The court allowed deductions apportioned on a percentage of the total deductions to taxpayer's care giving services, based upon the number of employees and space involved in only care giving, and denied the deductions based on sales of medical marijuana; however, labor and other costs the Commissioner conceded to have been properly reported on the tax return were attributable to cost of goods sold in the medical marijuana business.
2007 U.S. Tax Ct. LEXIS 14">*14 P provided counseling and other caregiving services (collectively, caregiving services) to its members, who were individuals with debilitating diseases. P also provided its members with medical marijuana pursuant to the California Compassionate Use Act of 1996, codified at
Held:
Held, further, P's provision of its caregiving services and its provision of medical marijuana were separate trades or businesses for purposes of
128 T.C. 173">*173 LARO, Judge: Respondent determined a $ 355,056 deficiency in petitioner's 2002 Federal income tax and a $ 71,011 accuracy-related penalty under
FINDINGS OF FACT
Certain facts were stipulated and are so found. The stipulation of facts and the exhibits attached thereto are incorporated2007 U.S. Tax Ct. LEXIS 14">*17 herein by this reference. When the petition was filed, petitioner was an inactive California corporation whose mailing address was in San Francisco, California.
Petitioner was organized on December 24, 1996, pursuant to the California Nonprofit Public Benefit Corporation Law,
2007 U.S. Tax Ct. LEXIS 14">*18 Petitioner operated with a dual purpose. Its primary purpose was to provide caregiving services to its members. Its secondary purpose was to provide its members with medical marijuana pursuant to the California Compassionate Use Act 128 T.C. 173">*175 of 1996 and to instruct those individuals on how to use medical marijuana to benefit their health. Petitioner required that each member have a doctor's letter recommending marijuana as part of his or her therapy and an unexpired photo identification card from the California Department of Public Health verifying the authenticity of the doctor's letter. Petitioner required that its members not resell or redistribute the medical marijuana received from petitioner, and petitioner considered any violation of this requirement to be grounds to expel the violator from membership in petitioner's organization.
Each of petitioner's members paid petitioner a membership fee in consideration for the right to receive caregiving services and medical marijuana from petitioner. Petitioner's caregiving services were extensive. First, petitioner's staff held various weekly or biweekly support group sessions that could be attended only by petitioner's members. The "wellness2007 U.S. Tax Ct. LEXIS 14">*19 group" discussed healing techniques and occasionally hosted a guest speaker; the HIV/AIDS group addressed issues of practical and emotional support; the women's group focused on women-specific issues in medical struggles; the "Phoenix" group helped elderly patients with lifelong addiction problems; the "Force" group focused on spiritual and emotional development. Second, petitioner provided its low-income members with daily lunches consisting of salads, fruit, water, soda, and hot food. Petitioner also made available to its members hygiene supplies such as toothbrushes, toothpaste, feminine hygiene products, combs, and bottles of bleach. Third, petitioner allowed its members to consult one-on-one with a counselor about benefits, health, housing, safety, and legal issues. Petitioner also provided its members with biweekly masseuse services. Fourth, petitioner coordinated for its members weekend social events including a Friday night movie or guest speaker and a Saturday night social with live music and a hot meal. Petitioner also coordinated for its members monthly field trips to locations such as beaches, museums, or parks. Fifth, petitioner instructed its members on yoga and on topics2007 U.S. Tax Ct. LEXIS 14">*20 such as how to participate in social services at petitioner's facilities and how to follow member guidelines. Sixth, petitioner provided its members with online computer access and delivered to them informational 128 T.C. 173">*176 services through its Web site. Seventh, petitioner encouraged its members to participate in political activities.
Petitioner furnished its services at its main facility in San Francisco, California, and at an office in a community church in San Francisco. The main facility was approximately 1,350 square feet and was the site of the daily lunches, distribution of hygiene supplies, benefits counseling, Friday and Saturday night social events and dinners, and computer access. This location also was the site where petitioner's members received their distribution of medical marijuana; the medical marijuana was dispensed at a counter of the main room of the facility, taking up approximately 10 percent of the main facility. The peer group meetings and yoga classes were usually held at the church, where petitioner rented space. Pursuant to the rules of the church, petitioner's members were prohibited from bringing any marijuana into the church. Petitioner also maintained a storage2007 U.S. Tax Ct. LEXIS 14">*21 unit at a third location in San Francisco. Petitioner used the storage unit to store confidential medical records; no medical marijuana was distributed or used there.
Petitioner paid for the services it provided to its members by charging a membership fee that covered, and in the judgment of petitioner's management approximated, both the cost of petitioner's caregiving services and the cost of the medical marijuana that petitioner supplied to its members. Petitioner notified its members that the membership fee covered both of these costs, and petitioner charged its members no additional fee. Members received from petitioner a set amount of medical marijuana; they were not entitled to unlimited supplies.
