Marijuana Taxation Without Legalization

Weed_Christina_webIf you turn on the news, television or radio, it is difficult to avoid discussions of marijuana and its legalization. Recently, Bethenny Frankel, known for appearing on the “Real Housewives of New York,” and for creating the “Skinnygirl cocktails,” has announced her intention to brand and market “Skinnygirl Marijuana,” which she boasts will not give you the munchies.[1]

In the world of professional football, consumption of marijuana is still strictly forbidden pursuant to NFL policy. However, the NFL has recently been forced to consider whether the medicinal properties of marijuana warrant a change.[2]

This year, the U.S. almost had its first “Weed Bowl” between Washington and Colorado teams, where marijuana has been fully legalized, but the Broncos had an unexpected early exit from the NFL Playoffs. In Seattle, a local grower of marijuana has “honored” Seattle Seahawks player, Marshawn Lynch, by naming a strain of marijuana after the Seattle running back—aptly titled “Beast Mode.”[3]

Outside of the NFL and pop culture, the public perception of marijuana consumption is changing. Recently, Congress passed a spending bill[4] that would essentially defund federal efforts to combat the use of medical marijuana in states where it has been legalized. The bill is still pending, but it is one example of the overall changing attitude towards marijuana.

Federal Law

The federal government has not yet legalized the use of marijuana for recreational or medical purposes. Just like any other business, however, businesses that sell marijuana must report gross receipts on a federal income tax return. Said businesses are permitted a deduction for Cost of Goods Sold (COGS), but they are not permitted a deduction for ordinary and necessary business expenses, such utilities or advertising expenses, pursuant to Internal Revenue Code (IRC) §162.

This is due to the provisions of IRC §280E, which provides: “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.“

Marijuana is still listed as a Schedule I[5] substance, which is the most dangerous classification of a drug. For this reason, business expenses, including those for electricity, repairs and rent, may not be deducted on a taxpayer’s return.[6]

Requiring income to be reported and taxed, while prohibiting a deduction for expenses against this income, can be catastrophic for many small businesses that sell marijuana. There is some relief for businesses who engage in additional, separate activities from those related to marijuana.

For example, if a business that sells or dispenses marijuana also provides caregiving services, a deduction for ordinary and necessary business expenses related to those caregiving services may be allowed.[7] Of course, it is up to the taxpayer to demonstrate that any expenses claimed relate to that separate caregiving, or other, activity.

Tax Preparer Concerns

The IRS takes the position that only Congress can change IRC §280E.[8] Accordingly, tax preparers may have concerns about preparing tax returns for those in the business of selling or dispensing marijuana.

In response to these concerns, Karen Hawkins, an official from the IRS Office of Professional Responsibility, has indicated that there is guidance, and court cases, regarding which expenses may be deducted. To the extent that tax preparers comply with the parameters set forth in those cases, and IRC §280E, there should not be any concern for tax preparers.[9]

More specifically, Ms. Hawkins stated: “Within those parameters what we would essentially be saying to the preparers in those states is that you’ve got some hard conversations to have with your clients about what goes on to the tax return, but as long as you are adhering to what the tax law says about treatment, you’re going to be within the confines of what Circular 230 expects of your due diligence.”[10]

Tax preparers can expect to receive further guidance sometime this year according to the Office of Professional Responsibility.[11]

Variation in Taxation Among the States

Despite the fact marijuana has not been legalized by the federal government, many states have legalized medical use of marijuana. Colorado, Washington, Alaska, Oregon and Washington, D.C., have legalized marijuana for all purposes.[12]

Of the 21 states that have legally authorized use of marijuana for medical or palliative purposes, 13 of those states impose some form of tax; four of those states specifically do not have a tax (Montana, Oregon, Alaska and Vermont); and the taxation in the other three states remains unclear.

In California

Medical use of marijuana has been legal in California since 1996, although many taxpayers may not have realized it. The California State Board of Equalization (SBOE) did not issue sellers permits to medical marijuana dispensaries pursuant to a policy against issuing licenses or permits to businesses engaged in illegal activities.

Of course, the SBOE still considered sales at the marijuana dispensaries to be subject to tax. This caused uncertainty for taxpayers. Clarification came in 2007, when the SBOE issued two notices.[13] These notices provided that sellers of marijuana should obtain seller’s permits and remit sales tax on sales. Accordingly, sales of marijuana are subject to both state sales tax and income tax.

