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Olive v. Commissioner

Court of Appeals for the Ninth Circuit
792 F.3d 1146, 2015 WL 4113811, 116 A.F.T.R.2d (RIA) 5150 (2015)
ELI5:

Rule of Law:

Under Internal Revenue Code § 280E, a taxpayer may not deduct ordinary and necessary business expenses from a trade or business if that business's sole income-generating activity consists of trafficking in a federally controlled substance, even if the business also provides other services and amenities for free.


Facts:

  • Martin Olive operated the Vapor Room Herbal Center ('Vapor Room'), a medical marijuana dispensary in San Francisco, during 2004 and 2005.
  • The Vapor Room's only income-generating activity was the sale of medical marijuana in three forms: dried leaves, edibles, and THC concentrate.
  • The dispensary was set up like a community center, offering a wide range of complimentary amenities and services to its patrons.
  • These free offerings included the use of vaporizers, snacks and drinks, yoga, movies, massage therapy, and counseling on personal and legal matters related to medical marijuana.
  • Patrons could use the Vapor Room's vaporizers at no charge, regardless of whether they purchased marijuana at the dispensary or brought their own.

Procedural Posture:

  • Martin Olive filed business income tax returns for 2004 and 2005, claiming deductions for ordinary and necessary business expenses for the Vapor Room.
  • The Internal Revenue Service (IRS) assessed deficiencies and penalties against Olive, disallowing all business expense deductions under I.R.C. § 280E.
  • Olive petitioned the U.S. Tax Court (a court of first instance) to challenge the IRS's determination.
  • The Tax Court ruled in favor of the Commissioner of Internal Revenue, upholding the disallowance of the deductions.
  • Olive (Petitioner-Appellant) timely appealed the Tax Court’s decision to the U.S. Court of Appeals for the Ninth Circuit.

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Issue:

Does I.R.C. § 280E, which disallows tax deductions for a trade or business that "consists of trafficking in controlled substances," apply to a medical marijuana dispensary whose only income-generating activity is the sale of marijuana, but which also provides numerous complimentary caregiving services and amenities?


Opinions:

Majority - Graber, Circuit Judge

Yes, I.R.C. § 280E applies to the dispensary. A 'trade or business' is defined as an activity entered into with the dominant hope and intent of realizing a profit. Here, the Vapor Room’s sole profit-generating activity was the sale of medical marijuana, which is trafficking in a substance prohibited by federal law. The court reasoned that the various complimentary services and amenities, such as counseling, yoga, and snacks, were not separate trades or businesses because they did not generate any income. Instead, they were expenses incurred to attract customers to the sole business of selling marijuana. The court distinguished this case from Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner (CHAMP), where the dispensary operated two distinct, income-generating businesses: selling marijuana and providing caregiving services for a fee. Because the Vapor Room had only one business—selling a controlled substance—that business 'consisted of' trafficking, and therefore § 280E bars all deductions.



Analysis:

This decision solidifies the significant tax barrier for state-legal cannabis businesses under federal law. It clarifies that merely offering complimentary services alongside cannabis sales is insufficient to create a separate, legitimate business for tax purposes, thereby preventing the deduction of related expenses. The ruling establishes that to avoid the full impact of § 280E, a business must have a distinct, bona fide, and income-generating non-trafficking component. This precedent reinforces the financial difficulty for dispensaries structured like the Vapor Room and provides a clear, though narrow, path for businesses attempting to legally mitigate their federal tax burden by operating multiple, distinct lines of business.

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