Cannabis businesses that buy and sell marijuana are all too familiar with the tax consequences of IRC 280E. In brief, the section prohibits deductions incurred in a tax year in carrying on a trade or business if such trade or business consists of trafficking in controlled substances prohibited by Federal law. Accordingly, marijuana dispensaries are essentially prohibited from deducting ordinary and necessary business expenses, including expenses for staffing, payroll, and leases.
One small ray of hope for marijuana dispensaries comes from the holding in CHAMP v. Commissioner that permitted the marijuana dispensary to deduct expenses that could be allocated to its separate caregiving business. Of course, the taxpayer had to first establish that it was engaged in two businesses; one that trafficked in marijuana whose deductions were prohibited by 280E, and the other consisting of extensive caregiving services whose expenses were deductible. While the taxpayer in CHAMP was successful in evidencing a separate business with deductible expenses, many marijuana dispensaries have been unable to persuade tax courts of the same. The reason why lies in the unique facts of CHAMP.
The Taxpayer in CHAMP vs. Most Marijuana Dispensaries
In CHAMP, the taxpayer operated very differently than the typical marijuana dispensary. For instance, whereas most marijuana dispensaries operate for profit, the dispensary in CHAMP operated on a break-even basis as a nonprofit. In addition, most marijuana dispensaries have their employees spend the majority of their time on the business of buying and selling marijuana, with perhaps a minor percentage of their time involved in selling non-marijuana items. In contrast, the taxpayer in CHAMP had 17 of the 24 employees in addition to the director dedicated to the provision of caregiving services, and only 7 employees tasked with the provision of medical marijuana. Furthermore, whereas some marijuana dispensaries provide complimentary food, drinks, and services, the taxpayer in CHAMP provided extensive caregiving services covered by a flat monthly rate that included all services and a set amount of marijuana. Those services included:
- Hygiene supplies
- Daily lunches for low-income members
- Weekly and biweekly support groups, including an AIDS support group of which 47 percent of its members suffered from AIDS.
- Bikweekly masseuse services
- One-on-one counseling about benefits, health, housing, safety, and legal issues
- Yoga
- Weekend social events
- Monthly field trips to beaches, museums, or parks.
- Online computer access
While it’s tempting to think that marijuana dispensaries can replicate some of these services at minimal cost in an attempt to deduct some expenses, the taxpayer in CHAMP provided extensive services in a manner that persuaded the court that it’s genuine purpose was to provide caregiving services and its secondary function was the distribution of marijuana.
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- The Difference Between CHAMP Members and Marijuana Dispensary Clients - May 17, 2021
- Why Was The Taxpayer in CHAMP Succesful? - April 6, 2021
Jin Kim is a tax attorney in California representing cannabis businesses with federal and state tax debt. Her cannabis practice focuses on helping businesses in the marijuana industry navigate federal and state tax challenges with the IRS, CDTFA, and state tax agencies.
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