Maybe Not, But They’d Better Pay Their Taxes

That’s the lesson for Martin Olive, courtesy of Judge Diane Kroupa, in 139 T. C. 2, filed 8/2/12. And Judge Kroupa does a judicial double reverse backflip worthy of Olympic gold, in the tradition of The Great Dissenter, Judge Mark Holmes, by allowing ol’ Marty more costs of goods sold than IRS allowed him, notwithstanding that he was dealing a Federally-designated controlled substance.

To tie in with the Bob Dylan 1966 hit “Rainy Day Woman #12 and 35”, alluded to in the title of this blogpost, Marty was pushing pot, but it was OK by California law. He was selling pursuant to the California Compassionate Use Act of 1996 (CCUA), codified at Cal. Health & Safety Code sec. 11362.5 (West 2007), 139 T.C. 2, at p. 2. This beneficent statute allows persons certified by licensed health care practitioners, and their caregivers, to obtain cannibis sativa and similar plantlife to alleviate their symptoms.

Marty specialized in vaporware. No, not imaginary software announced by giant outfits to stifle innovation, but which never hit the market. Marty vaporized the boo, so the sick, sore and lame might more easily ingest its analgesic properties. He was one of fifty licensed grass pushers, once he remembered to get his license.

Marty provided atmosphere as well as vapor. “He established the Vapor Room so that its patrons, almost all of whom were recipients (including some with terminal diseases such as cancer or HIV/AIDs) could socialize and purchase and consume medical marijuana there.

“Petitioner designed the Vapor Room with a comfortable lounge-like, community center atmosphere, placing couches, chairs and tables throughout the premises. He placed vaporizers, games, books and art supplies on the premises for patrons to use at their desire. He set up a jewelry-store-like glass counter with a cash register on top and jars of the Vapor Room’s medical marijuana inventory displayed underneath and behind the counter.” 139 T. C. 2, at pp. 5-6.

We should have had Marty around when we were in college, eh? Maybe not; only joking, IRS, OPR and Departmental Disciplinary Committee.

Unfortunately, public benefactor Marty underreported income and claimed deductions for his grassroots operation. But Section 280E prohibits any deductions for expenses paid or incurred in trafficking substances illegal under Federal law, including, but without in any way limiting the generality of the foregoing as the high-priced lawyers say, Mother Mary (in case you wondered who, or rather what, was the star of the Beatles 1970 hit “Let It Be”).

However, in a retail sales operation, which concededly Marty was running, cost of goods sold is not a deduction, but an adjustment to gross receipts necessary to calculate gross income. Notwithstanding the foregoing, Judge Kroupa calls it a deduction, even though it isn’t.

Based on extrapolated evidence of Marty’s witnesses, with all of whose testimony Judge Kroupa had issues, she nevertheless gave Marty a Cohan break and gave him some more costs of goods sold than IRS would allow.

Marty escapes some accuracy penalties because the law was unsettled at the time when he took deductions leading to part of his understatement of tax due, but not thereafter when he took others, so a Rule 155 will sort that out.

Judge Kroupa obviously has Chief Justice of the Supreme Court in her future. It’s not a deduction, but it is.