Question

Many states have legalized the sale of marijuana for personal and/or medical purposes. However, it is still a federal crime to sell marijuana in any of the 50 states, regardless of the state laws. Income from any and all sources, including illegal activities, is taxable at the federal level, including income from the sale of marijuana. What has the tax court ruled about tax deductions for business expenses for those engaged in the sale of marijuana? Cite and summarize at least one US Tax Court case to support your answer

Answer 1

For businesses engaged in sale of marijuana, they prefer to avoid classifying expenses as cost of goods sold because they can’t deduct these expenses until the inventory items are sold. The businesses must be structured in such a way that maximizes the cost of goods sold & minimizes non deductible expenses. Hence the dispensary businesses must be structured in such a way that all qualifying expenses are allocated under COGS.

In addition to this, IRS under section 162 provides deduction for all ordinary & necessary business expenses which includes rent, utilities, advertising etc.

There are also limitations to deductions under section 162. For example deductions that are against the public policy namely bribes, kickbacks, fines or penalties paid to the government are not allowed. Hence expenses such as speeding tickets, parking fines, bribes are not allowed deductions for all taxpayers. Similarly IRC denies all ordinary & necessary business expenses paid or incurred in connection with sale or trafficking of controlled substances.

Example of a case:

In tank truck rentals vs. commissioner, the Supreme Court it is sufficient to deny a deduction where expense impacts the government policy. The courts must weigh the severity of frustration that the deduction would cause if allowed. The court further stated that if the expense is illegal, the frustration of state policy is most direct. Despite this, in the other case of tank truck rentals, commissioner vs. Sullivan, the Supreme Court allowed rent as deduction even though the payment of rent was illegal for use of bookmarking establishment