May 3, 2016 / by Stephen P. Pingree

While most applicants for the soon to be awarded Hawaii Medical Marijuana Dispensary licenses understand that any business must deal with State and Federal Income taxes, there may be some confusion about the applicability and consequences of the Federal Internal Revenue Code Section 280E. IRC 280E denies all normal business tax deductions to any trade or business “trafficking in controlled substances” within the meaning of the Controlled Substances Act Schedule I. Marijuana remains listed in CSA Schedule I, and therefore any business touching Marijuana (e.g. dispensary, cultivation, production, and perhaps labs) may not take any normal business income tax deductions on its federal income tax returns pursuant to IRC 280E.

Hawaii State Tax law usually follows the Federal Internal Revenue Code in administering the Hawaii Income tax law to Hawaii businesses. Currently, the Hawaii Legislature is moving HB2707 HD2 SD1 through committee with a specific amendment to HRS 235 (Hawaii Tax Law) that will exempt the application of IRC 280E for any legal Hawaii MMJ business. This article will focus on the history of IRC 280E, the consequences for MMJ businesses, the impact on patients, Federal Case law pertaining to IRC 280E, pending Federal Legislation, and the future for Hawaii MMJ businesses.

Federal tax law requires that ALL income, legal and illegal, must be reported and taxed. Section 280E of the Internal Revenue Code was enacted by Congress in 1982 to deny organized crime and drug dealers the ability to profit from illegal income.

Because IRC 280E specifically refers to the Controlled Substance Act, Schedule I, which also includes “marijuana”, any business that touches marijuana when filing their Federal Income Tax returns (or State returns where state income tax exists; e.g. Hawaii) will be denied the normal business deductions in an IRS audit of their Federal Income Tax returns (or State returns where state income tax exists; e.g. Hawaii). Normal business deductions include:

  • Employee salaries
  • Utility costs such as electricity, internet and telephone service
  • Health insurance premiums
  • Marketing and advertising costs
  • Repairs and maintenance
  • Rental fees for Facilities
  • Payments to contractors
  • General administrative costs; bookkeeping, legal, technology costs
  • State excise taxes
  • Purchasing cost of cannabis
  • Depreciation of cannabis


Since states began legalizing medical marijuana (MMJ) and marijuana (MJ) businesses, those businesses have been forced to either pay federal and state income tax on nearly 90% of their income, or engage in expensive and complicated “slice and dice” management company and business operating techniques. For instance, CPAs and attorneys counseling MJ clients have devised various methods of separating the “normal” business activities from those directly involved with marijuana to attempt to get around the consequences of IRC 280E. Some of their recommendations involve setting up separate legal entities to manage the employees and the facilities, time management schemes to separate employees’ time spent touching MJ from time spent selling T-shirts, and so on.

Who is impacted and suffers the consequences of IRC 280E? Of course the MJ businesses who pay extra fees to tax advisors to “slice and dice” their business activities and to lawyers to defend audits and lawsuits lose a lot of money, even before they see their remaining profits wiped out by a tax rate of nearly 90% of their income. But businesses can raise their prices - then it is the PATIENTS who end up paying for more expensive medicine to offset the tax burden, or if it is unaffordable, the patients do not buy as much medicine, which hurts the patients and the businesses both, and makes the black market look more attractive.

The CPAs and attorneys advising their MJ business clients have been relying on two Federal Court tax cases. The most often cited case is from the U.S. Tax Court called CHAMP (2007)1. The CHAMP non-profit organization provided its members with medical marijuana pursuant to California law. The IRS proposed to disallow all of the business’ deductions and costs of goods sold, determining that those items were “Expenditures in Connection with the illegal Sale of Drugs”. According to the IRS the Petitioner (business) had a single trade or business of trafficking in medical marijuana.

CHAMP asserted that it was engaged in two separate and distinct businesses; primarily providing caregiving services, and secondarily supplying medical marijuana to its members. [The cases are cited in the footnotes if readers want the detailed facts]. Basically, the U.S. Tax Court held that just because one business is engaged in an illegal activity, it does not mean that the other business is tainted and the legal business should be allowed to take normal business tax deductions for the other legitimate business activities.

Well, this set all the tax advisors about creating entities and business practices, per CHAMP, in order to get around IRC 280E. Of course, the IRS rejected most claimed deductions anyway. Then came a subsequent and more recent U.S. Tax Court case, Olive 20122, that in effect overruled CHAMP, disallowing all deductions with one exception. The Tax Court allowed Olive to claim cost of goods sold - “COGS”. This led to more manipulations by tax advisors to fit expenses into COGS. That caused the IRS Office of Chief Counsel (the IRS top lawyers) to issue an eight-page Memorandum in January 2015 advising tax professionals on how the IRS would treat deduction claims for COGS3. The IRS’s position is a complicated one involving “inventory” and “non-inventory” costing tax rules.

The most obvious method of resolving the IRC 280E tax issue for MJ businesses is to change the federal law. In fact, there is a strong bill, formally titled “Compassionate Access, Research Expansion and Respect States” or CARERS Act, pending before both the Federal Senate (SB 683) and House (HB 1538). The CARERS Act is gaining more sponsors in both chambers weekly, and it appears to be moving forward (call your Senators and Representatives!). The CARERS Act:

  1. Amends the Controlled Substances Act to protect states’ rights
  2. Reschedules Marijuana from Schedule 1 to 2. (eliminates IRC 280E)
  3. Allows states to import treatments
  4. Provides veterans access, allowing doctors to recommend MMJ
  5. Expands opportunities for research by removing bureaucratic R&D hurdles
  6. Permits financial services for MJ businesses by providing safe harbors for banks

The CARERS Act is being aggressively lobbied for by all the national MJ organizations and, at this point, has its best chance of passing this year.

Meanwhile, the State of Hawaii Legislature, taking the lead in the nation as it did by increasing the smoking age to 21, is moving forward with HB2707 HD2 SD1 that will, among other good changes discussed in previous HDA Update articles, amend the Hawaii Tax Law to specifically not follow the Internal Revenue Service IRC 280E. We urge you to please call your local state Senators and Representatives to urge their support of this measure, and to submit testimony before each committee hearing.

The impact for legal Hawaii MMJ businesses will be felt as early as tax year 2016 for State income tax returns filed in 2017. All parties in the MMJ industry will benefit: the State, in addition to GET, will collect the same taxes that it does from all other legitimate businesses in Hawaii; the MMJ businesses will incur fewer tax preparation related costs and keep their profit and prices reasonable; and the patients will benefit by having reasonably priced medicine.


1 Californians Helping to Alleviate Medical Problems, Inc v. Commissioner, 128 T.C. 173 (2007) (CHAMP).
2 Martin Olive v. Commissioner, 139 T.C. No. 2 (2012).
3 Internal Revenue Service Memorandum, Number 201504011, Release Date: 1/23/2015.

Stephen P. Pingree, Attorney at Law, has over 30 years of experience defending tax and financial investigations in civil audits, criminal investigations and criminal indictments through trial.  Steve over the years has given many seminars to CPAs, EAs, Tax Practitioners and attorneys on these subjects.  Steve is always available, at no charge, to consult with tax practitioners.  Please feel free to call Stephen P. Pingree, Attorney at Law, at 808-983-9520.