Imagine a successful medical marijuana dispensary generating millions in revenue and incurring significant business expenses. When tax season arrives, the owner naturally wants to claim deductions to reduce their taxable income. But is this allowed under federal tax law, even if the business is legal under state law?
The answer, according to the recent case United States v. Richmond, No. 24-1525 (6th Cir. Jan. 30, 2025), is a resounding no. This case even shows that non-compliance at the Federal level can even result in jail time. This presents a complex challenge for state-legal marijuana businesses.
Facts & Procedural History
This is a criminal tax case. The defendant-appellant, which we will refer to as taxpayer, owned a Michigan medical marijuana dispensary. The business was successful, with annual revenues exceeding $1 million from 2012 to 2014.
However, the taxpayer’s individual tax returns for those years did not reflect this income. He omitted all financial information related to the dispensary business and instead reported income from a separate web-design business. This discrepancy triggered an IRS audit.
During the audit, the taxpayer’s accountant advised him to amend his returns, report the dispensary income, and refrain from deducting the company’s business expenses due to Section 280E of the tax code. The taxpayer disregarded this advice and filed an inaccurate amended return that claimed many of the dispensary’s expenses.
Ultimately, the taxpayer was convicted of tax crimes, including tax evasion and filing false returns. The district court ordered him to pay over $2.75 million in restitution to the IRS.
The Prohibition on Deducting Marijuana Business Expenses
Section 280E of the tax code states that no deduction or credit shall be allowed for any amount paid or incurred in carrying on a trade or business that consists of trafficking in controlled substances, including marijuana, which is prohibited by federal law.
In other words, marijuana businesses cannot deduct most ordinary business expenses from their taxable income, even if the business operates legally under state law. This includes expenses like rent, utilities, wages, and advertising costs that would typically be deductible under Section 162.
There is one narrow exception for the cost of goods sold, which can be subtracted from gross receipts to calculate gross income. However, this is an adjustment, not a deduction.
Why Does This Prohibition Exist?
The history of Section 280E traces back to the 1981 court case Edmondson v. Commissioner, where a drug dealer successfully argued that he could deduct certain “ordinary and necessary” business expenses from his illegal drug profits.
Congress enacted Section 280E to close this loophole and prevent illegal drug dealers from benefiting from business expense deductions. However, because marijuana remains illegal under federal law, Section 280E also applies to state-legal marijuana businesses.
The Consequences of Non-Compliance
Failing to comply with Section 280E can lead to serious consequences, as the Richmond case illustrates. Improperly deducting business expenses and failing to report income from a marijuana business can result in substantial tax underpayments, exposing the owner to civil tax penalties and potential criminal charges.
In Richmond’s case, his non-compliance resulted in a restitution order of over $2.75 million. Depending on the size and profitability of the business, the financial consequences of non-compliance can be severe.
The Takeaway
This case serves as a stark reminder of the unique tax challenges faced by medical marijuana businesses. While legal under state law, these businesses are still subject to the federal prohibition on deducting most business expenses.
Non-compliance with Section 280E, even if unintentional, can lead to severe financial and legal consequences. Marijuana business owners must tread carefully and stay informed about their tax obligations to avoid the fate of defendants like Richmond.
Ultimately, until there is a change in federal law, marijuana businesses must accept the reality of higher effective tax rates and the inability to deduct most expenses. Careful tax planning, meticulous recordkeeping, and professional advice are essential to navigating this complex landscape successfully.