On May 6, 2002, petitioner's board of directors decided that petitioner would henceforth discontinue all of its activities. Petitioner thus ceased conducting any activity and filed a "Final Return" (Form 1120, U.S. Corporation Income Tax Return) for 2002. This return reported the following items on the basis of an accrual method of accounting:
| Gross receipts or sales | $ 1,056,833 | ||
| Less returns and allowances | 8,802 | ||
| Balance | 1,048,031 | ||
| Cost of goods sold: | |||
| Inventory at beginning | |||
| of year | $ 12,551 | ||
| Purchases | 575,317 | ||
| Cost of labor | 203,661 | ||
| Other costs: | |||
| Cash (over/under) | $ 1,680 | ||
| Operating supplies | 29,077 | ||
| Program costs | 13,026 | ||
| Total other costs | 43,783 | 43,783 | |
| Inventory at end of year | |||
| of year | -0- | ||
| Total cost of goods sold | 835,312 | 835,312 | |
| Gross profit | 212,719 | ||
| Deductions: | |||
| Compensation of officers | 14,914 | ||
| Salaries and wages | 44,799 | ||
| Repairs and maintenance | 1,456 | ||
| Rents | 25,161 | ||
| Taxes and licenses | 28,201 | ||
| Depreciation | 8,409 | ||
| Advertising | 200 | ||
| Employee benefit programs | 24,453 | ||
| Other deductions: | |||
| Accounting | 5,086 | ||
| Auto and truck | 308 | ||
| Bank charges | 1,097 | ||
| Computer expense | 961 | ||
| Dues and subscriptions | 20 | ||
| Employee development | |||
| training | 1,940 | ||
| Insurance | 7,727 | ||
| Internet service | |||
| provider | 2,238 | ||
| Janitorial | 1,409 | ||
| Laundry and | |||
| cleaning | 105 | ||
| Legal and | |||
| professional | 5,500 | ||
| Meals and | |||
| entertainment | 402 | ||
| Miscellaneous | 269 | ||
| Office expense | 4,533 | ||
| Outside services | 4,421 | ||
| Parking and toll | 120 | ||
| Security | 2,185 | ||
| Supplies | 660 | ||
| Telephone | 7,870 | ||
| Utilities | 18,514 | ||
| Total other deductions | 65,365 | 65,365 | |
| Total deductions | 212,958 | 212,958 | |
| Taxable loss | 239 |
2007 U.S. Tax Ct. LEXIS 14">*22
In a notice of deficiency mailed to petitioner on August 4, 2005, respondent disallowed all of petitioner's deductions and costs of goods sold, determining that those items were "Expenditures in Connection with the Illegal Sale of Drugs" within the meaning of
The "Total deductions" were ordinary, necessary, 2007 U.S. Tax Ct. LEXIS 14">*23 and reasonable expenses petitioner incurred in running its operations during the subject year. The specific expenses underlying those deductions are as follows: . The $ 14,914 deducted for compensation of officers reflects the salary of petitioner's executive director. The executive director worked 50 hours a week for 17 weeks. . The executive director directed petitioner's overall operations and was not directly engaged in petitioner's provision of medical marijuana. The $ 44,799 deducted for salaries and wages reflects the compensation of petitioner's 24 other employees. Seven of the 24 employees were involved in petitioner's provision of medical marijuana. The other 17 employees were involved with petitioner's provision of caregiving services. . The $ 1,456 deducted for repairs and maintenance reflects expenses petitioner incurred to repair and maintain its main facility. . The $ 25,161 deducted for rents reflects $ 15,000 of rent for the main facility, $ 5,700 of rent for the use of the church, and $ 4,461 of rent for the storage unit and a photocopier. . The $ 28,201 deducted for payroll taxes reflects petitioner's liability for the payment of payroll taxes. . The $ 8,4092007 U.S. Tax Ct. LEXIS 14">*24 deducted for depreciation reflects depreciation of petitioner's property. . The $ 200 deducted for advertising reflects the cost of advertising by petitioner, including a $ 150 expense for the rental of a booth where petitioner distributed literature. . The $ 24,453 deducted for employee benefit programs reflects the cost of a health insurance policy that petitioner maintained for its employees. . The $ 5,086 deducted for accounting reflects the fees of petitioner's accountant. 128 T.C. 173">*179 . The $ 308 deducted for auto and truck reflects repairs made to a van used to transport members. . The $ 1,097 deducted for bank charges reflects bank service charges petitioner incurred. . The $ 961 deducted for computer expense reflects the cost of purchasing and maintaining computers petitioner used in its operations. . The $ 20 deducted for dues and subscriptions reflects dues petitioner paid to an association comprising persons performing functions similar to those of petitioner. . The $ 1,940 deducted for employee development training reflects costs petitioner incurred to train its bookkeeper and management team. . The $ 7,727 deducted for insurance reflects the cost of petitioner's liability2007 U.S. Tax Ct. LEXIS 14">*25 insurance. . The $ 2,238 deducted for Internet service provider reflects the cost of petitioner's Internet services. . The $ 1,409 deducted for janitorial