High times? Concerns, risks for CPAs working with marijuana businesses.

• Author: Galyan, Ani
• Position: Emerging regulations

In 1996 California voters passed Proposition 215, also known as the Compassionate Use Act of 1996 (CUA), which allows patients and their primary caregivers to cultivate or possess marijuana for personal medical treatment with the recommendation of a physician. In 2003, Senate Bill 420, commonly referred to as the Medical Marijuana Program Act (MMP) was enacted to establish statewide guidelines for Proposition 215 enforcement.

Under the MMP, qualified patients and their designated caregivers are entitled to "associate within the State of California in order to collectively or cooperatively to cultivate marijuana for medical purposes."

There are 23 states with some form of marijuana legalization for use, possession or distribution. In Colorado, Washington, Oregon, Alaska and Washington, D.C., laws to varying degrees have decriminalized the recreational use of marijuana. However, under federal law it's unlawful to manufacture, distribute, dispense or posses any Schedule 1 controlled substance (21 U.S.C. Sec. 801). Marijuana is classified as such under the Controlled Substance Act (CSA).

Possession and Trafficking of Marijuana

There are several federal statutory schemes that can be and are being used to regulate the growth of the marijuana business. Among them are the Internal Revenue Code and Bank Secrecy Act (BSA).

Internal Revenue Code

Though a marijuana business is illegal under federal law, it is obligated to pay federal income tax on its taxable income because IRC Sec. 61(a) does not differentiate between income derived from legal and illegal sources. Income from manufacturing, distribution or dispensing of marijuana, as it is classified under the CSA, is an illegal source income for federal income tax purposes.

Generally, businesses are allowed to deduct ordinary and necessary expenses incurred in carrying on a trade or business under Sec. 162(a). However, Sec. 280E provides that "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."

Since marijuana is a Schedule I controlled substance under the CSA, Sec. 280E applies to a marijuana business. In enacting Sec. 280E, Congress explained that the disallowance of deductions related to trafficking of illegal substances does not preclude the adjustment to gross receipts with respect to...