Tax Court Confirms No Deductions for State-Legal Cannabis Business, Part VII: Five Lessons Learned from Harborside vs. IRS

Marijuana businesses have a great deal to learn from Harborside Health Center’s disappointments and victory in the medical marijuana dispensary’s recent tax case.

Although the Tax Court’s conclusion in the Harborside v. IRS case is not what we would have liked to see (with the exception of the accuracy-related penalty decision), we must admit that this was an well-written case that provides marijuana businesses with invaluable guidance. Here are five important lessons we have extrapolated from the court’s opinion:

Lesson #1: Staying in compliance does not guarantee protection from government intervention

From the very beginning, Steve DeAngelo took great pains to ensure that Harborside was in compliance with all State of California requirements as prescribed for medical marijuana dispensaries. He also ensured that all of Harborside’s federal tax returns were promptly filed. That didn’t stop the government from finding holes in DeAngelo’s accounting that lead to an audit and subsequent Tax Court case.

Objection to marijuana activities run deep in our society. If you work with cannabis, you must not only stay in compliance but should also engage experienced and aggressive guidance and representation to protect your interests.

Lesson #2: If the government abandons one claim against you, that doesn’t necessarily mean it can’t bring another

Just because the government fails in one claim against you, doesn’t mean it can’t raise another. Res judicata will only bar a subsequent claim if (1) it is identical to one already tried by a court, (2) it involves the same parties, and (3) there has already been a final judgment on the merits.

Lesson #3: Don’t expect the court to change what we already know, by arguing semantics

So long as marijuana remains a drug listed on Schedule I of the Controlled Substances Act, 26 U.S. Code § 280E will prevent marijuana dispensaries from deducting their ordinary and necessary business expenses. Arguing semantics may result in some interesting case reading, but is unlikely to change tax policy.

Lesson #4: If nearly everything you’re doing is selling marijuana, don’t argue that you operate a separate non-marijuana trade or business without ample evidence.

If nearly all of your revenue is generated from marijuana sales, do not expect any of your business expenses to be deductible. It is possible to take business deductions for non-marijuana-related activities, but you’ll need to make sure that those activities are managed separately, preferably with distinct staffing and facilities, so that no court would determine that you are operating a single trade or business.

Lesson #5: Keeping good books and records could save you a significant amount of money in the long-run

The fact that Harborside kept excellent records and was able to substantiate all their claimed deductions was a significant factor in the court ruling that accuracy-related-penalties were not warranted.

San Francisco Cannabis Law Group

Canabusiness accounting rules are complicated, so make sure that you have a qualified tax professional advising you from the outset. Marijuana businesses are on the government watchlist, and the IRS will not hesitate to question your tax returns. You can lessen the impact of the inevitable tax audit by making sure that your staff is properly documenting your inventory and costs, and that you are maintaining meticulous records.

The full service tax law firm of Moskowitz, LLP has successfully assisted many cannabusinesses with audits and tax litigation matters. To learn more about our services to the marijuana industry, contact our San Francisco office today.