The Contradiction Behind Legalized Cannabis


As most people are aware, the cannabis industry operates in a legal gray area. Eight states, as well as the District of Columbia, have made marijuana legal for adult (or recreational), use. This directly conflicts with the Controlled Substances Act. One of the many problems presented by the legal uncertainty. Cannabis businesses are still required to pay federal taxes, and the IRS strictly enforces a rule that is meant to penalize operators of illegal, drug-trafficking businesses.

In 1974, Jeffrey Edmondson filed a federal income tax return for his personal business, which was the sale of amphetamines, cocaine, and marijuana.

Despite the fact that his business was plainly illegal, he was able to write off approximately 20,000 miles on his car, trips to San Diego, food, entertainment, airfare, long distance phone calls, and even his rent, (because he worked out of his home.) Congress was understandably outraged that the US Tax Code essentially legitimized the sale of illegal drugs by allowing black market operators to claim exemptions. In response, they passed Federal Tax Rule 280E. This rule prohibits anyone “trafficking in controlled substances,” from deducting any of the expenses associated with that business. This rule was intended to stop criminal drug dealers from operating a successful business by taxing them out of existence. In the wake of legalization, 280E has demanded that marijuana businesses pay taxes on gross income, which creates an effective tax rate of approximately 70%. This is far, far higher than traditional retail businesses and it makes owning a marijuana business quite challenging because of the exorbitant tax rate.

The owners of a now-closed dispensary, Total Health Concepts, are challenging that rule in federal court. Under 280E the business owes more than $150,000 but they claim that the IRS was wrong to deny deductions and credits for typical business expenses that are commonly offered to other retail businesses. Furthermore, they argue that marijuana businesses are not “drug traffickers,” since relevant state law permits their existence. The IRS disagrees, because they are a federal agency, following federal law, which does define Total Health Concepts as drug traffickers.

If Total Health Concepts is successful in this endeavor, it would have wide-reaching effects for the entire industry. Marijuana businesses would be able to refer to this decision as proof for why they owe less money to the federal government.

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