Federal and Pennsylvania Tax Deduction Limitations on Medical … – Lexology (registration)
The growing, processing, dispensing, and use of medical marijuana became legal in Pennsylvania on May 18, 2016, under the Medical Marijuana Act, Act 2016-16 (S.B. 3), 35 P.S. § 10231.101, et seq. (the Act). Medical marijuana organizations, however, face significant tax disadvantages in operating their businesses because marijuana remains a schedule I controlled substance under federal law. Among those obstacles, medical marijuana organizations are subject to limitations in deducting their business operating expenses — even if those business expenses are not otherwise illegal.
While medical marijuana businesses are illegal under federal law, they are still obligated to pay federal income tax because income from both legal and illegal sources is taxable. However, businesses that traffic controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) are not permitted deductions in calculating federal taxable income for ordinary and necessary business expenses.
As a general rule, to calculate federal taxable income, businesses are allowed to deduct ordinary and necessary expenses paid or incurred in carrying on the trade or business, except that they may not deduct specific kinds of illegal payments such as illegal bribes or kickbacks. IRC Section 280E provides an even broader restriction and prohibits deductions for expenses incurred as part of a business consisting of trafficking schedule I or II controlled substances, even if those business expenses are otherwise lawful. For example, rents, salaries, telephone, and transportation expenses are not deductible to businesses trafficking in controlled substances but would be deductible for other types of businesses.
Taxpayers that conduct multiple businesses may be less affected by Section 280E. If a taxpayer has two separate trade or businesses, one of which is the trafficking in controlled substances and the other being lawful, the taxpayer may deduct ordinary and necessary business expenses attributable to