Eighteen states and the District of Columbia have now decriminalized or legalized marijuana for at least some purposes. You hear a lot
about the conflict between these state laws and the federal statute
criminalizing the sale and possession of marijuana. But since the
Justice Department isn’t consistently coming after marijuana sellers,
the more immediate problem for many of them is federal tax law. “The federal tax situation is the biggest threat to businesses and could push the entire industry underground,” the leading trade publication for the marijuana industry reports.

Here’s why: Ordinary businesses are taxed by subtracting their
business expenses from their gross revenue to arrive at their net
income, or profit. That amount is subject to tax. By contrast, sellers
of controlled substances—in other words, drugs, including marijuana—are
not permitted to deduct any ordinary business expenses other
than the cost of the goods they are selling. That’s because of §
280E of the federal tax code, which Congress enacted in the 1980s to
punish drug dealers. The provision was largely symbolic for decades,
since few drug dealers filed income tax forms. But now, state-licensed
marijuana sellers must pay federal taxes not only on their profits but
also on the money they spend on salaries, rent, advertising, and all the
other expenses related to running a business. In fact, it is
conceivable that § 280E could require a business to pay more in
tax than its total profits for the year.

I teach tax law, and I have a solution: Marijuana sellers should operate
as nonprofit “social welfare organizations.” To qualify for a federal
tax exemption, a social welfare organization must have as its primary
purpose the promotion of the common good and general welfare of the
people in its neighborhood or community. Currently, many social welfare
organizations operate businesses in poor and distressed neighborhoods,
providing jobs and job-training for residents and improving the
conditions for economic development. For example, Homeboy Industries
is a tax-exempt nonprofit that trains and employs former gang members
in Los Angeles to work in a bakery, a café, and a retail store. …

Eventually, it probably makes sense for Congress to repeal § 280E
and treat marijuana sellers the same as any other business. If the
states want to legalize and regulate marijuana, the federal government
shouldn’t use the tax code to interfere. But until that question is
settled, avoiding § 280E by operating as a social welfare
organization will allow a neighborhood-based seller to be at the
forefront of the legalization experiment—while furthering the interests
of the local community. All it takes is a few visionary nonprofit entrepreneurs, and an IRS not afraid to do the right thing.