Pubdate: Mon, 08 Jun 2015
Source: Albuquerque Journal (NM)
Copyright: 2015 Albuquerque Journal
Contact:  http://www.abqjournal.com/
Details: http://www.mapinc.org/media/10
Author: James R. Hamill
Note: James R. Hamill is the director of Tax Practice at Reynolds, 
Hix & Co. in Albuquerque.

TAX LAW OUT OF SYNCH WITH STATE POT TRENDS

With marijuana still illegal under federal statutes, a business based 
on reefer can't take usual deductions

Oliver Wendall Holmes said "taxes are the price we pay for 
civilization." No one likes paying taxes, but Americans actually do 
agree that taxes are necessary and we have a wonderful system of 
government that allows us to choose those who represent us in our 
social compact of how to spend tax dollars.

All we want is for the tax system to be fair. The problem is there 
are several notions of what a fair system would look like. As Russell 
Long, one of the last senators to actually understand the tax system, 
once said, "Don't tax you, don't tax me, tax the fellow behind the tree."

While we do need taxes, we also recognize that taxes distort economic 
behavior. So one of many policy objectives in crafting tax laws is to 
reduce the distortive impact that taxes have on economic behavior.

Social norms change and, as they do, our concept of what is fair can 
also change. Like it or not, there is a growing movement, no pun 
intended, to legalize the use of marijuana. Colorado, Washington, 
Alaska, Oregon and the District of Columbia have permitted production 
and sale of marijuana.

There are also now 23 states plus Washington, D.C., that permit the 
use of marijuana for medical purposes. So, marijuana production and 
sale is a type of industry, one that, like others, is affected by the 
distortive impact of taxes.

But marijuana production and sale is special because our tax laws 
were changed 35 years ago to support the war on drugs that had 
started 12 years earlier. Marijuana production and sale is now a 
legal industry in many states, but an industry particularly burdened 
by the distortive impact of taxes.

Business income is, of course, subject to tax. A business owner is 
allowed to subtract, from gross receipts, the reasonable costs of 
operating the business. This includes both costs of the goods sold to 
customers, as well as ordinary and necessary expenses of operating 
the business.

Our tax system applies a statutory rate to a net income figure that 
is determined using the laws enacted by the legislative branch and 
signed by the executive branch. Many of these laws attempt to 
encourage business expansion and success. For example, we allow as 
much as $500,000 of equipment purchases to be written off against 
income immediately (this figure is subject to extension by Congress).

But the effect of taxes on a marijuana business is quite the 
opposite. In 1970, marijuana was classified as a schedule I 
controlled substance by the federal Controlled Substances Act. In 
1982, the tax law was changed to deny any tax deduction for a 
business that involves trafficking in a controlled substance.

Before states passed legislation legalizing marijuana sales, the 1982 
prohibition on deductions arose in only a handful of tax cases 
involving illegal drug trafficking. I was in tax practice in all of 
the post-1982 years and never heard any pleas to reduce the tax law's 
punitive treatment of business expenses for illegal drug trafficking.

Now, with state law changes affecting the production and sale of 
marijuana, the 1982 law applies to a state law-legal trafficking 
activity. The problem is that the activity is still illegal under federal law.

The legislative history of the 1982 law makes clear that the 
prohibition on deductions does not apply to costs of goods sold. This 
mitigates its effect, but all other ordinary business expenses, such 
as salaries, equipment purchases, building rent and so on, are disallowed.

The end result is that the marijuana business is taxed on its gross 
profit (sales minus costs of goods sold). Some may think that's good 
because it discourages the creation and growth of such businesses. 
States that have legalized the activity may not agree.

But the 1982 law also denies a medical expense deduction for anyone 
who has a doctor's prescription to use marijuana for medical 
purposes. Why? Because the marijuana, whether obtained by 
prescription or not, cannot be lawfully obtained under federal law 
and that is a requirement for a federal deduction.

Right or wrong, the national view on marijuana use, for medical 
purposes and otherwise, has changed since 1982. But the federal tax 
law remains stuck in 1982.
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MAP posted-by: Jay Bergstrom