Cannabis Business Taxation – IRC 280E – Olive v. Commissioner, 9th Circuit Court of Appeals Analysis

Over $2 million in tax and penalties assessed San Francisco Vapor Room dispensary for not complying with federal income tax laws that apply to medical marijuana businesses – IRC 280E – Olive v. Commissioner, 9th Circuit Court of Appeals Confirming Deductibility of Cost of Goods Sold, but Denying Deductions of Ordinary or Necessary Trade or Business Expenses Connected to Medical Marijuana


On July 9, 2015 the US Court of Appeals for the 9th Circuit confirmed the Tax Court decision of August 2, 2012 assessing deficiencies and penalties arising from taxpayer’s operation of a medical marijuana dispensary in California. The Circuit Court affirmed its earlier 2002 decision in DHL Corp. v Commissioner, that IRC 280E precludes deducting any amount of ordinary or necessary business expenses associated with taxpayer’s dispensary operations under federal law. While typically businesses are allowed to deduct ordinary or necessary business expenses under IRC section 162, IRC section 280E creates an exception to deductibility if the business is trafficking in controlled substances. Although the use and sale of medical marijuana are legal under California law, see Cal. Health & Safety Code sections 11362.5, the use and sale of marijuana remain prohibited under federal law, see 21 USC section 812 (c).


The Tax Court in Olive v. Commissioner found the only income generating activity of the taxpayer Martin Olive, doing business as the Vapor Room, was the sale of medical marijuana. There was no charge for use of lounge services, for counseling services, provisioning vaporizers, providing food, yoga, movies or other amenities offered patients of the Vapor Room. Since the sole income producing activity of the Vapor Room was trafficking in a controlled substance under federal law, the courts concluded all expenses of operating the Vapor Room cannot be deducted for federal tax purposes.

Taxpayer argues its business consisted of caregiver services and selling marijuana. Because the taxpayers accounting system showed no revenue other than from selling marijuana, this argument was ignored by the courts.

The courts distinguished its earlier decision from 2007 in Californians Helping Alleviate Medical Problems (CHAMPS) v. Commissioner, where the taxpayer was found to be involved in more than one trade or business, with the primary one being extensive caregiver and counseling services. In CHAMPS the tax court concluded the primary purpose was providing caregiver services to its members. The court compared the Vapor Room to a bookstore that allows its guests to sit in comfortable chairs, drink coffee or team eat cookies, attend events, get advice, all for free while deciding whether to buy a book. The court explained CHAMPS however was like a bookstore that also sold coffee, pastries and food in a café like area, besides selling books.

The courts also stated that while Congress may not have intended 280E to apply to activities legal under state law, until Congress changes the statute it must be enforced based on its plain meaning as the courts have long done in a wide range of situations not foreseen by Congress when enacting tax legislation, as often occurs in tax interpretation cases. Finally the courts confirmed even if Congress decides not to expend funds to enforce federal law prohibiting trafficking in marijuana, has no impact on interpretation of tax statutes.

While the 9th Circuit Court of Appeals glossed over the issue of deductibility of cost of goods sold (COGS) even for marijuana dispensaries, the Tax Court in 2012 affirmed COGS are deductible and not subject to IRC section 280E’s prohibition of deducting ordinary or necessary trade or business expenses. The Vapor Room taxpayer however could not provide any receipts to support the COGS item on its tax returns, only its own ledgers. The court also concluded the testimony of the Vapor Room’s CPA was not reliable, and was not an adequate substitute for invoices or reliable documentation proving COGS expenditures. Nevertheless the court considered testimony on the average COGS of other dispensaries, and allowed a COGS deduction of 75% despite the IRS audit agent denying any COGS deduction.

Measuring COGS and explaining the expense items that may be included in it for marijuana businesses are beyond the scope of this article.

About the Author

Thomas “Tom” Cifelli practices business law and provides other specialized consulting and investment banking services to growth companies. He practiced public accounting as a CPA for over 15 years earlier in his career. Visit Linked In for Mr. Cifelli’s complete profile and experience..

Comments are closed.

Powered by WordPress. Designed by WooThemes