Business Deductions Up In Smoke

The following three cases published this past summer provide guidance to cannabis businesses and their owners in preparing their federal income tax returns. These cases turn on the application of IRC Section 280E, which precludes taxpayers from deducting any expense relating to a business that consists of trafficking in cannabis. The application of Section 280E is generally discussed here. Set forth below are the key takeaways from these cases and a general summary of each case,

The Tax Court recently held that Altermeds, LLC (Altermeds) did not have adequate records to prove that it was entitled to non-cannabis business expense deductions or an accurate cost of goods sold (COGS) exclusion. Alterman v. Commissioner, T.C. Memo 2018-83. On audit, the IRS disallowed Altermeds’ business expense deductions pursuant to Section 280E and decreased Altermeds’ exclusion from gross income for COGS. In this case, the taxpayers argued that some of the business expenses were deductible because they were part of a non-cannabis business; however, the Tax Court held that they did not adequately brief the issue or provide records of expenses to prove that Altermeds was operating a separate non-cannabis business and the amount of expenses related to it. The Tax Court upheld the IRS’ adjustment to COGS finding that Altermeds did not correctly calculate COGS because it did not include its beginning and ending inventories in the calculation and did not provide documentation of beginning and ending inventories that could be used to estimate those amounts to increase the COGS adjustment.

In Loughman v. Commissioner, T.C. Memo 2018-85, the Tax Court held that a Colorado S corporation (Palisades) that grew and sold cannabis could not deduct wages it paid to its officers. In that case, the taxpayers were S corporation shareholders and officers of Palisades and were assessed tax based on their income from their ownership interests in Palisades. On audit, the IRS disallowed Palisades’ business expense deductions pursuant to Section 280E, including its deduction for wages paid to the taxpayers as its officers of Palisades. The taxpayers argued that since S corporations are required to pay a reasonable wage to officers, Palisades should be allowed to deduct wages paid to its shareholders as officers; to do otherwise would be...