No deduction for medical-marijuana business expenses, says the Ninth Circuit

Olive v. Comm’r, No. 13-70510 (9th Cir. July 9, 2015).

The Vapor Room’s sign (credit: Thomas Hawk / flickr)

The Vapor Room’s sign (credit: Thomas Hawk / flickr)

The Vapor Room is a medical-marijuana dispensary in San Francisco. While its apparently a cooperative now, back in 2004 and 2005—the tax years at issue in this case—it was a sole proprietorship owned by Martin Olive. On his income-tax returns for those years, Olive deducted business expenses he had incurred from running the Vapor Room. 

Normally, section 162 of the Internal Revenue Code makes all “ordinary and necessary” business expenses deductible from income. Here, however, the IRS audited Olive and determined that another section of the Internal Revenue Code—section 280E—prohibited Olive from deducting his business expenses. Under section 280E, you can’t deduct business expenses that come from a “trade or business” that “consists of trafficking in controlled substances . . . which is prohibited by Federal law.”  While trafficking in medical marijuana is legal under California law, it remains illegal under federal law. 

On appeal to the Ninth Circuit, Olive makes three main arguments against the IRS—all three of which the Ninth Circuit rejects.

First, Olive argues that for a “trade or business” to “consist[] of trafficking in controlled substances,” the business must consist solely of trafficking in controlled substances. Here, the Vapor Room also offers games, books, and art supplies; yoga, movies, and massage therapy; complementary snacks; and free counseling and education. But the Ninth Circuit analogizes these services to similar services a bookstore might offer to its patrons—comfortable reading chairs, free coffee and cookies, and author readings. The “trade or business” of the bookstore, says the Ninth Circuit, would still consist of selling books, since the other amenities are meant to support its bookselling business. So here: the Vapor Room may offer its patrons other amenities, but those other amenities are meant to entice customers into buying medical marijuana. 

Olive’s second argument is that Congress enacted IRC section 280E before medical-marijuana dispensaries existed, so section 280E shouldn’t apply here. The Ninth Circuit responds that the law is what Congress actually said, not what it may have imagined or expected. And what it actually said applies to medical-marijuana dispensaries.

Third and last, Olive points out that earlier this year, Congress forbade certain funds from being used to prevent states from implementing their medical-marijuana laws. According to the Ninth Circuit, though, an appropriations law passed in 2015 can’t stop the IRS from defending an appeal that arises from the 2004 and 2005 tax years. And anyway, says the court, the IRS is only enforcing a tax. That may make it more costly to run a dispensary, but it doesn’t prevent people from using or distributing medical marijuana.