Trafficking under IRC § 280E - John R. Dundon II, Enrolled Agent
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Trafficking under IRC § 280E

Business Entity Selection and the Tax Consequences of Converting

Trafficking under IRC § 280E

The Internal Revenue Code is a complex beast.  In the lunacy of it all I’ve been asked to define ‘trafficking’ as it relates to 26 USC § 280E – Expenditures in connection with the illegal sale of drugs which states as follows:

“No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.”

As I understand the Controlled Substance Act the word trafficking is more often than not used in conjunction with the word ‘illicit’ as in nefarious or illegal.  This begs the very question as to whether the cultivating, possessing and distributing of marijuana in a state (Colorado) where the substance is fully legal under state law rises to the threshold of trafficking as it is used in the Controlled Substances Act.

Naturally the laws of interstate commerce should in my opinion generally prevail.  If however marijuana does not cross state borders then in my humble layman’s opinion the federal government in theory under our constitution has no basis for intervention.  Of course you will always find the pundits from the other side pontificating the evils of the drug as they swirl down their martinis and pop their pills but let’s not get into name calling.

When it comes to the IRS, the Service is obligated to enforce the letter of the federal law.  Marijuana is federally illegal and if taxpayers are in the business of cultivating it and distributing it for profit or otherwise then the argument goes they are by the letter of the federal law guilty of ‘trafficking’ in a controlled substance regardless of state law.

Presently and with all due respect the IRS seems to be lacking a standard of enforcement over dispensaries, cultivators and bakeries in these regards.  The recent court case of Olive v. Commissioner seems to make the efficacy of a dispensary’s income tax return achieve an allowable threshold when Cost of Goods sold are allowed as offsets to gross receipts but general business expenses are disallowed. This attempt at a standard is overtly far reaching in that the intent of IRC 280E as it pertains to the Controlled Substances Act was to curtail illicit activity.  If the activity is not illicit by state law then moving it around inside that state’s border should by default be transportation not trafficking.

It is my personal opinion that moving a fully legal product inside a state border is NOT ILLICIT NOR IS IT TRAFFICKING. If the substance is fully legal by state law than possessing it, cultivating it and even distributing it in no way reaches the threshold of ‘illicit activity’.

Until further tax court cases help iron out a standard I believe a reasonable solution is to narrowly define ‘trafficking’ under IRC 280E as a transaction where marijuana dispensary employee ‘X’ hands a product containing marijuana to a customer and the customer in turn hands employee ‘X’ money for the marijuana product.  In this limited time and space a transaction happens that could be argued to be perceived as trafficking and as such the expenses associated with that limited transaction should perhaps not be deductible under 280E of the Internal Revenue Code.

When trafficking is narrowly defined all other costs should by default in theory become legitimate business expenses be they general and administrative or cost of goods sold. This is just one simple man’s opinion and the Service presently has a vastly different opinion.  There is a middle ground somewhere and it appears the courts will have to find it for us. Because like it or not this is a growth industry. Tread lightly.  Stay tuned…


Pursuant to the requirements related to practice before the Internal Revenue Service, any tax advice contained in this communication (including any attachments) is not intended to be used, and cannot be used, for purposes of:  Avoiding penalties imposed under the United States Internal Revenue Code, or Promoting or recommending to another person any tax-related matter