When a business is engaged in two separate activities, do all ordinary and necessary business expenses of both become nondeductible because one activity involves an illegal activity (trafficking in a controlled substance)?
Taxpayer Says: All expenses related to separate activities of providing caregiving and medical marijuana (under the California Compassionate Use Act of 1996) are fully deductible.
Internal Revenue Service Says: None of the expenses are deductible because the corporation engaged in a single activity of trafficking in a controlled substance.
From IRC Section 162(a): Taxpayers may generally deduct the ordinary and necessary expenses incurred in carrying on a trade or business.
From IRC Section 261: “No deduction shall in any case be allowed in respect of the items specified in this part.” The phrase “this part” refers to part IX of subchapter B of chapter 1, entitled “Items Not Deductible”. “Expenditures in Connection With the Illegal Sale of Drugs” is an item specified in part IX.
From IRC Section 280(E): 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 such 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.
In the context of section 280E, marijuana is a schedule I controlled substance. (Sundel v. Commissioner, T.C. Memo 1998-78, affd. without published opinion 201 F.3d 428 (1st Cir. 1999).
Such is so even when the marijuana is medical marijuana recommended by a physician as appropriate to benefit the health of the user. (United States v. Oakland Cannabis Buyers’ Coop., 532 U.S. 483 (2001))
California Compassionate Use Act of 1996: Codified at Cal. Health & Safety Code sec. 11362.5 (West Supp. 2007). Intended to ensure that seriously ill Californians have the right to obtain and use marijuana for medical purposes where that medical use is deemed appropriate and has been recommended by a physician who has determined that the person’s health would benefit from the use of marijuana in the treatment of any illness for which marijuana provides relief.
THE CAUSE OF THE DISPUTE
IRC Section 280(E) was written specifically to deny deductions related the illegal trafficking in drugs listed in the Controlled Substances Act. The question is whether there was congressional intent to deny the deduction of all of a taxpayer’s business expenses simply because the taxpayer was involved in trafficking in a controlled substance in addition to carrying on a separate activity.
WHAT WOULD YOU DECIDE?
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THE COURT’S DECISION
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The IRS is correct in that the expenses related to the provision of medical marijuana are nondeductible.
However, the Court found the taxpayer was engaged in two activities and could deduct expenses not attributable to the provision of medical marijuana.