Pubdate: Mon, 27 Aug 2012
Source: Albuquerque Journal (NM)
Copyright: 2012 Albuquerque Journal
Author: James R. Hamill
Note: James R. Hamill is the director of Tax Practice at Reynolds, 
Hix & Co. in Albuquerque.


Former New Mexico Gov. Gary Johnson stands alone as the candidate for 
president who favors reforms of drug laws to include legalization and 
regulation of marijuana use. I don't know the feelings of the other 
candidates, but I can say that none is willing to go on record as 
favoring legalization of marijuana.

Huh, you say, this is a tax column, is it not? Well it turns out that 
the federal policy on marijuana is having quite a detrimental effect 
on the business of medical marijuana. At last count, at least 17 
states and the District of Columbia permit regulated use of marijuana 
for medical purposes.

Since Jan. 1, 2007 New Mexico has permitted marijuana use for 
treatment of 16 diseases or conditions. California has permitted 
medical marijuana use since 1996.

In recent years we have heard much debate about the effect of taxes 
on business, including the ability to survive, prosper and create 
jobs. Some argue that an increase in the top tax rate to the 
Clinton-era 39.6 percent will kill jobs.

Economists debate the effect of an increase in rates from the current 
35 percent to 39.6 percent, but I suspect there would be little 
debate about the business-killing effect of rates in excess of 100 percent.

A rather obscure section of the tax law disallows any business 
deductions for a business that involves trafficking in controlled 
substances. The definition of a controlled substance is found in 
federal law, and marijuana is a "Schedule I" controlled substance.

This provision remained obscure when drug trafficking was limited to 
those who may not have even filed tax returns. But the growth in 
state laws permitting medical use of a federally controlled substance 
raises this tax issue for state-regulated businesses.

Two recent Tax Court cases, the most recent decided this month, 
illustrate the problem that the tax law creates for medical marijuana 
businesses. Both cases held that the business could offset revenues 
with costs of goods sold (COGS), because COGS was not limited by the 
antitrafficking provision.

But outside of COGS, all other legitimate business expenses of a 
medical marijuana business are not deductible. An expert testified in 
the most recent case that, on average, a medical marijuana business 
has COGS of about 75 percent of revenues.

So let's say that a regulated marijuana business has gross revenues 
of $4 million, COGS of $3 million, and business expenses, including 
salaries of owners and employees, of $800,000. Net income is $200,000.

If we assume federal and state taxes are 40 percent, a nontrafficking 
business will pay $80,000 in taxes. However, a trafficking business 
cannot deduct the business expenses, so that the 40 percent tax rate 
applies to $1 million of taxable income, creating a tax due of $400,000.

So the $400,000 tax due on a net income of $80,000 is an effective 
tax rate of 200 percent. The tax due exceeds the income from the 
business. This is an unsustainable business model.

I don't expect the Gary Johnson model to be adopted, at least in the 
near term. But I do think that a federal tax law that undermines 
legitimately enacted states laws that create a regulated industry for 
medical use of marijuana could be modified in a manner that avoids 
the hot-button issue of nationwide legalization of marijuana use.

Q: My mother is 87 and lives almost entirely off her Social Security. 
She owns property in Colorado that she wants to sell so she can 
afford to move to a retirement center. The sale will probably create 
a gain of more than $100,000. She is worried that this will cause her 
Social Security to be reduced because she earns too much.

A: That will not happen. There is an excess earnings test that 
applies to earned income before a person reaches full retirement age. 
Your mother is past that age and the income you describe is not earned income.

The only effect that the income could have on Social Security is the 
amount of Social Security that is subject to tax. The investment 
income alone should cause 85 percent of her Social Security to be 
taxed, which is likely more than would be taxed without the investment gain.
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MAP posted-by: Jay Bergstrom