The document summarizes a recent court case that affirmed a tax code provision, Section 280E, that disallows businesses engaged in the sale of marijuana from deducting ordinary business expenses. Specifically, the 9th Circuit upheld the disallowance of deductions for a San Francisco marijuana dispensary called the Vapor Room. While the dispensary argued it provided additional services beyond marijuana sales, the court found its sole income-generating activity was the sale of marijuana. The ruling means marijuana businesses must ensure any supplemental services are charged separately in order to potentially deduct some expenses. The tax code provision will likely remain a "thorn in the side" of marijuana businesses until federal legalization changes their status under federal law.

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2. VOLUME 9 NUMBER 3 / Q3 2015
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IRC Section 280E:
A TAX THORN IN THE SIDE OF MARIJUANA BUSINESSES
JENNIFER L. VILLIER, JD, WEALTHCOUSEL LEGAL EDUCATION FACULTY
The number of U.S. states that have legalized medical
or recreational marijuana (or both) has grown to 23,
plus the District of Columbia. Despite state legaliza-
tion of the drug, the federal Controlled Substances
Act still categorizes marijuana as a Schedule 1 drug.
So although nearly half the states have legalized the
sale of marijuana for medicinal or recreational pur-
poses, federal penalties for the sale of less than 50 ki-
lograms of marijuana is punishable by up to 5 years in
prison and a $250,000 fine. The disconnect between
state and federal legal treatment of marijuana has re-
sulted in many issues and uncertainties for businesses
connected to the marijuana industry.1
As marijuana
legalization continues to spread across the U.S., many
business owners look to attorneys to advise them on
the opportunities and consequences of the gaps be-
tween state and federal law and the impact of the In-
ternal Revenue Code (“IRC”) on marijuana businesses.
In addition to the banking and employment law is-
sues marijuana businesses face, tax issues have arisen
as the Internal Revenue Service (“IRS”) and courts
consider the applicability of various IRC provisions
to state-authorized marijuana operations. One such
provision, §280E, is the subject of this article. Spe-
cifically, this article discusses the implications of the
9th Circuit’s recent decision in Olive v. Comm’r,2
which
affirmed the Tax Court’s holding that §280E disallows
the deduction of ordinary and necessary business ex-
penses by businesses engaged solely in the sale of
marijuana.
FACTS
The marijuana business at issue in Olive was the Va-
por Room Herbal Center (“Vapor Room”) located in
San Francisco, California, where the sale and use of
medical marijuana is legal. Vapor Room’s activities
included (i) selling medical marijuana; (ii) providing
patrons with a place to socialize, play games, read
and create artwork in a community center-like atmo-
sphere; (iii) offering yoga, movies and massage ther-
apy; (iv) stocking tea, water, pizza, sandwiches and
other snacks for patrons’ consumption; (v) counseling
patrons on personal, legal or political matters pertain-
ing to medical marijuana; (vi) loaning vaporizers to
patrons to enable them to inhale a THC-containing
vapor using marijuana purchased at Vapor Room or
elsewhere. Notably, Vapor Room charged patrons
only for the marijuana; everything else was offered at
no cost.
Vapor Room’s federal income tax returns for 2004
and 2005 reported net income for those years of
$64,670 and $33,778, respectively. Vapor Room re-
ported $236,502 (for 2004) and $417,569 (for 2005)
in business expenses related to its operations dur-
ing those years. The Tax Court held that, pursuant
to §280E, none of those business expenses were de-
ductible.3
The 9th Circuit affirmed.
ANALYSIS
Under IRC §§61(a)(2) and 162(a), individuals and busi-
nesses are taxed on gross income less permitted de-
ductions. IRC §§261-280H list items not deductible
from gross income, including §280E - amounts paid
or incurred for the purpose of carrying on any trade
or business that consists of trafficking in controlled
substances. The decision in Olive turned on the fact
that Vapor Room’s only income-generating activity
was the sale of medical marijuana. Because a “trade

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or business” is an activity “entered into with the dom-
inant hope and intent of realizing a profit,” the Court
found that Vapor Room’s “trade or business” was lim-
ited to medical marijuana sales, which is prohibited
by federal law. Therefore, §280E precluded Vapor’s
Room deduction of any of its business expenses.
The petitioner, Martin Olive, Vapor Room’s opera-
tor, argued that Vapor Room not only sells medical
marijuana, but it also provides caregiving services.
Therefore, according to the petitioner, Vapor Room’s
trade or business does not solely “consist of” medi-
cal marijuana sales. In support of his argument, the
petitioner cited CHAMP,4
a 2007 opinion in which
the Tax Court held that a medical marijuana business
that also provided extensive counseling and caregiv-
ing services was engaged in more than one trade or
business. The Tax Court determined that the CHAMP
enterprise’s primary purpose was to provide caregiv-
ing services and its secondary purpose was to pro-
vide medical marijuana. While §280E disallowed the
deduction of expenses incurred in connection with
the provision of medical marijuana, the business in
CHAMP was able to deduct expenses incurred in con-
nection with its counseling services. The marijuana
business in CHAMP charged its patrons a member-
ship fee to partake in its marijuana and counseling
services.
Olive, in the 9th Circuit’s opinion, can be distinguished
by the fact that Vapor Room does not charge a sep-
arate fee for its counseling services, caregiving or
snacks. Rather, Vapor Room charges its patrons for
marijuana based upon the quantity and quality of the
product, and on the individual customer’s ability to
pay. Ultimately, the free goods and services Vapor
Room offered were viewed by the Court merely as
a means to attract paying customers for its medical
marijuana.
TAKEAWAYS
The holding in Olive seems straightforward enough.
When running a state-authorized medical (or recre-
ational) marijuana outfit, in order to prevent §280E
from disallowing the deduction of all business ex-
penses, businesses should ensure that any supple-
mental activities or services are provided for a fee.
Additionally, businesses should maintain accurate and
detailed records of business expenses so that they can
be properly traced and proven to have been incurred
in connection with either the marijuana trade or busi-
ness (not deductible) or the non-marijuana trade or
business (deductible).
If marijuana sales and use are ever legalized on the
federal level, the §280E penalty on state-authorized
marijuana establishments should fall by the wayside.
Until then, §280E serves as a means by which the
federal government can enforce a tax on marijuana
businesses. Thus, the federal government may not
be interfering with the use, distribution, possession or
cultivation of marijuana in states where it is legal, but
it is certainly making it more costly to run a dispensary.
ENDNOTES
1 For a discussion of the banking and employment law
considerations facing marijuana businesses, as well as ethi-
cal issues facing attorneys that represent them, please see
The Legal Quagmire of Marijuana Regulation, WealthCoun-
sel Thought Paper (June, 2015).
2 Olive v. Comm’r of Internal Revenue, No. 13-70510 (9th
Cir. 2015)
3 Olive v. Comm’r of Internal Revenue, No. 14406-08 (T.C.
2012)
4 Californians Helping to Alleviate Medical Problems, Inc. v.
Comm’r (CHAMP), 128 T.C. 173 (2007)