reflects the cost of petitioner's garbage services. . The $ 105 deducted for laundry and cleaning reflects costs petitioner incurred to clean and launder napkins used in its food distribution. . The $ 5,500 deducted for legal and professional reflects the fees of petitioner's attorney. None of these fees involved any defense for criminal prosecution. . The $ 402 deducted for meals and entertainment reflects costs that petitioner incurred for meals furnished to its employees who worked late or long hours. . The $ 269 deducted for miscellaneous reflects miscellaneous expenses petitioner incurred. . The $ 4,533 deducted for office expenses reflects costs petitioner incurred for office supplies such as paper and printer toner. . The $ 4,421 deducted for outside services reflects the cost of petitioner's payroll service company. . The $ 120 deducted for parking and toll reflects petitioner's reimbursement to its employees who paid parking fees and tolls on behalf of petitioner. . The $ 2,185 deducted for security reflects the2007 U.S. Tax Ct. LEXIS 14">*26 cost of security at the main facility, including the costs of an alarm company and medical service. 128 T.C. 173">*180 . The $ 660 deducted for supplies reflects the costs petitioner incurred to buy various supplies. . The $ 7,870 deducted for telephone reflects the cost petitioner incurred for its telephone service. . The $ 18,514 deducted for utilities reflects the cost of the gas and electricity petitioner used at its main facility.
OPINION
The parties agree that during the subject year petitioner had at least one trade or business for purposes of
Accrual method taxpayers such as petitioner may generally deduct the ordinary and necessary expenses incurred in carrying on a trade or business. See 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.
128 T.C. 173">*181 In the context of
Respondent argues that petitioner, because it trafficked in a controlled substance, is not permitted by
2007 U.S. Tax Ct. LEXIS 14">*29 Congress enacted Ordinary and necessary trade or business expenses are generally deductible in computing taxable income. A recent U.S. Tax Court case allowed deductions for telephone, auto, and rental expense incurred in the illegal drug trade. In that case, the Internal Revenue Service challenged the amount of the taxpayer's deduction for cost of goods (illegal drugs) sold, but did not challenge the principle that such amounts were deductible. On public policy grounds, the Code makes certain2007 U.S. Tax Ct. LEXIS 14">*30 otherwise ordinary and necessary expenses incurred in a trade or business nondeductible in 128 T.C. 173">*182 computing taxable income. These nondeductible expenses include fines, illegal bribes and kickbacks, and certain other illegal payments. [S. Rept. 97-494 (Vol. 1), supra at 309.] There is a sharply defined public policy against drug dealing. To allow drug dealers the benefit of business expense deductions at the same time that the U.S. and its citizens are losing billions of dollars per year to such persons is not compelled by the fact that such deductions are allowed to other, legal, enterprises. Such deductions must be disallowed on public policy grounds. [Id.] All deductions and credits for amounts paid or incurred in the illegal trafficking in drugs listed in the Controlled Substances Act are disallowed. To preclude possible challenges on constitutional grounds, the adjustment to gross receipts with respect to effective costs of goods sold is not affected by this provision of the bill. [Id.]
Petitioner argues that its supplying of medical marijuana to its members was not "trafficking" within the meaning of
We now turn to analyze whether petitioner's furnishing of its caregiving services is a trade or business that is separate from its trade or business of providing medical marijuana. Taxpayers may be involved in more than one trade or business, 2007 U.S. Tax Ct. LEXIS 14">*33 see, e.g.,
We do not believe it to have been artificial or unreasonable for petitioner to have characterized as separate activities its provision of caregiving services and its provision of medical marijuana. Petitioner was regularly and extensively involved in the provision of caregiving services, and those services are substantially different from petitioner's provision of medical marijuana. By conducting its recurring discussion groups, regularly distributing food and hygiene supplies, advertising and making available the services of personal counselors, 2007 U.S. Tax Ct. LEXIS 14">*34 coordinating social events and field trips, hosting educational classes, and providing other social services, petitioner's caregiving business stood on its own, separate and apart from petitioner's provision of medical marijuana. On the basis of all of the facts and circumstances of this case, we hold that petitioner's provision of caregiving services was a trade or business separate and apart from its provision of medical marijuana.
