The Tax Court ruled that a medical marijuana dispensary was not entitled to any business deductions and allowed a lower amount for cost of goods sold (COGS) than the taxpayers claimed. The court also upheld accuracy-related penalties.
Facts: In 2009, Altermeds LLC, owned by Laurel Alterman, opened a medical marijuana dispensary in Louisville, Colo. The dispensary sold various forms of edible and smokable marijuana. It also sold marijuana-related merchandise including pipes, papers, and other items used to consume marijuana. For 2010 and 2011, Alterman and William A. Gibson filed joint returns including Schedules C, Profit or Loss From Business, for Altermeds, which reported $770,306 in business expense deductions and $717,208 in COGS for the two years combined, against $1,552,048 in gross receipts. Upon examination, the IRS increased Altermeds's gross receipts, disallowed business expense deductions except for depreciation and Sec. 179 expenses, and reduced its COGS. It issued the taxpayers a notice of deficiency.
Issues: After concessions, the remaining issues were the amounts of COGS and whether some business expenses could be deducted against income from sales of nonmarijuana merchandise.
Sec. 280E disallows any deduction or credit for expenses incurred in a trade or business of trafficking in controlled substances as defined by schedules I and II of the Controlled Substances Act, P.L. 91-513. Marijuana is a Schedule I controlled substance. Marijuana dispensary owners may, however, reduce their gross sales by COGS, defined as:
- The cost of merchandise on hand at the beginning of the tax year;
- Plus the cost of merchandise purchased since the beginning of the tax year;
- Plus the direct and indirect cost of producing merchandise;
- Minus the cost of inventory on hand at the end of the tax year.
The taxpayers conceded that Altermeds trafficked in a controlled substance within the meaning of Sec. 280E but argued its sale of nonmarijuana merchandise was a separate business from the marijuana sales and that the business's expense deductions for the nonmarijuana merchandise business were not disallowed by Sec. 280E.
With respect to the amount of COGS, the IRS argued that the taxpayers' calculations did not account for beginning and ending inventories. The taxpayers contended the court could use the Cohan rule to estimate the inventories. The Cohan rule allows courts to use estimates for which there is a reasonable basis (Cohan, 39 F.2d 540 (2d Cir. 1930)).
Holding: The court noted that Altermeds derived almost all its revenue from marijuana sales and that its sales of nonmarijuana merchandise complemented its efforts to sell marijuana. Thus, it held that the nonmarijuana portion was interrelated with the marijuana portion, and the two could not be separated. The court declined to apply the Cohan rule to inventories to determine COGS, stating that it was unable to determine a basis for estimation from the record. Thus, it limited COGS to the amount conceded by the IRS.
In upholding the penalties, the court stated that the taxpayers were negligent by failing to keep adequate books and records and lacked reasonable cause because they did not obtain advice from their tax preparers and bookkeeper regarding inventory accounting or the effect of Sec. 280E.
- Alterman, T.C. Memo. 2018-83
— By David Silversmith, CPA, CFP, CFE, MBA, senior tax accountant at Fulvio & Associates, New York City.