As marijuana has become, at the state level in certain states, legal to sell in some form (medical or recreational) those looking to enter that market find that federal law does not condone this business. In addition to still being treated as an illegal substance under federal law, the Internal Code has a nasty treatment for any such business found at IRC §280E. The taxpayer in the case of Alterman v. Commissioner, TC Memo 2018-83, discovered just how harsh the federal tax law is in this area.

IRC §280E provides:

No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.

The provision bans a deduction for any business expenses aside from the cost of the product (that is, the marijuana) for such a business.

The taxpayer in this case operated Altermeds, LLC, a disregarded entity. That entity sold marijuana-based products and, after initially buying the marijuana from a third party, began growing its own marijuana for sale.

The Tax Court described the following income and deductions reported by the taxpayer for the years at issue on the Altermeds Schedule C:

For 2010, the Schedule C reported gross receipts of $894,922. The Schedule C reduced gross receipts by cost of goods sold of $464,119. The Schedule C also reported business-expense deductions of $385,489.

For 2011, the Schedule C reported gross receipts of $657,126. The Schedule C reduced gross receipts by cost of goods sold of $253,089. The Schedule C also reported business-expense deductions of $384,817.

Obviously, all the expenses aside from the cost of sales were at risk once IRC §280E is considered. Faced with that prospect, the taxpayers presented the following argument:

Although Alterman and Gibson concede that Altermeds, LLC, trafficked in controlled substances, they contend that it had a separate business of selling non-marijuana merchandise and that the business-expense deductions of this separate business are not disallowed by section 280E.

The “other line of business defense” is an acceptable one, but taxpayers must be able to show that there is a separate business and account for those expenses that are tied to each business being conducted (the marijuana businesses and the others). As the Court notes:

Whether selling non-marijuana merchandise was a separate business from selling marijuana merchandise is an issue of fact that depends on, among other things, the degree of economic interrelationship between the two activities. See Californians Helping to Alleviate Med. Problems, Inc. v. Commissioner (CHAMP), 128 T.C. 173, 183 (2007). …

If, however, selling non-marijuana merchandise were considered a separate business, then the expenses of that business would be deductible. See CHAMP, 128 T.C. at 183-185 (stating that caregiving services were a business separate from provision of marijuana; expenses of providing caregiving services were deductible).’

The Court, however, did not find that the taxpayers had multiple businesses in this context, noting:

Under the circumstances, we hold that selling non-marijuana merchandise was not separate from the business of selling marijuana merchandise. First, Altermeds, LLC, derived almost all of its revenue from marijuana merchandise. Second, the types of non-marijuana products that it sold (pipes and other marijuana paraphernalia) complemented its efforts to sell marijuana.18 Altermeds, LLC, had only one unitary business, selling marijuana. See Canna Care, Inc. v. Commissioner, T.C. Memo. 2015-206, at *12, aff'd, 694 F. App'x 570 (9th Cir. 2017).

The Court specifically dealt with the taxpayer’s amount of claimed “non-marijuana” business related expenses:

lterman and Gibson argue that these deductible expense are $54,707.03 in 2010 and $57,517.93 in 2011. These amounts are equal to 40% of a list of subtotals in a table in the brief filed by Alterman and Gibson after trial. Each subtotal bears a vague description, for example “Non-COGS Utilities”.

However, the brief fails to adequately explain why any portion of those subtotals is deductible. In particular the brief fails to:

identify any specific payments that make up these subtotals;
provide record citations to support these subtotals; and
propose findings of facts regarding these subtotals.

Alterman and Gibson's argument regarding the amounts of business-expense deductions attributable to a putative second business was not briefed properly. See Rule 151(e)(3) (brief must include proposed findings of fact with references to the record); Rule 151(e)(5) (brief must include arguments regarding any disputed questions of fact). Even if we thought that the sale of non-marijuana merchandise was a separate business, Alterman and Gibson's failure to properly brief the amount of deductions that would be attributable to this business would preclude us from allowing any deductions for the separate business.

Thus, the Tax Court limited deductions to the cost of goods sold amounts that the IRS had conceded in the case. Even there, the taxpayer’s poor and inconsistent records resulted in the allowed deductions being less than the amounts the taxpayer had originally claimed.