John R. Bullis: Medical marijuana business has limited deductions
Martin Olive quit college and opened a medical marijuana dispensary in San Francisco in 2004. He reported $65,000 of income in 2004 and $34,000 of income in 2005. All of his customers were recipients under the California Compassionate use Act of 1996.
IRS audited his returns and used the “ledgers” Olive produced at trial to compute his gross income in 2004 and 2005. His gross receipts for 2004 per the ledgers were $1,968,000 and 2005 gross receipts were $3,302,000.
The tax code has a section that limits deductions where the trade or business consists of trafficking in controlled substances that are prohibited by federal law (Sec. 280E).
Basically his direct cost of the marijuana was allowed as a deduction by the court, but his expenses for rent, utilities, wages, etc. were not allowed.
The court heard testimony from Olive and other witnesses, but while finding the ledgers were reliable evidence of gross receipts, it found the testimony was “… rehearsed, insincere, and unreliable …”
As a cash basis taxpayer, he was to report his cash receipts and to maintain sufficient and reliable records to allow IRS to verify his income and expenses. The court concluded 75.16 percent of his sales was a reasonable measure of the cost of the marijuana purchased. It also further adjusted the estimated cost of marijuana purchases by 6.5 percent since Olive gave away some of the marijuana. The case record does not show how the court was able to determine those percentages.
The court denied any operating expenses for rent, wages, etc in accordance with code section 280E. The court realized California authorized such an activity, but it is still against federal law. A previous decision on the same issues was done regarding a California business that sold marijuana and that case had the same results, no deduction for expenses of operation, just the direct cost of goods sold was allowed.
The court said deductions were strictly a matter of legislative grace and Congress set the rules in code section 280E. This matter may be discussed by the next Congress, if they can find time to do so. Right now it is a conflict between federal law and state law. It causes me to wonder what is next in tax law.
Did you hear? “Everyone who has ever taken a shower has had an idea. It is the person who gets out of the shower, dries off and does something about it who makes a difference.” — Nolan Busnell, entrepreneur.
John Bullis is a certified public accountant, personal financial specialist and certified senior adviser who has served Carson City for 45 years. He is founder emeritus of Bullis and Company CPAs.