Dispensary owners now finally have some precedent to follow in arriving at federal taxable income. In Olive v. Comm’r, 139 T.C. No. 2 (8/2/12), Mr. Martin Olive the owner of an operation called the Vapor Room was required to prove among other things that he was entitled to deduct the Vapor Room’s claimed amounts of cost of goods sold (COGS). The Tax Court essentially made the following decisions:
1. The Vapor Room’s cost of goods sold (COGS) was not over stated and in fact the Court decided based on oral testimony that 75.16 % of revenue was a reasonable measure of the Vapor Room’s Cost Of Goods Sold and generally allowed that percentage of sales as COGS offset for both years at issue.
2. Mr. Oliver could not deduct any of the Vapor Room’s ‘expenses’ citing both Internal Revenue Code Section 280(e) and its previous decision in Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner, 128 T.C. 173 (2007) (CHAMPS), holding that medical marijuana was a controlled substance and thus related business ‘expenses’ were not deductible.
3. The accuracy-related penalties imposed by the IRS were essentially upheld but because Code Sec. 280(e) relevant to medical marijuana dispensaries had not yet been decided when Mr. Olive filed his federal income tax returns for 2004 and 2005, the accuracy-related penalty did not apply to the portion of each underpayment that would not have resulted had Martin been allowed to deduct his substantiated expenses.
Basically COGS in accounting standards is considered a ‘revenue offset’ reported as a subtraction from revenue on the ‘income’ portion of an income statement which is separate and distinct from actual ‘expenses.’ Evidently it appears this is where the tax court is choosing to draw the line in applying IRC 280(e). So be sure to understand the distinction between cost of goods sold and expenses when arriving at your taxable income. COGS will bring down your taxable income and ‘expenses’ will not.