Don’t Use Your Product When Preparing a Tax Return

In the Beck v. US case decided by the Tax Court yesterday, it is apparent that you should not be using marijuana when preparing your income tax return (I am not sure if the Mr. Beck was or not; I will let you decide).  The State of California allows marijuana to be disbursed for medical reasons.  It is legal in California, however, it is still illegal under Federal law.

The tax code allows businesses that are trafficking in a controlled substance (such as marijuana) to deduct cost of goods sold (i.e. the cost of the product), but does not allow the business to deduct any of the other operating costs such as labor, rent, etc.

In preparing his income tax return, Mr. Beck report exactly $1.7 million of gross sales and deducted cost of goods sold of $1,429,614 along with $194,094 of additional expenses.  Included in both sales and cost of goods sold (according to Mr. Beck) is $600,000 of marijuana that was seized by the DEA in a raid.

Some of the issues that the IRS and the Tax Court found regarding this case were:

• The business could not substantiate any of the income or deduction items.  The marijuana business is almost all cash and the cash till records were routinely either destroyed or lost by Mr. Beck.
• Second, if you are going to estimate your gross sales, don’t use a nice round number such as $1,700,000.  That is almost a guarantee of an audit.
• Third, you can’t deduct a loss of product if you have not included it in income.  When the DEA raided the business, Mr. Beck estimated the value of the product at $600,000, however, he could not provide any details on what was stolen and the cost of the product, etc.  I know I get the question many times about deducting rent that was not collected on a house rental.  The answer is you can’t deduct the rent since you have not reported the income.  The same applies here.  Mr. Beck indicated he had included it in sales, but offered no proof.

Washington State allows for the sale or recreational marijuana (the second state after Colorado).  I have heard that 1,000 square feet of marijuana production will yield about $350,000 of gross revenue.  This is what I call a cash crop, however, the income tax laws are very harsh on any marijuana business as Mr. Beck found out.

Paul Neiffer, CPA