marijuana Act allows the purchase and sale of recreational cannabis products (subject to licensing and a host of state and local restrictions) beginning in January 2018, marijuana is still a scheduled substance under the federal Controlled Substances Act (“CSA”). Under federal law, therefore, marijuana use is illegal, even for medical purposes. Therein lies the rub.

Ordinary and Necessary Business Expenses

Generally speaking, Internal Revenue Code (“IRC”) § 162 allows a business to deduct its “ordinary and necessary expenses” paid or incurred during the taxable year. Accordingly, salaries, travel expenses, rent, and other payments may be offset against business income when computing the tax liability of the enterprise. The ability to deduct business expenses under § 162 is limited, however, to those types of expenses that are not expressly excluded.

IRC § 280E is a Stinger!

Unfortunately, expenses incurred in a retail marijuana operation may be excluded under IRC § 280E, which states:

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. [Emphasis added.]

Ninth Circuit and Tax Court Decisions May Disallow Business Expense Deductions

IRC § 280E has been construed in at least two important decisions that affect California businesses. In Olive v. Commissioner of Int. Rev., 792 F.3d 1146 (9th Cir. 2015), the Ninth Circuit Court of Appeals affirmed the Tax Court’s decision that § 280E precluded the taxpayer, a medical marijuana dispensary, from deducting any ordinary or necessary business expenses associated with trafficking in a controlled substance that was prohibited by federal law. The court disagreed with the taxpayer’s argument that in enacting § 280E in the early 1980s, Congress did not intend for it to apply to marijuana dispensaries currently allowed by law in many states. Ultimately, only one type of business expense deduction was allowed under IRC § 280E: cost of goods sold.

In Canna Care Inc. v. Commissioner, 2015 Tax Ct. Memo 215, the Tax Court again found that under IRC § 280E, no deduction could be allowed for operating expenses due to the fact that marijuana is a controlled substance and, at the federal level, is considered trafficking in the sale of narcotics. In Canna Care, the taxpayer offered various health services in addition to dispensing marijuana. It could deduct expenses related to those legitimate health services.

Federal Tax Issues Affect Different Business Models in Different Ways

Recognize that there are always a number of variables at play in determining the tax liability of any ongoing enterprise. Because of the complexity of the issue involved, it usually pays to seek sound, solid, experienced counsel by legal experts. Prudent business owners turn to experienced attorneys like CKB VIENNA LLP for assistance. For years now, we have represented all sorts of businesses in many types of legal and regulatory environments. We have researched the technical requirements of Prop 64 and the myriad of other regulations that will have an impact on the sale of recreational marijuana in California. Our team understands the complexity of the issues and stands ready to represent you aggressively. We have offices in Rancho Cucamonga, San Bernardino, and Los Angeles. Contact us by telephone—909.980.1040—or complete our online form.