Taxpayers cannot take deductions for business expenses associated with operating a medical marijuana dispensary, according to a recent ruling by the Ninth Circuit Court of Appeals.

In 2012, the United States Tax Court assessed penalties and fines against San Francisco’s Vapor Room Herbal Center, finding the medical marijuana dispensary inappropriately deducted $654,071 as “business expenses” on its 2004 and 2005 tax returns.   Although the Internal Revenue Code allows individuals and businesses to deduct “ordinary and necessary expenses” from their gross income,  the Code prohibits deductions for any “trade or business [that] consists of trafficking in controlled substances . . . prohibited by Federal law.”  I.R.C. § 280E.  The Tax Court determined that operating a medical marijuana dispensary constituted trafficking a controlled substance prohibited by federal law, regardless of whether it was legal in California.

Martin Olive – the owner of Vapor Room – appealed to the Ninth Circuit, arguing (among other things) that Congress intended § 280E to apply only to “street dealers,” not medical marijuana dispensaries (which, at the time Congress enacted the Internal Revenue Code, did not yet exist).  The Ninth Circuit disagreed, stating that subsequent state legalization of marijuana was irrelevant to the question of whether “marijuana is a controlled substance ‘prohibited by Federal law.’”  As it is clear marijuana is illegal under federal law, the Ninth Circuit upheld the Tax Court’s decision and noted that “i[f] Congress now thinks that the policy embodied in § 280E is unwise as applied to medical marijuana sold in conformance with state law, it can change the statute.  We may not.”