Marijuana Dispensary’s Deductions go Up in Smoke

Medical-Marijuana-SymbolIn an opinion that would make Willie Nelson shake his head, the Tax Court held that a taxpayer was not entitled to deduct business expenses related to his “Health Care” business (read: medical marijuana dispensary).  The Court also disallowed the taxpayer’s cost of goods sold (COGS) and casualty loss for items seized during the Drug Enforcement Administration’s (DEA) raid of his dispensary in 2007.

The taxpayer resided in California and owned two medical marijuana dispensaries in 2007 operating under the name Alternative Herbal Health Services (“AHHS”).  AHHS sold various strands of marijuana, pre-rolled marijuana joints, and edible food items prepared with marijuana.  It did not sell any pipes, papers, or vaporizers, however they were made available to customers to medicate on site.  AHHS provided several educational activities to its customers at no charge including “loading, grinding, and packing marijuana for customers’ use of bongs, pipes and vaporizers.”  On January 11, 2007 the DEA searched the taxpayer’s dispensary in West Hollywood and seized marijuana, food items suspected to contain marijuana, and marijuana plants.

The taxpayer had a very short record retention policy, as his typical practice was to shred all sales and inventory records at the end of the day or by the next day.  When it came time to prepare his 2007 tax return, the taxpayer gave the numbers to his attorney who then gave them to his tax return preparer.  The Schedule C for his 2007 tax return reported a “Health Care” business with $1,700,000 in gross receipts and $1,429,614 in COGS and $194,094 in expenses.  The taxpayer included $600,000 attributable to the value of the marijuana seized by the DEA in his gross receipts and COGS entries for 2007.  All of the gross receipts and expenses reported on the taxpayer’s 2007 return were from the sale or expenses associated with AHHS’s marijuana or marijuana edibles.  After three amended answers, the IRS asserted a tax deficiency of $1,047,743 and assessed a $209,549 accuracy-related penalty under section 6662(a) for the 2007 tax year.

Under IRC § 280E a taxpayer may not deduct any amount paid or incurred in carrying on a trade or business if such trade or business consists of trafficking controlled substances which is prohibited by Federal law or the law of any state in which the trade or business is conducted.  The Court relied on its own decision in Californians Helping To Alleviate Med. Problems, Inc. (CHAMP) v. Commissioner, 128 T.C. 173 (2007) and the U.S. Supreme Court’s decision in Gonzales v. Raich, 545 U.S. 1 (2005) to determine that the taxpayer was trafficking in a controlled substance within the meaning of IRC § 280E.

However, Judge Goeke distinguished this case from CHAMP, where a potion of the taxpayer’s operating expenses were allowed because the taxpayer’s activities included those unrelated to the sale or distribution of marijuana.  In this case, the taxpayer provided no evidence that AHHS sold any non-marijuana-related items.

The Court also disallowed the taxpayer’s IRC § 165 casualty loss deduction and denied his characterization of the marijuana seized by the DEA as COGS in 2007.  The Court found that characterizing the marijuana seized by the DEA as COGS was difficult the taxpayer’s record retention policy left little substantiation for the value of items seized.  Even if he had been able to provide substantiation the product could not be considered COGS because was confiscated and, in fact, was not sold.  When the smoke cleared, Jude Goeke unsurprisingly upheld the accuracy-related penalty under IRC § 6662(a).

Read the full opinion here: Beck v. Commissioner, T.C. Memo. 2015-149.

 

Second Circuit: Co-Op Owner Is Entitled to Casualty Loss

circseal2The Second Circuit Court of Appeals has reversed the Tax Court’s decision that a New York City co-op owner, Ms. Alphonso, could not deduct casualty losses that occurred on grounds owned in common with other cooperative shareholders.

The Tax Court held that Ms. Alphonso could not take a deduction for a casualty loss because she did not hold a property interest in the damaged property. The damage in question occurred when a retaining wall along the common property of the cooperative apartment building collapsed. The co-op shareholders contributed to the necessary repairs and clean-up. Ms. Alphonso took a deduction of about $23,000 for her share of the repairs, claiming that it qualified as a casualty loss under under IRC §165(c)(3).

The Tax Court did not address the merits of the casualty loss claim. Rather, the Court ruled as a matter of law that Ms. Alphonso did not hold a “sufficient” property interest in the common area of the apartment building to qualify for the deduction.

The Second Circuit vacated the Tax Court holding that although Ms. Alphonso’s interest in the damaged common area was not exclusive with respect to her fellow tenant shareholders it was still a property right. Thus, the “property” element of section 165(c)(3) was satisfied. The Second Circuit remanded the case to the Tax Court for further proceedings on whether the claimed damages qualified as a casualty loss.

Read the Second Circuit’s opinion here:
Alphonso v. Commissioner, No. 11-2364 (2d Cir. Feb. 6, 2013)

Read the Tax Court opinion here.

Tax Court: Capital Gains, Casualty Losses and Ecdysiasts

It only takes a couple of paragraphs to recognize a Tax Court opinion drafted by Judge Mark V. Holmes whose distinctive style is inimitable.  In his latest effort, Judge Holmes expounds on sub-genres of hard rock and heavy metal music and flexes his vocabulary to describe what ordinary folks like us might just call a “strip club.”  The taxpayer’s incarceration, risk management techniques, and references to Great White and Head East only added to the tale.  All of this because of an incorrectly reported capital gain following a condemnation action. Taxation should always be so fun.

The 17 page Summary Opinion (which disposed of the taxpayer’s action but cannot be cited for precendent) had us reaching for the dictionary more than once as illustrated by the following sentence:

He rented out the old house to a tenant who installed minor improvements (e.g., poles) and opened an establishment felicitously–and paronomastically–called the “Landing Strip,” in which young lady ecdysiasts engaged in the deciduous calisthenics of perhaps unwitting First Amendment expression.

We couldn’t even find “paranomasia” (the root for the adverb above) in our three and a half inch thick Webster’s Unabridged Dictionary of the English Language.  Fortunately the internet offered up the answer, which the curious can find here. All in a day’s work for Judge Holmes.

In the end, the taxpayer did get a bit of a break on the capital gain asserted by the IRS in the notice of deficiency but you’ll have to run the math yourself to know exactly how much as decision was entered under Tax Court Rule 155.

Read the opinion (and get the depreciation formula for the taxpayer’s gain) here.
Willson v. Commissioner, T.C. Summ 2011-132

(h/t: TaxProfBlog)

Tax Court: Co-op Owner Cannot Deduct Casualty Losses

The Tax Court, in a reviewed opinion by Judge Chiechi, finds that a shareholder in a cooperative housing corporation may not deduct losses incurred by the co-op and distributed among the shareholders under section 165(c)(3) or section 216(a).

Read the opinion here.
Alphonso v. Commissioner, 136 T.C. No. 11 (2011)