Enrolled Agents operating in eighteen states are facing complicated encounters with clients owning businesses in an industry that’s unusual – but rapidly expanding. EA solutions are limited for medical marijuana enterprises in these states. Despite their legal nature under state law, they are not considered legitimate businesses under federal law. This means potential trouble with the IRS.
Typical income tax reporting guidelines described in Enrolled Agent courses don’t apply to medical marijuana dispensaries. The IRS treats these ventures just like drug traffickers. The same consequences await entrepreneurs in Colorado and Washington dispensing marijuana for recreational use, which was recently legalized in those states.
As a result of the odd circumstances, Enrolled Agents must dig deeply into the recesses of their knowledge learned in EA exam review courses about the tax treatment of illegal drug distribution activities. The rules are certainly different than the basic tax calculations on gross income less business expenses. Federal tax deductions are denied for any business involved in trafficking controlled substances. This includes any dispensary of marijuana despite state entitlement to legally conduct that activity. Marijuana remains on the federal controlled substance list.
The IRS has stated that it has no choice but to enforce Section 280E, which was inserted into the Tax Code in the 1980s. For those tax professionals who have forgotten this section of their Enrolled Agent exam preparation, it states that “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 that trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any state in which such trade or business is conducted.” That long running sentence is enough to drive some of the 2,300 state-allowed marijuana dispensaries to consume part of their own inventory over the hostile tax situation confronting them.
However, an important lesson derived from CPE for Enrolled Agents is the Tax Court decision that allowed a medical marijuana dispensary to end-run the IRS. The dispensary engaged in a separate business as a caregiver. Expenses related to that part of the business are allowable tax deductions. Obviously, detailed financial records are required in accounting for the caregiver portion of operations. Some percentage of overhead in such arrangements is clearly allocable to nondeductible marijuana dispensing activity.
Fortunately, a deduction is permitted for product inventory cost of a marijuana dispensary. Therefore, cost of goods sold is a deductible item. But, deduction of general operating expenses is still disallowed. Again, purchase records of inventory sold are crucial to defending against IRS audits. As many California Enrolled Agents have already discovered, battles with the IRS over this issue are unavoidable.
IRS Circular 230 Disclosure
Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.