An obscure provision of the income tax law denies all business deductions to anyone whose business involves trafficking in a controlled substance. 

Few people agree that it would be good public policy to allow drug dealers a tax deduction for the costs associated with their illicit operations. On the other hand, one wonders how many drug dealers detail their illegal activities on their annual income tax returns.

In a Tax Court case involving Californians Helping to Alleviate Medical Problems (CHAMP), Inc., the court applied this rule in a way that some may not have anticipated.

CHAMP operated a medical marijuana dispensary. The business’s sole source of revenue was its sale of medical marijuana.

The patrons consumed the marijuana on the premises of the dispensary. They had to show either a doctor’s recommendation to use medical marijuana or a similar certificate issued by the municipal government.

The court recognized that California state law authorizes CHAMP to dispense medical marijuana. However, the court ruled that dispensing medical marijuana, even if sanctioned under state law, constitutes trafficking within the meaning of the federal income tax law.

The Tax Court refused to allow the deduction, even if the business is legal under state law.

“We now have so many regulations that everyone is guilty of some violation.” – Donald Alexander, Former IRS Commissioner