Ninth Circuit Says Pot Shops Can't Deduct Business Expenses

SAN FRANCISCO, Calif.—What with the recent announcements that some adult stars have created their own branded strains of marijuana, and that at least one of them has intimated that she's like to own a dispensary herself, it comes as sad news that while medicinal pot is legal for sale in California, its providers won't be able to deduct their legitimate business expenses from their federal tax returns. In a ruling released yesterday by the Ninth Circuit U.S. Court of Appeals, the court upheld a tax court decision that Martin Olive, owner of the Vapor Room Herbal Center, must pay back taxes on earnings from his business from 2004 and 2005 because the Internal Revenue Code Title 26 Sec. 280E states that a dispensary is a "trade or business ... consist[ing] of trafficking in controlled substances ... prohibited by Federal law," and thus is barred from "deducting any amount of ordinary or necessary business expenses associated with [its] operation." Apparently, Olive's problem is that he's too much of a good guy. As the ruling notes, "The Vapor Room is set up much like a community center, with couches, chairs, and tables located throughout the establishment. Games, books, and art supplies are available for patrons’ general use. The Vapor Room also offers services such as yoga, movies, and massage therapy. Customers can drink complimentary tea or water during their visits, or they can eat complimentary snacks, including pizza and sandwiches." And Olive offers all of this for free—which is somehow a no-no. Olive had claimed roughly $650,000 in expenses on the two tax returns in question, but as far as the Ninth Circuit is concerned, "The test for determining whether an activity constitutes a 'trade or business' is 'whether the activity "was entered into with the dominant hope and intent of realizing a profit".' The parties agree, and the Tax Court found, that the only income-generating activity in which the Vapor Room engaged was its sale of medical marijuana. The other services that the Vapor Room offered—including, among other things, the provision of vaporizers, food and drink, yoga, games, movies, and counseling—were offered to its patrons at no cost to them. The only activity, then, that the Vapor Room 'entered into with the dominant hope and intent of realizing a profit' was the sale of medical marijuana. Accordingly, Petitioner’s 'trade or business,' for § 162(a) purposes, was limited to medical marijuana sales." [Citations removed here and below] Apparently, the idea that Olive's providing all of those extra services and freebees was meant, at least in part, to attract more business to his dispensary was not an argument the court was willing to consider. Rather, it analogized Olive's dispensary to a bookstore that provided similar settings and refreshments to its clientele for free versus one that charged patrons for all those extras—and ruled that for taxing purposes, that meant the second bookstore actually had two businesses—book sales and refreshment sales—while the store that provided the extras for free was only in the business of selling books. The court also compared Olive's situation to that of another dispensary, Californians Helping to Alleviate Medical Problems, Inc. (CHAMP), which also sued to maintain its deductions—the difference being that CHAMP, in addition to selling marijuana, also provided "'extensive' counseling and caregiving services," which the court recognized as a second business of the clinic. Another rejected argument of Olive's was his assertion that "Congress could not have intended for medical marijuana dispensaries, now legal in many states, to fall within the ambit of 'items not deductible' under the Internal Revenue Code." "We are not persuaded," The Ninth Circuit stated. "That Congress might not have imagined what some states would do in future years has no bearing on our analysis. ... Application of the statute does not depend on the illegality of marijuana sales under state law; the only question Congress allows us to ask is whether marijuana is a controlled substance 'prohibited by Federal law.' If Congress now thinks that the policy embodied in §280E is unwise as applied to medical marijuana sold in conformance with state law, it can change the statute. We may not." Olive had a couple of other arguments, largely about Congress's current intent regarding legal marijuana use, which the court also rejected—so apparently, the only way legal pot dispensaries will be able to deduct expenses not directly related to selling marijuana will be a change in federal law. Such a change is not expected anytime soon. The Ninth Circuit's decision can be found here.