Former Tax Judge Indicted for Tax Evasion Wrote Cannabusiness Decision

Diane Kroupa helped establish the confusing rules for paying taxes on income from marijuana sales.


DeBarge Winery

A former U.S. Tax Court judge who was recently accused of cheating on her taxes wrote a 2012 decision that continues to complicate the finances of state-licensed marijuana merchants. According to an indictment announced yesterday, Diane Kroupa and her husband, Robert Fackler, disguised personal spending as business expenses on returns the couple filed from 2004, the year after she was appointed to the court, and 2012, the year she wrote an opinion that made it harder for medical marijuana dispensaries to deduct business expenses by attributing them to services other than the sale of cannabis.

Kroupa was applying Section 280E of the Internal Revenue Code, a provision aimed at drug dealers who are conscientious enough to file tax returns. Section 280E says "no deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business…consists of trafficking in controlled substances…which is prohibited by Federal law." Since marijuana is still banned by federal law, Section 280E applies even to cannabusinesses that states consider legitimate.

Citing a 2007 U.S. Tax Court decision that let Californians Helping to Alleviate Medical Problems (CHAMP) deduct expenses related to "counseling and other caregiving services" even though the organization also distributed marijuana, Martin Olive, the owner of another San Francisco dispensary, the Vapor Room Herbal Center, argued that the bulk of his expenses likewise were unrelated to "trafficking in controlled substances." Kroupa rejected that claim, saying Olive essentially was engaged in the business of selling pot, even if those sales were accompanied by "incidental" services such as advice and yoga classes.

At the same time, Kroupa said Olive should be allowed to subtract his full "cost of goods sold" (COGS), which consisted mainly of his marijuana purchases, from his gross revenue, because COGS, which "is subtracted from gross receipts in determining a taxpayer's gross income," does not qualify as a "deduction" under Section 280E. Kroupa's ruling was upheld by the U.S. Court of Appeals for the 9th Circuit in 2015.

The upshot of the distinction between COGS and business expenses is rather counterintuitive. A marijuana merchant cannot deduct ordinary business expenses such as rent and wages unless he can persuasively attribute them to activities other than selling marijuana. But he can deduct the cost of the marijuana he sells—either the price he paid for it or the expenses he incurred in growing and processing it. While a can of coffee in the break room may not be deductible, a jar of Purple Urkle buds in the sales area is.

The maneuvers that led to charges against Kroupa and her husband sound straightforward by comparsion. Federal prosecutors in Minneosta say they falsely reported money they spent on vacations, jewelry, clothing, spa treatments, pilates classes, wine, dry cleaning, homes in Minnesota and Maryland, and other personal items as expenses related to Grassroots Consulting, a business run by Fackler. According to the indictment, these bogus business expenses reduced their tax bill by a total of "at least $400,000."

Kroupa and Fackler are each charged with conspiracy, tax evasion, making and subscribing false tax returns, and obstruction of an IRS audit. The first two charges are each punishable by up to five years in prison, while the latter two charges can get you up to three years and one year, respectively.

"Reporting personal expenses as business expenses on your tax returns is not tolerated, regardless of your job or position," said Richard Weber, chief of criminal investigation at the Internal Revenue Service. "We expect all taxpayers to follow the law—whether you are a business owner, individual, or government official. We all must play by the same rules and pay our fair share."

Many of the expenses the feds say are phony, including money spent on computers, travel, Mandarin lessons, cellphone service, housing expenses (assuming Fackler had home offices in two locations), and even wine (for entertaining clients?), sound like they could be at least arguably related to Fackler's consulting business. You can read this case as well-deserved justice for someone who cheated on her taxes while punishing others for doing so, or as an attempt to scare taxpayers away from claiming legitimate deductions that cut into the government's revenue. Or both.