​On December 3, Luis shared an update on Ohio’s medical marijuana law with the National Business Institute. He also discussed marijuana at a national level, detailing tax collections and the IRS sections related to doing business in marijuana. Using recent case studies, Luis illustrated how businesses can and cannot deduct or capitalize indirect expenses. Issues such as labor and licenses were also addressed. Luis also presented this topic at a December 17 event put on by the National Business Institute in Dayton, Ohio

1. Medical Marijuana Law
in Ohio
Presented by
Luis Alcalde
December 3, 2019

2. Illegal doesn’t mean you don’t pay taxes!

3. Federal Tax Collections
on Marijuana 2017
$4.7 Billion Collected
on $13 Billion in Revenue
Source: Quartz News

5. Taxes: Adult Use Marijuana vs. Alcohol
Tax collections on retail cannabis surpassed $1 billion in
2018
Alaska, California, Colorado, Nevada, Oregon and
Washington state
$1.04 billion in cannabis taxes vs $304 million taxes on
beer and wine and $1.16 billion from all alcohol sales
Source: Institute on Taxation and Economic Policy (2019)

6. Arizona
$22.4 million in 2018
Montana
$1.8 million in 2018
New Jersey
$1.9 million in 2017
New Mexico
$9 million in 2018
Medical Marijuana Taxes (2017-2018)
New York
$2.6 million in 2018
Oklahoma
$70,000 in 2018
Pennsylvania
$2 million in 2018
Rhode Island
$2.7 million in 2018

7. Tax Equity + Fiscal Responsibility Act (1982)
TEFRA included IRS section 280E with little
debate or analysis
War on Drugs was going strong under
President Reagan
Edmonson v Commissioner, 42 T.C.M. 1533
(1981): Dealer in amphetamines, cocaine and
marijuana allowed to deduct cost of goods
sold + ordinary business expenses

8. IRS Code Section
280E
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.

9. Implications of
280E
No deductions for ordinary business
expenses and depreciation of assets
used in business
Most states use federal taxable income
(adjusted gross income) as the starting
point for state taxation
Absent any state enacted modifications
states would also disallow the
deduction of ordinary and necessary
business expenses based on conformity
to IRC Section 280E

10. What Can Congress
TAX?
Congress can tax income
Congress cannot tax return
of capital

11. INCOME RETURN OF
CAPITAL
Gain derived from
capital, from labor, or
from both combined
Tax concept for
payments which
represent return on
original investment

12. Return of Capital for
GOODS SOLD
Embraces expenditures
necessary to acquire, construct
or extract a physical product
which is to be sold
The seller can have no gain until
he recovers the economic
investment that he has made
directly in the actual item sold

13. COGS in Marijuana
BUSINESS

14. 26 U.S.C. 471 (a)
“Whenever in the opinion of
the Secretary the use of inventories
is necessary in order clearly to
determine the income of
any taxpayer, inventories shall be
taken by such taxpayer on such
basis as the Secretary may prescribe
as conforming as nearly as may be
to the best accounting practice in
the trade or business and as most
clearly reflecting the income.”

15. 1.471-3(b) - Resellers
1.471-3(c)) – Producers
1.471-11
Treasury Regulations

16. Resellers
DISPENSARIES
Invoice price paid to purchase
marijuana inventory less any trade
or other discounts
Transportation and other costs
necessary to gain possession of
the marijuana inventory

17. Production
RELATED
PROCESSORS
Rents
Utilities
Maintenance
Wages
Salaries/Benefits
Tools/Equipment not Capitalized
Indirect Material Costs
Cost of Quality Control + Inspections

18. Patients Mutual Assistance Corporation, d/b/a
Harborside Health Center v. Commissioner of
Internal Revenue, 151 T.C. 11 (2018)
Harborside’s business
bought and sold clones
of MMJ plants
Bought and sold MMJ
flower/buds + MMJ
infused products
Bought and sold non-
MMJ products
Various therapeutic
services were offered
Employees worked on
MMJ and non-MMJ
sales + products
99% of revenues came
from MMJ

19. “We . . . read section 280E to
deny business-expense
deductions to any trade or
business that involves trafficking
in controlled substances, even if
that trade or business also
engages in other activities.”

