Tax Filing Season Alert: Exercise Caution Before Signing a Tax Return for a Marijuana Business
It is legal to buy and sell marijuana for certain uses in Michigan, and it is legal to possess limited quantities for personal, recreational use in many cities in Michigan. Right?
And if Marijuana is legal to buy, sell, and use, then a business selling marijuana must file federal income tax returns and report and pay the appropriate amount of federal income tax. For the CPA, the question is "what is the appropriate amount of federal income tax?"
In the normal situation, a business would pay federal income tax on its net profit (i.e., "taxable income") by starting with gross sales and deducting ordinary and necessary business expenses to arrive at the tax base. However, in the unique case of marijuana sales, the Tax Court has held, and the Ninth Circuit Court of Appeals has affirmed, that expenses associated with the sale of marijuana are NOT DEDUCTIBLE under Section 162 of the Internal Revenue Code (the "Code"). The Circuit Court of Appeals held that this is true because Code Sec. 280E specifically precludes a deduction for these expenses because they are associated with a "trade or businesss . . . consist[ing] of trafficking in controlled substances . . . prohibited by Federal law."
While CPAs in the 6th Circuit (Michigan, Ohio, Kentucky, and Tennessee) are not necessarily bound by a 9th Circuit decision from California, a federal appellate decision is a powerful factor in evaluating whether a position is likely to be upheld if challenged. Therefore, any CPA preparing tax returns that include a marijuana business should exercise caution if the business activity is being reported after deducting expenses under Code Sec. 162. To be conservative, in the absence of deductions, the marijuana business would pay federal income tax on gross sales.