In accordance with a 2007 Tax Court decision (Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner, 128 T.C. No. 14) and a 2010 IRS Chief Counsel Letter (2011-0005)), the IRS last week issued a ruling to Harborside Health Center that § 280E prohibits the deduction of any expenses of its medical marijuana dispensary:

Section 280E of the Code disallows deductions incurred in the trade or business of trafficking in controlled substances that federal law or the law of any state in which the taxpayer conducts the business prohibits. For this purpose, the term “controlled substances” has the meaning provided in the Controlled Substances Act. Marijuana falls within the Controlled Substances Act.

The denial of deductions for rent, payroll, health insurance, and worker’s compensation insurance resulted in an additional $2.4 million tax liability for 2007 and 2008 (the IRS is examining Harborside’s 2009 and 2010 returns). Harborside paid over $2 million to California and $1 million to Oakland in medical marijuana excise taxes last year. Congressman Pete Stark has introduced a bill to allow medical marijuana dispensaries to deduct its expenses like other businesses, but the bill’s fate is uncertain. Harborside claims the IRS’s position will drive it and other medical marijuana dispensaries out of business.

• The Atlantic, How the Tax Code Could Destroy Medical Marijuana
• The Bay Citizen, IRS: Oakland’s Largest Pot Dispensary Owes Millions
• MSNBC, IRS Ruling Strikes Fear in Medical Marijuana Industry
• San Francisco Chronicle, Oakland Pot Dispensary Gets $2.5 Million IRS Bill 
• TaxProf Blog, IRS Tries to Bogart Medical Marijuana Club’s Deductions