Medical marijuana is now legal in 29 states plus the District Of Columbia and recreational marijuana is legal in 8 states plus the District Of Columbia. In 2000, 70% of Americans believed marijuana should be illegal. Attitudes have since dramatically changed with a complete flip as a 2017 Yahoo News/Marist Poll survey showed that 83% support legalization. Despite this huge turn in public opinion and about 60% of the U.S. population are living in states that have legalized marijuana, marijuana is still designated as a Schedule I controlled substance and therefore is still illegal under Federal law.
Illegal Income Is Still Taxable Income
I.R.C. §61(a) essentially states: “Gross income means all income from whatever source derived”. There is no distinction between legal and illegal income – meaning that if it is income, it is taxable. This concept was affirmed in a U.S. Supreme Court case, James vs. United States, 366 U.S. 213 (1961), where the Court stated that “gains are no less taxable because they have been acquired by illegal methods”.
Deductions Against Illegal Income Are Limited.
I.R.C. §280E 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 Schedules I and II of the Controlled Substances Act, 21 U.S.C §812) which is prohibited by federal law or the law of any state in which such trade or business is conducted.”
In reading I.R.C. §280E one would think that no deductions are allowed in a marijuana-related business but if that were the case, the U.S. Tax Court has stated that this statute would have been stricken as unconstitutional as the Sixteenth Amendment to the U.S. Constitution prohibits the Federal government from taxing “gross receipts”. Reading vs. Commissioner Of Internal Revenue, 70 T.C. 730 (1978). So the way I.R.C. §280E operates is to allow marijuana-related businesses to deduct Costs Of Good Sold but not “ordinary and necessary” business expenses. This tax treatment prevails regardless that you are conducting a marijuana business that is duly licensed in a State that has legalized marijuana because such business is still illegal under federal law.
It should be apparent that the cost of acquiring the marijuana itself is part of Costs Of Good Sold but what if you produce the marijuana? We advocate that producers can also capitalize the direct material costs (marijuana seeds or plants), direct labor costs (planting, cultivating, harvesting and sorting), and certain indirect costs that include repairs, maintenance, utilities, rent, taxes, depreciation, employee benefits and officer’s salaries). Resellers too should consider a more expansive view of Cost Of Goods Sold that includes capitalizing the costs of transportation and other necessary charges incurred in acquiring possession of the marijuana and maintaining the inventory for resale.
To illustrate the potential tax savings, check out this example of a marijuana-related business with monthly gross receipts of $100,000 ($1,200,000 annually):
|
With No Tax Planning |
With Tax Planning |
|
| Gross receipts |
$1,200,000 |
$1,200,000 |
| Cost Of Goods Sold |
-0- |
$780,000 |
| Gross Profit |
$1,200,000 |
$420,000 |
| Taxes at 35% on Gross Profit |
$420,000 |
$147,000 |
| Ordinary And Necessary Business Expenses |
$900,000 |
$120,000 |
| Your Net Profit <Loss> |
<$120,000> |
$153,000 |
You can see how important it is that the business be able to capitalize as much of these expenses into inventory to show a higher Cost Of Goods Sold and hence lower taxes which equates to higher profits.
What Should You Do?
So until the tax code is changed so that marijuana is not subject to the restrictions of I.R.C. §280E, it is important that anyone in the marijuana business seek tax counsel knowledgeable with the strategies associated with I.R.C. §280E and what accounting systems must be in place to legally show the lowest amount of net taxable income as possible. Let the tax attorneys at the Law Offices Of Jeffrey B. Kahn P.C. located in Orange County, San Diego County and other locations in California help you meet your challenges minimizing your taxes and conduct business in a manner that avoids prosecution by the Federal authorities and meets California laws and regulations.
