The Harborside Health Center cannabis dispensary lost in the United States Tax Court. The Tax Court disallowed all of the dispensary’s expenses. However, the Tax Court opinion provides a roadmap for how to avoid the “Cannabis Tax Trap.”
In Patients Mutual Assistance Corporation dba Harborside Health Center v. Commissioner, 151 T.C. 11 (2018), the Tax Court disallowed all of a cannabis dispensary’s deductions for business expenses. Pursuant to Internal Revenue Code Section 280E, a taxpayer cannot deduct expenses attributable to the trafficking of drugs that are deemed illegal under federal law. In addition to selling marijuana, the dispensary provided therapeutic services to its marijuana customers. The dispensary also sold non-marijuana containing products such as hats, hemp bags, books about marijuana and marijuana paraphernalia. The petitioner conducted all of its business activities in the same entity.
The Tax Court determination to disallow all expense deductions was based on the following factors:
- High Percentage of Receipts from Marijuana Sales: The petitioner derived over 98% of its income from the sale of cannabis;
- No Separation of Marijuana and Non-Marijuana Related Employees: The same employees provided both cannabis and non-cannabis products and therapeutic services;
- Low Percentage of Floor Devoted to Non-Marijuana Inventory: The non-marijuana products occupied only 25% of the petitioner’s sales floor;
- No Public Access to Non-Marijuana Products. The non-marijuana products were not accessible to the general public because only those people who passed through the petitioner’s security procedures could access the non-marijuana products;
- Close Connection of Therapeutic Services with Marijuana Sales. Therapeutic services were not offered separately from the marijuana sales, and
- No Formal Separation of Non-Marijuana Business Activities. The petitioner did not have a separate entity, management, books, or capital for its non-marijuana sales activities.
As a result of these factors, the Tax Court concluded that the dispensary sales of non-marijuana products and services had a “close and inseparable organizational and economic relationship” with the primary business of selling marijuana. Consequently, the Tax Court determined the dispensary could not deduct expenses related to those products and services because they were merely an “incident to” primary business of selling marijuana.
To avoid the Cannabis Tax Trap, dispensaries should consider the following:
- Conduct separate lines of businesses through separate entities. That is, place a dispensary’s marijuana sales business in a separate entity from other lines of business such as therapeutic services or sales of products that do not contain marijuana;
- Offer therapeutic services independent of marijuana sales;
- Offer to the general public products that do not contain marijuana; and
- Employ separate personnel for the dispensary’s marijuana sales business and the dispensary’s non-marijuana sales operations such as therapeutic services and sales of products that do not contain marijuana.