Respondent argues that the "evidence indicates that petitioner's principal purpose was to provide access to marijuana, that petitioner's principal activity was providing 128 T.C. 173">*184 access to marijuana, and that the principal service that petitioner provided was access to marijuana * * * and that all of petitioner's activities were merely incidental to petitioner's activity of trafficking in marijuana." We disagree. Petitioner's executive director testified credibly and without contradiction that petitioner's primary purpose was to provide caregiving services for terminally ill patients. He stated: "Right from the start we considered our primary function as being a community center for seriously ill patients in San Francisco. And only secondarily as a place where2007 U.S. Tax Ct. LEXIS 14">*35 they could access their medicine." The evidence suggests that petitioner's operations were conducted with that primary function in mind, not with the principal purpose of providing marijuana to members.
As stated by the Board of Tax Appeals in
Respondent relies heavily on his assertion that "Petitioner's only income was from marijuana-related matters, except for a couple of small donations". The record does not support that assertion, and we decline to find it as a fact. Indeed, the record leads us to make the contrary finding that petitioner's caregiving services generated income attributable to those services. In making this2007 U.S. Tax Ct. LEXIS 14">*36 finding, we rely on the testimony of petitioner's executive director, whom we had an opportunity to hear and view at trial. We found his testimony to be coherent and credible, as well as supported by the record. He testified that petitioner's members paid their membership fees as consideration for both caregiving services and medical marijuana, and respondent opted not to challenge the substance of that testimony. While a member may have acquired, in return for his or her payment of a membership fee, access to all of petitioner's goods and services without further charge and without explicit differentiation as to the portion of the fee that was paid for goods versus services, we do not believe that such a fact establishes that petitioner's 128 T.C. 173">*185 operations were simply one trade or business. As the record reveals, and as we find as a fact, petitioner's management set the total amount of the membership fees as the amount that management consciously and reasonably judged equaled petitioner's costs of the caregiving services and the costs of the medical marijuana.
Given petitioner's separate trades or businesses, we are required to apportion its overall expenses accordingly. Respondent argues2007 U.S. Tax Ct. LEXIS 14">*37 that "petitioner failed to justify any particular allocation and failed to present evidence as to how * * * [petitioner's expenses] should be allocated between marijuana trafficking and other activities." We disagree. Respondent concedes that many of petitioner's activities are legal and unrelated to petitioner's provision of medical marijuana. The evidence at hand permits an allocation of expenses to those activities. Although the record may not lend itself to a perfect allocation with pinpoint accuracy, the record permits us with sufficient confidence to allocate petitioner's expenses between its two trades or businesses on the basis of the number of petitioner's employees and the portion of its facilities devoted to each business. Accordingly, in a manner that is most consistent with petitioner's breakdown of the disputed expenses, we allocate to petitioner's caregiving services 18/25 of the expenses for salaries, wages, payroll taxes, employee benefits, employee development training, meals and entertainment, and parking and tolls (18 of petitioner's 25 employees did not work directly in petitioner's provision of medical marijuana), all expenses incurred in renting facilities2007 U.S. Tax Ct. LEXIS 14">*38 at the church (petitioner did not use the church to any extent to provide medical marijuana), all expenses incurred for "truck and auto" and "laundry and cleaning" (those expenses did not relate to any extent to petitioner's provision of medical marijuana), and 9/10 of the remaining expenses (90 percent of the square footage of petitioner's main facility was not used in petitioner's provision of medical marijuana). 6 We disagree with respondent that petitioner must further justify the allocation of its expenses, reluctant to substitute our judgment for the judgment 128 T.C. 173">*186 of petitioner's management as to its understanding of the expenses that petitioner incurred as to each of its trades or businesses. Cf.
2007 U.S. Tax Ct. LEXIS 14">*39 All arguments by the parties have been considered. We have rejected those arguments not discussed herein as without merit. Accordingly,
Decision will be entered under
1. Unless otherwise indicated, section, subchapter, and chapter references are to the applicable versions of the Internal Revenue Code, and Rule references are to the Tax Court Rules of Practice and Procedure.↩
2. At a general election held on Nov. 5, 1996, the California electors approved an initiative statute designated on the ballot as Proposition 215 and entitled "Medical Use of Marijuana". See To ensure that seriously ill Californians have the right to obtain and use marijuana for medical purposes where that medical use is deemed appropriate and has been recommended by a physician who has determined that the person's health would benefit from the use of marijuana in the treatment of * * * any * * * illness for which marijuana provides relief.
3. Under California law, public benefit corporations are organized for a public or charitable purpose; they are not operated for the mutual benefit of their members but for a broader good. See
4. In other words, respondent concedes that the disallowance of
5. In support of its position, petitioner relies upon
6. While we apportion most of the $ 212,958 in "Total deductions" to petitioner's caregiving services, we note that the costs of petitioner's medical marijuana business included the $ 203,661 in labor and $ 43,783 in other costs respondent conceded to have been properly reported on petitioner's tax return as attributable to cost of goods sold in the medical marijuana business.↩
