Tax Court Holds Medical Marijuana Retailer Underreported Income

The owner of a California medical marijuana dispensary was found to have underreported income.

Moreover, he was precluded from deducting most of the expenses he claimed because the business consisted of trafficking in controlled substances.

Martin Olive operated the Vapor Room Herbal Center as a sole proprietorship in San Francisco. The Vapor Room’s principal business is the retail sale of medical marijuana under California law. The IRS found deficiencies in Olive’s income tax for 2004 and 2005, respectively, after determining that he failed to substantiate any costs of goods sold or expenses reported.

The Tax Court, in Olive v. Commissioner, 139 T.C. No. 2, agreed with the IRS that Olive underreported gross receipts, and that he could not deduct his claimed expenses.  While his business was legitimate under California law, Section 280E of the Tax Code precludes a deduction of any amount for a trade or business where the “trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances … which is prohibited by federal law.”

Olive claimed this provision was inapplicable. The Vapor Room’s business did not consist of the illegal trafficking in a controlled substance, he contended, because it was legitimate under California law. However, the Tax Court noted it has previously held that a California medical marijuana dispensary’s dispensing of medical marijuana pursuant to the California law constituted “trafficking” within the meaning of the Internal Revenue Code.

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