Tax Court Upheld by Ninth Circuit on IRC 280E Expense Deductibility

IRS logoOn July 9, 2015, the Ninth Circuit issued its decision in Olive v. Commissioner of Internal Revenue, which resulted in the first published appellate court opinion in the thorny and often-litigated area of income tax deductibility under Internal Revenue Code section 280E. That section prohibits a business entity from deducting ordinary and necessary business expenses from income derived from the operation of a trade or business that consists "of trafficking in controlled substances . . . prohibited by Federal law."

Because the taxpayer, Martin Olive, did not succeed in overturning the tax court’s decision in his appeal, the "conventional wisdom" following the decision was that this was a blow to the cannabis industry. In reality, however, when one examines the language and the reasoning of the Ninth Circuit’s opinion, it provides practitioners representing dispensaries with valuable tools to achieve deductibility of such expenses in ongoing or future litigation.

The way things turned out, Martin Olive had just showed too good a heart in conducting his business to enable the Ninth Circuit to overturn his tax court decision. Mr. Olive sold medical marijuana but, as the Court pointed out, the other services that his Vapor Room offered—including, the provision of vaporizers, food and drink, yoga, games, movies, and counseling—were given to its patrons "at no cost to them." For this reason, the Court concluded that Olive’s "trade or business" was limited to medical marijuana sales. The Court further concluded that given the limited scope of Olive’s business, the business consisted solely of trafficking in controlled substances, which is prohibited by Federal law; consequently, under §280E, the expenses that Olive "incurred in the course of operating the Vapor Room cannot be deducted for federal tax purposes."

In contrast, the vast majority of dispensaries currently in operation sell a variety of products and services besides cannabis. In addition to realizing revenue from the "vaporizers, food and drink, yoga, games, movies, and counseling" that Olive provided for free, many dispensary operators have branched out into selling e-pen devices, as well as a wide range of branded products other than the "controlled substance" itself.

For all of these dispensaries, if and when their cases are litigated in tax court, the factual scenario will be the flip side of Olive. Following the Ninth Circuit’s reasoning, the "income-generating activities" of these dispensaries do not consist "solely of trafficking in medical marijuana." Therefore, the result of these cases likely could be very different from the Ninth Circuit result in Olive.

Exactly how different the results will be remains to be seen. Many attorneys and accountants practicing in this area have become adept at performing “280E allocations” in which deductible and non-deductible expenses are allocated according to a formula. (In the case of Californians Helping to Alleviate Medical Problems, Inc. v Commissioner (2007) 128 TC 173, for example, the allocation performed by the tax court judge resulted in 85 percent of the total expenses being deemed deductible expenses.) In addition, there will almost certainly be other, new lines of argument raised by taxpayers’ counsel based on the language and reasoning of the Olive opinion, as our firm anticipates going to trial in several different tax court cases involving cannabis dispensaries in the coming year.


Henry Wykowski is nationally recognized as the go to attorney for the cannabis industry.

He initially distinguished himself in the defense of the landmark case of CHAMP v. Commissioner, limiting the punitive applicability of IRC Sec. 280E. Since then, Henry has been lead counsel in the cannabis industry’s most important cases, including the Harborside Health Center, and Berkeley Patient's Group forfeitures. He serves as counsel for many of the most prominent members of the industry.

Henry is a founding member and Counsel of the National Cannabis Industry Association (NCIA).  

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