Half of all states and the District of Columbia have legalized the use or sale of marijuana, either for medicinal purposes or in some cases recreational and medicinal purposes. Despite these changes to state laws, marijuana is still classified as a Schedule I drug under federal law. This tension between state and federal laws has created serious and perhaps unintended tax consequences for marijuana dispensaries.
Under Section 280E of the Federal Tax Code, businesses selling "controlled substances (within the meaning of schedule I and II of the Controlled Substances Act)" are barred from taking tax deductions or credits "for any amount paid or incurred during the taxable year."
Therefore, marijuana dispensaries can only deduct the cost of goods sold (COGS), but not "ordinary and necessary" business expenses. As a result, some dispensaries face a federal tax rate of anywhere from 60 to 90 percent. This type of tax burden is likely a significant barrier of entry for many companies.
A legal challenge could be a game-changer for marijuana dispensaries
Section 280E was enacted in 1982 with the purpose of preventing drug kingpins from gaining any tax benefit through the sale of illegal substances. Now, with the mainstreaming of marijuana in many states, it could be argued that Section 280E was not intended to apply to companies that are doing business that is legal under various state laws. In fact, Harborside Healthcare Center, a California company with more than $30 million in gross revenues, has challenged the legality of Section 280E in federal Tax Court.
For years, Harborside had been taking business deductions that a "normal" business would take. The IRS disagreed with this approach, stating that Harborside owed $2.4 million in delinquent taxes. Harborside takes the position that it should have the same deduction privileges as any legitimate business. Harborside's attorney, Henry Wykowski, has argued before the Tax Court on behalf of marijuana dispensaries previously.
The Tax Court is not expected to rule on the Harborside case until sometime in 2017. If the Court holds that Section 280E no longer applies to marijuana dispensaries, it would dramatically impact businesses across the United States. Not only would businesses within the industry face lighter tax burdens, but a lower tax rate could encourage other companies to enter this market.
Any federal tax issue, whether an audit, tax assessment or other matter, demands exceptional legal counsel. The lawyers of Goldburd McCone LLP vigorously protect the rights of taxpayers across New York, the United States and internationally.
Sources: Marijuana Dispensary Takes on IRS in Tax Court, Accounting Today, by Craig W. Smalley, September 13, 2016, Stakes Are High As Medical Marijuana Test Case Heads To Tax Court, Forbes.com, Kelly Phillips Erb, June 5, 2016