Don't bank on it

Local regulations only scratch the surface of worries for NH’s budding medical marijuana industry

Statewide news coverage describing local challenges confronting medical marijuana dispensaries, most recently in Plymouth, only scrape the surface of the legal and regulatory challenges facing the industry as it seeks to gain a foothold in the mainstream commercial life of New Hampshire.

A recent decision by the Ninth Circuit Court of Appeals, the largest federal circuit in the country, covering much of the West Coast, addresses the federal tax status of these businesses. The decision illustrates how the federal government’s resistance to marijuana as a business will continue to plague the industry, even in states where these businesses operate legally under state law.

On July 9, the court, in Olive v. Commissioner, concluded that a business legally selling medical marijuana to patients under state law in California was prohibited by the Internal Revenue Code from deducting “ordinary and necessary business expenses.”

The decision found that traditional income tax deductions for ordinary and necessary business expenses that businesses take in deriving their overall federal tax liability (for employee wages, insurance, business travel) will be foreclosed by the IRS in audits, once the issues become ripe in East Coast states like New Hampshire. 

The court was un-persuaded by arguments that successful legalization efforts in over 20 states, along with a refusal by the Congress to fund the litigation at issue in the case, constituted an expression of post hoc congressional intent to limit the restrictions to states where marijuana remains illegal in all circumstances. 

Complexities in the area regarding how broad the prohibition will extend will nevertheless continue to abound. The Ninth Circuit’s ruling did not affect earlier decisions by the U.S. Tax Court, the federal tribunal responsible for mediating most federal tax disputes in the United States, permitting marijuana businesses to deduct their cost of goods sold. 

Moreover, this summer, the IRS issued substantial guidance on how marijuana businesses may deduct their cost of goods sold, including costs associated with state excise taxes, which the IRS has concluded fall outside the exceptions set forth under the Internal Revenue Code.

Banking industry resistance

Among other things, commentators have predicted that this complex set of rulings from the Tax Court and the IRS, disallowing ordinary and necessary business expense on the one hand but permitting cost of goods sold deductions on the other, will cause businesses to re-characterize some of their ordinary business expenses as costs associated with obtaining their inventory.


While the IRS position on cost of goods sold provides some relief to this industry in the abstract, resistance to marijuana businesses from the banking industry will continue to place substantial barriers between marijuana businesses and their ability to accurately track costs associated with their inventories for tax reporting purposes. 

Indeed, while most businesses track costs through a check registry that draws on information from their banking instruments, marijuana businesses have been forced to deal in cash and so have more difficulty tracking their costs. This situation places many marijuana businesses in the position of wanting to accurately track their costs and having no legitimate mechanism by which to do so.

The industry has received little sympathy from the courts on the issue. The U.S. Tax Court, in one decision, faulted and even penalized a medical marijuana dispensary for doing business in cash, though the industry has very little ability to conduct business in any other fashion.

Recent efforts by the marijuana industry to engage in self-help to correct these deficits have been met with resistance by the federal government. This summer, the Federal Reserve refused to accredit a credit union in Colorado established to service the state’s rapidly growing legalized marijuana industry, in part in response to such accounting issues. 

Two sets of bills are pending in the Congress to address these issues. One, the Business Tax Equity Act, would remove the tax code’s restrictions in regard to entities operating legally under their state’s laws. The other set of bills, the Marijuana Businesses Access to Banking Act, would remove certain barriers to entry to the banking system for marijuana businesses. 

Regrettably for the marijuana industry, the Banking Act would not relieve banks of many fundamental administrative barriers, such as substantial reporting requirements, that make engaging in business with the marijuana industry costly. Nor does the Banking Act immunize banks or their employees from prosecution. Lack of access to banking is therefore likely to have a continuing, negative effect on a taxpayer’s ability to substantiate its cost of goods sold, even if reform efforts prove successful.  

Michael S. Lewis, an attorney at Rath, Young and Pignatelli, specializes in complex commercial litigation and tax controversy matters. 

Categories: Law