Will Medical Marijuana Sellers Get the Capone Treatment?

Suppose you are lucky enough to operate a medical marijuana dispensary in a state that—unlike, say, Montana—explicitly authorizes such businesses. Then you would be "in clear and unambiguous compliance with existing state laws providing for the medical use of marijuana," so you should not have to worry about federal drug charges, according to a policy announced by the Justice Department in October 2009. But that does not mean you won't have legal trouble with the federal government. In fact, a recent story in the Marin Independent Journal suggests that by the time the IRS gets through with you, you might wish you had only been raided by the DEA:

The Internal Revenue Service has notified the Marin Alliance for Medical Marijuana in Fairfax [California] that it owes millions of dollars in unpaid back taxes, according to the alliance's founder and director, Lynnette Shaw.

Shaw said the IRS audited the alliance's tax returns for 2008 and 2009 and disallowed all of its business deductions. She said that although dispensaries throughout the state are being audited by the IRS, the alliance is the first to be told it can't deduct business expenses.

"Every dispensary in the nation, past, present and future, is dead if this is upheld," Shaw said.

Why can't a medical marijuana dispensary deduct business expenses? Because Section 280E of the Internal Revenue code 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." At the same time, however, the fact that your business involves selling a Schedule I drug does not mean you don't owe tax on your illegal income. As the IRS helpfully explains, "Income from illegal activities, such as money from dealing illegal drugs, must be included in your income on Form 1040, line 21, or on Schedule C or Schedule C-EZ (Form 1040) if from your self-employment activity."

[Thanks to Tom Murphy for the tip.]