Tax Issues for Medical Marijuana :)

In 2008, Michigan voters approved the legalization of medical marijuana  Medical marijuana clinics are opening and this creates new and interesting issues in how these clinics will be taxed.  This post will explain the following federal tax issues:

• will deductions be allowed for expenses of medical marijuana clinics?
• will medical marijuana clinics be allowed tax exempt status?

I’m going to have a little fun with this post, so please don’t be offended.  

Deducting Expenses Incurred in Illegal Activities.

Last year I wrote a light hearted post on deducting expenses in illegal activities.  View that post here. 

In 1969, Congress added language to the tax law that explicitly denied deductions for the following expenses:

• Bribes and kickbacks. IRC §162(c)
• Fines and penalties. IRC §162(f)
• Punitive damages portions of criminal antitrust violations. IRC §162(g)

The legislative history of these provisions indicate that this list is all inclusive—thus, expenses of illegal activities are deductible against federal income tax unless Section 162 explicitly provides that the expenses are not deductible (as it does in the above list).

However, IRC §280E provides that no deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any business if such business consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibits by Federal law OR the law of any State in which such trade or business is conducted.

While medical marijuana may be legal under Michigan law, it is still illegal under Federal law (Marijuana is on schedule I of the Controlled Substances Act and therefore is an illegal controlled substance).  Under Section 280E, business expenses will be disallowed when the substance is illegal under either Federal or state law.  Since medical marijuana is illegal under Federal law, business expenses will be disallowed even though medical marijuana is legal under Michigan law.

In 2007, the Tax Court confirmed the IRS’ position on the disallowance of business expenses under Section 280E for a not-for-profit California corporation selling medical marijuana legally under California law. 

Can a Medical Marijuana Clinic Achieve Tax Exempt Status?

The federal government does not allow Section 501(c) status to medical marijuana clinics due to public policy reasons.  Application of the public policy doctrine to the allowance of Section 501(c) status dates back to a series of court cases in the early 1970s related to non-profit status of racially discriminatory schools.  In Bob Jones University vs. U.S., the Supreme Court that “to warrant exemption under Section 501(c)(3), an institution must fall within a category specified in that section and must demonstrably serve and be in harmony with the public interest.” 

Since the position of the federal government is that medical marijuana violates public policy, it will not grant tax exempt status to medical marijuana clinics.