Current Federal Tax Developments

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Offers in Compromise Available for State Legal Marijuana Sellers, But §280E Expenses Not Counted in Computing Available Income

The IRS in a memorandum issued by the Small Business Self Employed Division (SBSE-05-0416-0016) has outlined how the agency will approach requests for offers in compromise for businesses that cultivate and sell marijuana in states where state law makes such activities lawful.

The memorandum will supplement procedures found in the Internal Revenue Manual at IRM 5.8.5 (Offers in Compromise—Financial Analysis) and 5.8.7 (Offers in Compromise, Return, Terminate, Withdraw, and Reject Processing).

Although state laws may make the cultivation and sale of marijuana legal, federal law still classifies such activities as illegal. Generally the IRS has rejected offers in compromise for taxes that arise from illegal activities as being against public policy (see IRM

The good news for those who have liabilities that are traced back to the cultivation and sale of marijuana is that the memorandum states that such offers are not to be automatically rejected on public policy grounds. The memorandum notes that:

These provisions are specific to the marijuana industry, where state statutes allow the activity, and are not intended as guidance for other instances involving taxpayers who are in violation of federal law.

So, for instance, if the taxpayer had been growing and selling marijuana in a state where the activity was not legal, or was not in compliance with the state rules where it was legal, these rules would not apply.

However with the good news comes bad news—the computation of income available to pay taxes will be based on federal tax law rules, in particular including the rules at IRC §280E.

IRC §280E denies a deduction for any expenses aside from cost of goods sold that are related to the business of trafficking in federally controlled substances—of which marijuana is one such substance. So, for instance, the cost of paying employees, rent, and the like would not be considered in the computation of the value of future income used to compute the minimum necessary offer.

As a practical matter, this likely will mean that an OIC will only be an option for a taxpayer that has abandoned the business, and so no longer will have any expenses that would be subject to the IRC §280E rules.