A Cannabis Tax Court Case That Made Me Laugh

I read a lot of Tax Court Cases, and this one had me so confused, I thought the taxpayers were doing the case pro se (representing themselves). This is a case of an attorney just wanting to collect a large fee, because there is no legal footing to stand on. For the millionth time:

§ 280E Expenditures in connection with the illegal sale of drugs.

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.

Cannabis is legal in a lot of states, but IRC §280E precludes cannabis companies from deducting anything other than COGS. Here is an article about a cannabis company that wanted to do things on the cheap, until they get in trouble.

Alterman owned Altermeds, LLC, a disregarded entity treated as a sole proprietorship for federal tax purposes, which opened a retail store under the business name Altermeds (the dispensary). It sold smokable marijuana, either as prerolled marijuana cigarettes (i.e., joints) or as dried marijuana buds, as well as marijuana in edible form, such as brownies and cakes, and orally-consumed tinctures (collectively, marijuana merchandise). In addition, the dispensary sold products that contained no marijuana, such as pipes, papers, and other items used to consume marijuana (collectively, non-marijuana merchandise).

In 2012, IRS examined Alterman and Gibson’s 2010 and 2011 returns, focusing exclusively on Altermeds, LLC’s Schedules C (Profit or Loss from Business). In a notice of deficiency, IRS determined that Altermeds, LLC, underreported gross receipts by $24,663 and $8,359 for 2010 and 2011, respectively. The notice allowed costs of goods sold of $388,231 and $1,021 for tax years 2010 and 2011, respectively. In addition, IRS disallowed all of Altermeds, LLC’s Schedule C business expense deductions for the 2010 and 2011 tax years under Code Sec. 280E, except for depreciation and Code Sec. 179 expensing ($49,671 and $719 for the 2010 and 2011 tax years, respectively). IRS also determined accuracy-related penalties under Code Sec. 6662(a).

Would you believe that the internal bookkeeper did these returns? Alterman hired a cannabis specialist, but realized he was too expensive, and went back to the bookkeeper. Unexplainably, in 2010, and 2011 the dispensary had no beginning inventory. COGS is calculated by beginning inventory, plus purchases, and any other expenses, less ending inventory. There are legal ways to increase COGS, but to be bold enough to deduct your other expenses, because you sell drug related items and clothing, that made up for 5% of total sales. These expenses were sold out, and the Tax Court was left to apply rough justice on what actual COGS is.

What’s got me, when the return the expensive guy prepared didn’t get audited. However, I couldn’t believe any attorney would take a losing case.