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Thursday, January 29, 2015

The Law is an Ass

The law is an ass, or so says Charles Dickens. After reading the IRS’ latest missive on sales of marijuana, I think I agree.

The tension between federal and state law on the sale of marijuana carries over to federal income taxes. While the sale of marijuana is legal in some states at varying levels (e.g., medical use only vs. recreational use), it is still a controlled substance under federal criminal law. Thus, a state-legal marijuana seller is still an illegal enterprise. Interestingly, under federal tax law, the proceeds of criminal operations are still subject to income tax – as Al Capone learned.

Complicating the life of an illegal drug seller is Code Section 280E that says a taxpayer may not deduct any amount for a trade or business when the business consists of trafficking in Schedule I or Schedule II controlled substances.However, due to constitutional concerns that the income tax cannot be a gross receipts tax, the Senate Report to that code section said the reduction of gross receipts by the cost of goods sold should still be allowed.

A few years later, the uniform capitalization rules of Code Section 263A were enacted. These rules can create reduction in income from the sale of goods by capitalizing expenses that previously would not be included in cost of goods sold.

So getting us to the recent announcement, the IRS is now advising that these new expenses that would be capitalized under Code Section 263A cannot be capitalized for persons selling marijuana, because this would allow a taxpayer to have more in deductions than Code Section 280E should allow under the extra-official allowance of a reduction for cost of goods sold that is allowed by a mere Senate Report and not the law itself. Did I lose you? To implement this ridiculousness, the IRS is telling taxpayers to use the “old” Code Section 471 rules (under regulations issued before Code Section 263A) in determining what goes into cost of goods sold for these taxpayers. This doesn’t even get to the craziness of applying an anti-drug dealer provision of the Code (Code Section 280E) to businesses authorized under state law.

The IRS also struggled with the question of whether sellers of marijuana that nonetheless still use the cash method of accounting, should be forced onto the inventory/accrual method so as to be able to get these reductions. Persons that have that as an issue should consult the IRS pronouncement.

Chief Counsel Advice 201504011

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