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Is operating a medical marijuana business conducting business or is it trafficking in controlled substances? The IRS has taken the position that such a business is trafficking in controlled substances and the 10th Circuit Court of Appeals agreed in Alpenglow Botanicals, LLC v. U.S., a case decided in July 2018.

Alpenglow Botanicals, LLC (“Alpenglow”) operated a medical marijuana business in Colorado where such a business was legal under state law. However, marijuana remains a controlled substance under the Controlled Substances Act.

The IRS conducted an audit of Alpengow for the years 2010, 2011, 2012 and denied Alpenglow’s deductions for rent, labor, compensation of officers, advertising, taxes, licenses, depreciation, and wages and salaries. There is no question that (assuming the amount of these expenses were reasonable) they would be deductible expenses for a business. However, § 280E of the Internal Revenue Code states that, “No deduction or credit shall be allowed for any amount paid or incurred… in carrying on any trade or business if such trade or business… consists of trafficking in controlled substances…”

Alpenglow’s members paid the tax due as a result of the IRS denying its deductions and filed a claim for refund.

Among the arguments made by Alpenglow, they argued that denying their business the deductions listed above, they were being taxed on gross receipts instead of net receipts. They argued that necessary business expenses are actually exclusions from income, not deductions. Citing the U.S. Supreme Court’s decision in Commissioner v. Sullivan, a 1958 U.S. Supreme Court case, the 10th Circuit held that because Congress essentially made a marijuana business taxable on its gross income by denying deductions for business that traffic in controlled substances, such a business may be taxed on its gross receipts. Further, the Court pointed to the well-established rule of law that ordinary and necessary business expenses are discretionary deductions and matters of legislative grace that the taxpayer bears the burden of proving its entitlement to and are not mandatory exclusions of income.

The Court sided with the IRS and agreed that Alpenglow could not take the deductions and its members were therefore not entitled to a refund of the taxes they paid as a result of the audit.

It would not be surprising to see this case, or a case with similar facts, at the U.S. Supreme Court in the relatively near future. For now, although states may allow medical marijuana businesses to operate under state law, since the federal Controlled Substances Act still classifies marijuana as a controlled substance, the medical marijuana businesses will not be able to take advantage of many tax deductions. This issue will continue to develop in the next few years.

Rebecca K. Wohltman is an associate attorney at Mathis, Marifian & Richter, Ltd. and practices in Belleville, Illinois and St. Louis, Missouri. She concentrates her practice in taxation, estate planning and business law. She is a proud alumnae of McKendree University and recently received her LLM in Tax at Washington University.

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