Growing Without Rain

News and Views about Taxes

Legitimate enterprise or illegal drug trafficker? Only the IRS knows for sure

with 4 comments

The Sacramento Bee reports that the IRS is looking into the tax returns of an Oakland medical center that, among other things, dispenses medical marijuana:

Harborside Health Center proclaims itself the world’s largest marijuana dispensary. For certain, it is California’s most ambitious – a holistic care center with a naturopathic physician, acupuncturist, chiropractor, yoga instructors and therapists in “universal life force energy.”

Its Oakland facility handles $22 million in annual medical marijuana transactions.

Now Harborside is attracting scrutiny from the Internal Revenue Service. Since last year, the IRS has been auditing 2008 and 2009 federal tax returns for the Oakland location, one of two outlets Harborside operates for 70,000 medical marijuana users. The other facility is in San Jose.

The outcome may eventually establish whether U.S. tax authorities treat medical marijuana as a legitimate enterprise or illicit drug trafficking.

The relevant law is 26 USC section 280E, which reads:

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.

Harborside is relying on this 2007 case to be able to claim its largest deduction. I’m no lawyer, but after reading Kay Bell’s assessment of the decision I think Harborside could be on shaky ground. I guess we will see how this plays out; it just seems to me as though the IRS has better audit targets than the medical marijuana community in states where it’s legal.

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Written by nctaxpro

February 19, 2011 at 12:03 pm

4 Responses

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  1. Wondering how this will turn out, and how it might relate to small-time growers. How is this handled IRS-wise? We had just harvested 8lbs for a local cancer co-op, house got burglarized. All items, including the med-mari were reported to police and homeowners’ insurance. Got some reimbursement from insurance. Now wondering how to report on tax return without DEA showing up at the door!!!

    Watching from the Sidelines

    March 31, 2011 at 11:09 pm

    • Interesting question!

      For a theft loss for which you were only partially reimbursed you’d file Form 4684 to claim any loss from the theft. On that form, however, you have to identify the specific property that you lost, and I doubt that the IRS would even recognize a theft of property that from their point of view is illegal for you to be holding in the first place. It would be consistent with the other positions that they have taken with respect to enterprises that are not considered legal at the Federal level – you are required to report income from those activities but you are not allowed to take otherwise legitimate business deductions for expenses related to the generation of that income.

      nctaxpro

      April 1, 2011 at 6:29 pm

      • Thanks for that reply. You just confirmed what I already had determined from reading as much IRS literature as I could find related to this. Of course they want you to pay taxes on your illegal activities. I even found that you must pay taxes on the fair market value of items you steal! But any losses or expenses you incur in the course of the activities they deem illegal are not deductible. Big, big two-faced, one-way street there!

        Watching from the Sidelines

        April 1, 2011 at 6:37 pm

      • Circular 230 Disclaimer: To ensure compliance with requirements imposed by the IRS, any U.S. tax information contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any matters addressed herein. This post is based on my understanding of the tax law in effect at the time it was written as it applies to the facts that you provided. Any change or addition to those facts could materially and adversely affect my analysis and conclusions, and in that event, the analysis should not be relied upon.

        I posed this question on Eva Rosenberg’s Web site, http://taxmama.com/, which triggered some discussion on the possible ways you can go about this. If you really want to make an issue of this, you could file your return without claiming the loss (so that you are protected from being put into a penalty-and-interest situation if/when the IRS decides to deny your claim), and then file an amended return to claim the loss. I’m not recommending either that you do or don’t – that is totally your decision to make.

        nctaxpro

        April 2, 2011 at 2:48 pm


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