The marijuana cases continue in the Tax Court as a consequence of various state laws allowing for state (though not federal) legal sales of marijuana. In the case of Beck v. Comissioner, TC Memo 2015-149 another unique issue for such operations was addressed.
IRC §280E generally does allow deductions, aside from cost of sales, for a taxpayer selling a federally controlled substance such as marijuana, even if the that sale is deemed to be legal under state law. In this case, one key issue was what was considered a cost of sale.
Jason Beck ran a medical marijuana business that became of interest to the federal Drug Enforcement Administration (DEA). As the Court noted:
On January 11, 2007, the DEA was authorized to conduct a search of petitioner's West Hollywood dispensary. In the affidavit attached to the Federal search warrant application, the DEA special agent described the items to be seized as evidence, fruits, and instrumentalities of violations of several Federal drug statutes related to possession with the intent to distribute a controlled substance, marijuana. The Central District of California authorized the DEA to seize numerous items, including controlled substances such as marijuana and edibles. On January 17, 2007, DEA special agents entered petitioner's West Hollywood dispensary and conducted a search of the premises. The DEA seized items [*9] including controlled substances, food items suspected to contain marijuana, and marijuana plants. The DEA also seized $1,470.71 and $11,082.
On his 2007 return, Jason claimed $600,000 as part of cost of sales that he claimed represented the cost of the marijuana the DEA seized.
The Tax Court found two problems with Jason’s claim. The first was that, simply, he had no support for his claimed costs. As the Court noted:
Petitioner seeks to characterize the cost of marijuana seized by the DEA as COGS. Petitioner values the seized marijuana at $600,000 but has provided no evidence as to how he computed this amount. Petitioner carried at least 70 different strands of marijuana in the West Hollywood dispensary. Petitioner failed to identify which strands were among the marijuana confiscated by the DEA. Petitioner did not provide any evidence regarding the amounts he paid for the strands of marijuana or how he determined his selling prices for the various [*18] strands of marijuana. In addition to marijuana, the DEA also seized edibles and marijuana plants. However, it is unclear whether petitioner is including costs of these items in the $600,000. Because of his complete failure to substantiate the value of the seized marijuana, petitioner is not entitled to claim $600,000 as part of his Schedule C COGS.
But, the Court noted, there was a more fundamental problem—the marijuana wasn’t sold. As the opinion notes:
Additionally, if petitioner had provided substantiation, the seized marijuana would still not be allowable as COGS because the marijuana was confiscated and not sold. See Holt v. Commissioner, 69 T.C. 75, 78 (1977), aff'd, 611 F.2d 1160 [45 AFTR 2d 80-763] (5th Cir. 1980).
Some readers may be thinking there is another way to deal with this. IRC §165 generally allows for deductions of losses incurred where assets are held with an eye towards income or profit. The Tax Court dealt with that as well, noting:
Although it is not entirely clear from the pleadings, petitioner appears to seek to deduct a section 165 loss for the marijuana seized by the DEA. In general, section 165(a) allows a deduction for any loss sustained during the taxable year and not compensated for by insurance or otherwise. Sec. 165(a). However, section 280E provides that no deduction or credit (including a deduction pursuant to section 165) shall be allowed for any amount paid or incurred in connection with trafficking in a controlled substance. Holt v. Commissioner, 69 T.C. 75. Therefore, petitioner is not entitled to a section 165 loss deduction for the marijuana seized by the DEA.