Within California, many counties are eager to tax the sale of marijuana, but they are not always eager to allow cannabis dispensaries to be established within their city or county.

Does Tax Revenue Really Grow on Trees … er, Plants?

In Colorado, sales from recreational dispensaries are expected to be $295 million for 2014, with $51 million in tax revenue,[14] despite the fact marijuana sales for recreational use are subject to a 27.9 percent tax (2.9 percent sales tax, 10 percent marijuana sales tax, and 15 percent excise tax).[15]

In California, SBOE spokesperson Brian Miller indicated annual sales of marijuana in California are between $700 million and $1.3 billion, with resulting tax revenue between $59 million and $109 million.[16]

There is a potentially huge gap with respect to how much tax revenue California is actually receiving versus what it might be entitled to receive. Perhaps this is because marijuana can still be purchased on the black market relatively easily, and tax-free.

The Marijuana Tax Equity Act[17] that was introduced in 2013, but was not passed, would have amended the Internal Revenue Code to impose a 50 percent excise tax on sales of marijuana. If such a provision were passed, it is difficult to imagine that consumers would be willing to pay a 50 percent excise tax.

What to Expect in the Near Future

If the above-referenced spending bill is approved by President Obama, marijuana businesses in states where medical or recreational use is permitted can breathe easier, knowing they will not be subject to federal raids.

With recreational use being legalized in four states and Washington, D.C., and medical use being legalized in 21 states, it is clear the public perception of marijuana is changing.

Many businesses and entrepreneurs have expressed interest in developing marijuana products further. Recently, state universities in Colorado have been called upon to research and develop the product to maximize exploitation and research of marijuana’s potential health and medicinal benefits.[18]

Legalization of marijuana is an issue that is not likely to go away any time soon. Whether or not you support the outright legalization of marijuana, it is difficult to ignore the proven, and potential, health benefits that it may offer to many. It will be an interesting topic to follow in the months and years ahead.


Christina Weed, JD, LL.M., is an attorney at the Law Offices of Chastity A. Schults in Walnut Creek, a tax law and estate planning firm. Christina’s practice has an emphasis in Tax Law, Business Succession Planning and litigation. Christina is the Chair of the Tax Section of the Contra Costa County Bar Association and the Co-chair of the Contra Costa County Delegation of the California Conference of Bar Associations. You can reach her at christina@schultslaw.com or (925) 274-4608.


[1] Weiss, Geoff. “Bethenny Frankel Developing ‘Skinnygirl Marijuana,’ a Munchie-Free Weed Strain,” Entrepreneur, 16 Jan. 2015.
[2] “NFL Seeks Right Answer for Marijuana Use,” USA Today, 4 Aug. 2014.
[3] Young, Bob. “Pot Grower’s ‘Beast Mode’ Strain Packs Punch,” The Seattle Times, 26 Jan. 2014.
[4] H.R. 5016, 113th Cong. (2014).
[5] 21 U.S.C. §812(b)(1); 21 CFR 1308.11.
[6] See Olive v. Commissioner, 139 T.C. 19 (2012).
[7] Californians Helping to Alleviate Medical Problems, Inc., v. Commissioner, 128 T.C. No. 14, May 15, 2007.
[8] Wooten, Casey. “IRS Guidance Coming for Practitioners Preparing Returns for Marijuana Retailers,” 33 TMWR 1605 (November 19, 2014).
[9] Id.
[10] Id.
[11] Id.
[12] “Daily Chart: Mapping Marijuana,” The Economist, 20 Jan. 2015.
[13] These notices can be viewed on the SBOE website at http://www.boe.ca.gov/news/marijuana.htm#Resources.
[14] Whitaker, Bill. “The Marijuana Effect,” CBS, 60 Minutes, CBS, 11 Jan. 2015.
[15] “Marijuana Taxes: File,” Colorado Department of Revenue, Taxation Division, n.d. Also, sales of marijuana for medical use are taxed at a much lower 2.9 percent rate.
[16] “MEDIA RESOURCE: Medical Marijuana/Legalization of Marijuana,” n.p., n.d., http://www.boe.ca.gov/news/marijuana.htm.
[17] H.R. 501, 113th Cong. (2013).
[18] Kelly, David. “Colorado Seeks Permission to Grow Pot at State Universities,” LA Times, 25 Jan. 2015.

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