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Firms can legally sell medical marijuana in 19 states and the District of Columbia and recreational weed in two. They must pay federal income taxes, but unlike all other businesses they are prohibited from reducing their taxable income by deducting business expenses. It is, to say the least, an odd state of affairs.
Almost all firms are taxed on their income, that is, revenues minus expenses. But not businesses that sell drugs such as marijuana. In effect, they must pay a gross receipts tax, not an income tax. The loss of those deductions is a big deal. It results in very high effective tax rates and discourages tax compliance.
Congress passed the law explicitly barring deductions for drug sellers back in 1982. According to a nice summary by Stephen Fishman at nolo.com, this happened after the Tax Court ruled that a cocaine dealer could reduce his taxable income by subtracting the wholesale cost of the drugs he peddled. It even let him take a home office deduction for his illicit activities.
Curiously, the law (Sec. 280E, if you are keeping score) applies only to firms that sell illegal drugs. As Fishman notes, a professional hit man can deduct his cost of doing business. So can a prostitute. But a drug seller cannot. The law applies if the sales are barred under federal law even if they are perfectly legal in the state where the dispensary operates.
Or course, this is tax law we are talking about so things are not quite so clear cut. In 2012 the Tax Court allowed a California dispensary to subtract its wholesale cost of marijuana from gross income (the law explicitly bars only deductions or credits, not subtractions from income such as the cost of goods sold). But the firms cannot deduct other expenses, such as rent, advertising, legal fees and the like.
To further complicate matters, the Tax Court ruled in 2007 that a medical marijuana dispensary that also provides health care may deduct expenses for that part of its business, if it can show that caregiving is its primary feature.
Rep. Earl Blumenauer (D-OR) introduced a bill this week that would allow legal marijuana sellers to take the same deductions as all other businesses. A similar measure introduced back in 2011 by former Rep. Pete Stark (D-CA) went nowhere.
The whole issue is, in some ways, similar to same-sex marriage. These marriages are legal and absolutely indistinguishable from heterosexual unions in some states. But legally married couples are not allowed to file joint federal income tax returns because their unions are not recognized under federal law, thanks to the Defense of Marriage Act. The Supreme Court is expected to rule any day now on the constitutionality of DOMA.
If the court dumps DOMA, same-sex couples will soon be able to file joint returns (when some will find the fiscal benefits of marriage are somewhat less satisfying than the emotional rewards). But I suspect it will take a lot longer than that before legal drug sellers will be able to deduct their rent.
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