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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.

© 2020 Varnum LLPNational Law Review, Volume VI, Number 57

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About this Author

Eric M. Nemeth, Tax Planning Attorney, Varnum, Financial Controversy Lawyer
Partner

Eric is a partner and leads the tax team. He concentrates on tax and financial controversy (IRS and various States) from examinations appellate conferences, criminal investigations, witness representation and civil and criminal tax litigation. He works with government regulatory and general tax matters. He has served as Senior Trial Attorney for the District Counsel of the Internal Revenue Service and as Special Assistant U.S. Attorney for the Department of Justice. He is a frequent speaker on tax enforcement and has served as an expert witness and binding arbitrator....

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Wayne D. Roberts, Corporate tax attorney, Varnum
Counsel

Wayne is a member of Varnum’s Tax Team. His practice includes all aspects of federal and state tax planning and tax litigation. He represents both closely-held and Fortune 100 companies in tax disputes with the IRS, the Michigan Department of Treasury, and revenue departments in Pennsylvania, Indiana, Tennessee, New York, California and numerous other state and local taxing jurisdictions. 

616/336-6892