ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – TAX COURT DEALS A DEVASTATING BLOW TO THE MEDICAL MARIJUANA INDUSTRY
By Robert S. Schriebman 2021
On February 17, 2021, the US Tax Court dealt a fatal blow to the medical marijuana industry in California. Under California law the industry is legal. This means that the FTB, CDTFA and the EDD recognize the legality of the business operation. Ordinary, necessary, and reasonable business-related expenses are totally deductible in California. The industry pays sales tax on retail transactions and the EDD also collects employment and withholding taxes. Having said this, on the other side of the coin, the IRS does not recognize the legality of the business operation. If it conducts an audit, the IRS will disallow business and nonbusiness related expenses. You are welcome to challenge an IRS audit by going to the US Tax Court, but don’t think the judge is your friend.
The US Tax Court’s decision in San Jose Wellness v. Commissioner has effectively dealt a fatal blow to the deductibility of all expenses incurred in the business including charitable contributions and depreciation deductions. In prior articles on this website, I have shared with you past Tax Court cases that have disallowed commonly recognized deductions for inventory, rent, utilities and even wages. The San Jose Wellness case has gone even farther in not recognizing the medical marijuana industry as a legal enterprise. (CCH Dec. 61, 820, 156 T.C. No. 4, Feb. 17, 2021)
This article will discuss the San Jose Wellness (SJW) case in light of IRC §§ 167, 170 and 280E.
IRC §§ 167 and 280E
IRC § 280E is a short but deadly piece of law. It states in substance that no deductions or credits, in any amount, will be allowed for any business trafficking in controlled substances. This includes marijuana and its derivatives. Section 167 is all about depreciation deductions. Legitimate businesses are allowed depreciation deductions for both real and personal property used in the trade or business. In SJW the taxpayer argued that 280E should only be applied direct business- related expenses and not indirect expenses such as depreciation. The Tax Court held that the day-to-day costs incurred by SJW that were subject to depreciation under IRC § 167, are governed by the rules set forth in § 280E – end of discussion!
IRC §§ 170 and 280E
IRC § 170 is a complex code section that allows for charitable contribution deductions. Businesses, as well as individuals, are allowed to make donations to charity and receive a deduction. SJW sought to deduct contributions that it made and argued to the Tax Court that charitable contributions should be allowed because they were not paid for carrying on a trade or business as required by §280E. Again, the Tax Court disagreed. Charitable contributions by corporations often have underling business purposes. The Court linked §280E to §170 and disallowed the contribution deductions – end of discussion!
Overall Impact of § 280E
The Tax Court in the SJW case held that any activity at all by the medical marijuana industry, however benign, will be linked to § 280E and no deduction of any kind or any category is going to be allowed. Truly a devastating decision.
It is clear that there are irreconcilable differences between the medical marijuana industry at the state level as opposed to the federal level. Only Congress can change the situation. Let’s hope it is done speedily and in our day.
Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 50 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments. Mr. Schriebman is in private practice. He is not affiliated in any way with the EDD and he is not employed by the EDD or any other agency of the State of California.
Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
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