Law requires reporting of all income including that from illegal activity. Tax expert Vern Hoven breaks down what the IRS and court cases say about deductions and reporting related to medical marijuana sales.
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Vern Hoven: What is the tax ramification of selling Marijuana? In this case, it's medical marijuana. In medical marijuana, the reportable rule 61A says you got to report all income from no matter what sources. I don't care if it's an illegal or illegal activity, you got to report it. The problem with Marijuana is 280E. You’ve got to report the gross and you don't get any deductions. Wow, it would be that nasty, but we have a series of court cases that say there is some deduction that is allowed, and that is at least for the cost of goods sold—the above the line. You're not going to get operating cost but you're going to get the cost of goods sold.
So, the question is why? In the states, it's not illegal. I think more than half the states now. All are medical marijuana I think it's like six or so states allow recreational marijuana in the state level. Purpose reason is that it is considered illegal activity is at the federal level. It's a class one drug, it’s an illegal activity, and therefore 280E applies, and on the federal return, maybe on the state return, you get all of your expenses.
Until such time as the federal government or congress rules that marijuana is not a class one drug, we could deduct the cost of goods sold, because we have court cases, we can't deduct the selling cost and the travel, and the entertainment and the other below the cost of goods sold line deduction.
If you're a producer, you do get to deduct, as cost of goods sold, the direct cost to grow the marijuana. Some types of indirect cost are above the line part of cost of goods sold. If you're a seller of it, now all of a sudden it's just a cost of the purchase but your marketing cost, your other type of cost are not going to end up being allowed. So, there’s a case called Jason Beck that tells you even types of capital losses that are going to end up being deductible.
In other words, in the marijuana field, we're trying to put as much up into the cost of goods sold and the least amount into the operating cost, we're going to have to some fairly sophisticated records to whether you're the grower or the seller, that's what the rules are in reporting the income and expenses of medical marijuana.
The case you might want to look at is Olive. Olive is really interesting in that he has really bad books. It's a cash business in it and he was the owner of the Vapor Room. Would you just not like to have a client where the name of the Vapor Room and I kind of suspect the IRS could figure that out very quickly. He didn't have any records at all. The court said in Olive, "Wait a minute, he buys and sells marijuana." IRS, I know he has bad records, but you've got to allow him at least some above the line cost of goods sold deduction, and they estimated it. It under what's called the Cohan Rule.
The Cohan is a very basic tax law that says it is only fair that… Then the court said, Wait a minute, he sold marijuana. So he must have bought it. It's only fair that he gets some cost of goods sold even with bad records.
The last thing that I want to talk to you about is because they're dealing and your medical marijuana or recreational marijuana business is dealing almost exclusively in cash, what do you do about payroll? How does the business deposit the payroll that they collect and have to pay on their employees?
What we've given you is a couple of links, banks when you're supposed to take all payroll deposits and you can take it to the bank in a timely manner, same day within three days to do that. If a bank finds out that your client is involved in the sale of an illegal activity, they won't take the money and the IRS doesn't have the capacity for us to do on a daily basis take payroll withholding and let the medical marijuana business take it to the Internal Revenue Service.
The IRS does have certain procedures and you want to Google “unbanked business deposits.” We give you some guidance to this and the IRS will help you on this one, but they had to provide some way for these type of companies who are dealing in cash to pay the payroll tax withholding in cash and it's got to the Internal Revenue Service. Banks just simply won't do that.