Can you deduct your medical marijuana expenses on your tax return?

This article was originally published on the Marijuana Patients Organization site on February 1, 2014.

The internal revenue code says you can’t deduct your marijuana business expenses but the truth is you can deduct most of them. My name is James Campbell an accountant that specializes in federal tax issues for marijuana businesses and this is a TAX NUGGET.

The templates for deductibility of expenses in a medical marijuana business were created many years ago in California but they have only stood up to the scrutiny of the US Tax Court in recent cases and prevailed.

Now just because the US Tax Court has permitted certain tax treatments to be applied to medical marijuana businesses does not guarantee you a free pass on your business’ taxes. Your ability to substantiate your business activities by providing consistent and accurate records is key to your success with the taxman. If you can’t keep good records of both your sales and expenses, you’re taking on a risk of unfavorable audit findings that will have nothing to do with your marijuana business.

If the US Tax Court has taught anything about marijuana, it’s that if you are going to file a return for your marijuana business, you better make sure the representations are making on your returns are accurate. This was demonstrated in one case in which a dispensary was assessed substantial accuracy related penalties because their books would not jive to their return. The irony of that case was that their tax preparation was so poor, that the court allowed the taxpayer to refile their return in proper from to implement a medical marijuana defense including the testimony of expert witnesses. Let’s hope that your income taxes never reach this.

Cutting to the brass tax, identifying what is deductible and what is not you have to understand that it is your cost of goods sold that is your most important account. Cost of Goods Sold is a catch-all name for all direct and indirect input costs into your business of marijuana cultivation.

Basics examples of direct costs include soil, systems, lights and ballasts, genetic stock, nutrients, supplies and the labor wages of a grower. Examples of indirect costs include your facility costs, packaging, secondary processing, utilities, labor wages, some mileage, and state licensing and registration.

You need to be aware that your selling expenses are considered nondeductible expenses and the labor cost of a self-employed individual is never deductible. Medicine removed for personal use also has to be tracked.

You also need to understand that there is no such thing as free weed in the eyes of the taxman. In the same Tax Court case, the dispensary owner kept such bad records that he was unable to prove the amount of medicine he gave away or discounted. The Court in turn disallowed all of the owner’s sales discounts and assumed it was all for personal use.

Examples I see of this often involve a caregiver agreement in which a patient receives a fixed amount of medicine monthly. Recordkeeping for this should reflect a regular sale discounted 100%. From a records keeping perspective this is a wash but from a tax reporting standpoint it is exactly what it appears to be, a sale discounted 100% and accounts for inventory that was not consumed by you.