20. Deductions vs. COGS
Deductions
Legislatively granted
subtractions from gross
income to calculated
taxable income
In general, fully or partly
claimed during the tax
year in which they are
incurred
COGS
The cost of acquiring
inventory, through either
purchase or production
Have to be capitalized in
the year of acquisition or
production and either
amortized or wait until the
year sold to make the
corresponding adjustment
to gross income

21. Example Used in
Harborside
Deductions
Year One: Taxpayer incurs
$100 deductible expense
Taxpayer can reduce Year
One taxable income by
$100
COGS
Year One Taxpayer buys
100 units of inventory for
$100 (each unit costs $1)
Sells 10 units of inventory in
Year One and another 10
units each year thereafter
Can take a $10 adjustment
for COGS and $10 for year
2, year 3…until year 10

22. Taxpayer gets to deduct the
amount of income that is
taxable by $100 but the
difference is one of timing

23. Marijuana businesses can only use Section
471
Harborside ruled that marijuana businesses
cannot use Section 263A to capitalize
indirect expenses beyond what is listed in
Section 471
Section 263A expressly prohibits
capitalizing expenses that would not
otherwise be deductible and since 280E
prohibits all deductions to drug traffickers

24. Did Harborside have
two different trade
and businesses?

26. Tax Court agrees that a single tax payer
can have more than one trade or
businesses
An activity is a trade or business if the
taxpayer does it continuously + regularly
with the intent of making a profit
Multiple activities can constitute only a
single trade or business
Even separate entities activities can be a
single trade or business if they are part of
a “unified business enterprise” with a
single profit motive

27. ANALYSIS
of Separate Trade
of Business
Degree of organizational & economic
interrelationship between the various
undertakings
The business purpose which is (or might
be)served by carrying the various
undertakings separately or together
The similarity of the various undertakings
Patients Mutual Assistance Corporation,
d/b/a Harborside Health Center v.
Commissioner of Internal Revenue
Olive v. Commissioner, 139 T.C. 19, aff’d
792 F.3d 1146 (9th Cir. 2015)
Income Tax Regs. Sec. 1.183-1(d)

28. Fact-Based
ANALYSIS
of Harborside’s Separate
Trade or Business Inquiry
Employees spent 80-90% of their time on
marijuana
Floor space ratio was 75% marijuana/25%
non-marijuana products
Non-marijuana products: 0.5% of revenue
Sales floor only accessible to clients who
came to purchase marijuana
Branding was related to sale of marijuana
Free therapeutic services only amounted
to less than 1% of sales revenue
No separate books, management or
capital for non-marijuana sales
Court: non-marijuana items facilitated and
encouraged the sale of marijuana

29. Californians Helping to Alleviate
Med. Problems, Inc. v Commissioner
(CHAMP), 128 T.C. 173 (2007)
Taxpayer held to have
two distinct trade or
business
Customers paid a
single fee for caring
services + marijuana
18 employees provided
caring services +
7 sold marijuana
Employees did not mix
their duties
Marijuana sales only
occurred in 10% of
one of three facilities
Services provided were
different and apart from
marijuana sales

30. Services Provided in
CHAMP
Weekly/bi-weekly
support group sessions
Healing techniques +
emotional support
Addiction services, one-
on-one counseling
Daily lunches for low
income members
Members were
provided with hygiene
supplies
Weekend social events
with live music, movies,
hot meals + field trips

31. Documentation for
280E
Document every item of revenue
and expense no matter how
small with written receipts
Important to show where revenue
is coming from + what expenses
are COGS but also to avoid
negligence and/or fraud penalties
in filing the tax return

32. PROCESSORS
41 processor provisional licenses
have been awarded
10 processor certificate of operations

33. Employee Work
ACTIVITIES
Activities of each
employee documented
in job description
Activities are
tracked/monitored
while working
Activities of the
employee determines
the tax treatment
Labor associated with cultivation,
trimming, harvesting + processing
go into COGS as cost of production
Marketing and sales activities are
“trafficking” and cannot be
deducted or put in COGS

34. Production
COSTS
PROCESSORS
Water
Nutrients
Soil
Electricity
Rents
Consumables Garden Supplies
Packaging + Processing Materials
Fertilizer

35. COGS Calculation
Beginning Inventory + (Purchases/Direct
Expenses) – Ending Inventory = COGS

36. Luis Alcalde
Kegler Brown Hill + Ritter
lalcalde@keglerbrown.com
keglerbrown.com/alcalde
614-462-5454