## Facts

- Martin Olive operated the Vapor Room Herbal Center in San Francisco as a sole proprietorship selling medical marijuana under California law.
- The Vapor Room sold marijuana products and allowed on-site consumption; it also offered amenities and activities (e.g., couches, games, yoga, massage, snacks) at no charge.
- For 2004 and 2005, Olive reported business income and claimed significant Schedule C deductions (e.g., rent, wages, operating expenses).
- The IRS determined Olive underreported gross receipts and, invoking I.R.C. § 280E, disallowed deductions other than cost of goods sold (COGS).
- In Tax Court, the Commissioner increased asserted deficiencies and penalties by alleging additional unreported receipts; the court found Olive’s records inadequate to substantiate income and expenses.

## Issues

1. Whether Olive underreported gross receipts for 2004 and 2005 as determined by the IRS.
2. Whether Olive was entitled to additional COGS beyond amounts allowed by the IRS.
3. Whether I.R.C. § 280E barred deductions for ordinary and necessary business expenses where the business involved marijuana sales.
4. Whether the Vapor Room operated as a single trade or business (marijuana trafficking) or multiple trades or businesses (including separate caregiving/services).
5. Whether Olive was liable for accuracy-related penalties under I.R.C. § 6662.
6. Whether a federal appropriations rider limiting certain DOJ spending related to state medical marijuana laws affected the government’s ability to enforce § 280E in this tax dispute.

## Decision

- The Tax Court held Olive underreported gross receipts as alleged in the Commissioner’s amended pleading.
- The Tax Court allowed Olive additional COGS to the extent supported by the evidence.
- The Tax Court held the Vapor Room was a single trade or business consisting of trafficking in a federally controlled substance; § 280E therefore disallowed deductions for rent, wages, and other operating expenses (other than COGS).
- The Tax Court sustained accuracy-related penalties under § 6662 to the extent applicable.
- The Ninth Circuit affirmed, holding § 280E barred deductions for ordinary and necessary expenses because Olive’s trade or business consisted of trafficking marijuana prohibited by federal law.
- The Ninth Circuit rejected the argument that the appropriations rider prevented enforcement of the tax liabilities or limited the government’s defense of the case.

## Legal Principles

- Under I.R.C. § 280E, no deduction or credit is allowed for amounts paid or incurred in carrying on a trade or business that consists of trafficking in a controlled substance prohibited by federal law.
- Marijuana is a federally controlled substance for § 280E purposes regardless of state medical marijuana legality.
- COGS may be taken as an adjustment to gross receipts even when § 280E disallows deductions for other business expenses.
- Whether a taxpayer has multiple trades or businesses turns on the economic reality of the operations, including whether purported non-trafficking activities generate income and are separable from marijuana sales.
- Free amenities or services offered to facilitate marijuana sales, without a separate fee or revenue stream, do not create a separate trade or business outside § 280E.
- Inadequate records can support IRS income reconstruction and contribute to findings of underreported income and liability for accuracy-related penalties.
- An appropriations restriction on certain enforcement spending does not impliedly repeal § 280E and does not bar tax deficiency litigation concerning assessed liabilities.

## Conclusion

The Ninth Circuit affirmed that § 280E disallows ordinary and necessary expense deductions for a dispensary whose only income-producing activity is marijuana sales, treating ancillary free services as part of a single trafficking business; Olive could claim only COGS and remained liable for deficiencies and accuracy-related penalties.


Olive v. Comm’r, 792 F.3d 1146 (9th Cir. 2015)