We’ve covered a few tax court cases so far and want to keep you informed on the tax court cases we are seeing, as they can directly affect you as a cannabis owner. It’s a fact, you will be audited. The IRS has already stated the cannabis business will be audited. It is not a matter of if, but a matter of when. They are hiring more employees for this very reason. The IRS knows that cannabis companies are going to be looking at ways to cut down on the taxes they are going to have to pay on their revenue. Because cannabis companies have such a high tax rate, the IRS is going to make sure they get every dollar they are due. 280E not only puts cannabis companies in a hard position tax-wise, but it also gives the IRS more power when determining taxes owed. The IRS is not letting any cannabis companies get by. We’ve already seen the tax court hand down several rulings that back the IRS’s findings. Olive v Commissioner was one case that helps solidify the IRS’s stance on 280E.
Olive v Commissioner
Olive v Commissioner is one of the many cannabis business owners that tried to apply CHAMP’s winning argument in tax court to their business. Unfortunately, in this case, the CHAMP argument was denied by the tax court. Mr. Olive owned a California facility, The Vapor Room, where the sole source of revenue was from its sale of marijuana. Customers went to the Vapor Room to smoke or inhale vaporized marijuana. This was what the business profited from. Along with being able to consume cannabis, customers could also do other activities. The business was set up like a community center with couches for people to sit on and games, books, and art supplies available for customers to use. They also offered yoga, movies, and massage therapy. Customers could drink tea or water during their visit and enjoy complimentary snacks like pizza and sandwiches. The Vapor Room offered all these items for free.
Olive took normal business deductions on his tax return and the IRS ended up auditing him. The IRS said Olive couldn’t take the business deductions because he was trafficking a controlled substance. They disallowed the expenses and assessed a large tax balance. Olive tried to argue that because of these services offered, he should be able to deduct more operating expenses than just the cost of goods sold. The tax court distinguished the facts in his case from those in CHAMP. The court stated that the business sole purpose was to sell medical marijuana and that he offered the other services as part of the cannabis business. Unlike in CHAMP, the services provided to the clients were not extensive and were not the selling point of the business when compared to the selling of cannabis products. The court pointed out that all of the testimony from Olive and from his other witnesses was rehearsed, not impartial and not credible, which undoubtedly played into the court’s decision to rule in favor of the IRS. The court perceived Olive’s claim at court that the Vapor Room actually consisted of two businesses as simply an after-the-fact attempt to artificially equate the Vapor Room with the medical marijuana dispensary in CHAMP so as to avoid the disallowance of all of the Vapor Room’s expenses under §280E. Olive attempted to apply CHAMP after the fact but his arguments did not match his actual business practices. The court concluded that § 280E applied to Olive’s business and he could not deduct any of the Vapor Room’s claimed expenses other than the cost of goods sold.
Olive v Commissioner is a prime example of trying to work the system. Olive did not set up two different businesses in the beginning and did not run two separate businesses throughout the year. He sold marijuana and offered free services to his clients. This is not the same as the CHAMP case.
If you need help setting up your cannabis business structure or need help doing the accounting, Polston Tax can help! We’ve studied the tax law and know what your company needs to do to avoid ending up like the Vapor Room. Give us a call at 844-841-9857 or click below to schedule a free consultation.